Last week Microsoft (NASDAQ: MSFT ) shook up the smartphone world when it unveiled the HTC One (M8) with the handset's namesake manufacturer. In addition, the company said 17 third-party Windows Phones are in production or will be announced shortly. And while Microsoft should be commended for moving forward with its smartphones, investors should not confuse movement with progress. As is, Microsoft's Windows Phone strategy makes no sense.
Remember buying Nokia's phone business
In a push to become a "devices and services" company and diversify away from its current revenue generators -- the Windows operating system and Microsoft Office -- Microsoft paid $7.2 billion for Nokia's device business. Analysts were encouraged by the purchase because it signified Microsoft was serious about operating system and hardware integration -- something that hasn't been done well outside of Apple.
However, other moves have proved contradictory to this integration thesis. First, after announcing its Nokia bid, Microsoft decided it would no longer charge a fee to hardware makers to put Windows on devices smaller than 9 inches. While the fee before the cut was only $15 per unit, this was a large step for a company that makes the majority of its revenue from licensing fees. In addition, the aforementioned 17 third-party phones seem at odds with a company looking to monetize its own hardware.
Does Microsoft want a "walled-garden" approach like Apple?
If Microsoft wants a walled-garden approach (aka a closed platform) to compete with Apple at the high end -- a tall order -- the company should focus its efforts on the Nokia deal and ignore third-party original equipment manufacturers. In the end, quality and hardware/software integration are hard to replicate when working with numerous OEMs.
Apple has been the only smartphone company to do well with the walled-garden approach. With phones designed from the bottom up with a focus on functionality and user experience, the smartphone market has been good to Apple and its iPhone line. Over the last four quarters, Apple has sold nearly $100 billion worth of iPhones -- good for over 50% of its revenue haul.
Or does Microsoft want to continue its current licensing strategy?
On the other end of the spectrum is something akin to Microsoft's current business model. If one looks to its existing strategy in computers, the goal is to present a cohesive operating system and let OEMs design and manufacture the hardware.
This strategy has been rather successful for Microsoft and made Windows the dominant operating system in computers. However, one reason for this dominance was due to first-mover advantage and continued network effects.
Obviously, the first-mover advantage can't be replicated, but when it comes to network effects, the operating system that most benefits is Google's Android -- an OS that OEMs and developers flock to due to its nearly 80% global market share.
Microsoft's announcement of the new HTC phone was inauspicious, considering the HTC One for Microsoft is merely a repurposed version of HTCs Android phone. Does Microsoft really want to compete with Google's operating system at this juncture?
In addition, this hybrid strategy presents a wrinkle in the OEM partnership. Recently, Hewlett-Packard CEO Meg Whitman drew attention when she blamed her company's lack of a turnaround in part on Microsoft::
HP's traditional highly profitable markets face significant disruption. Wintel devices are being challenged by ARM-based devices. ... We are seeing profound changes in the competitive landscape. ... Current partners like Intel and Microsoft are turning from partners to outright competitors. [Emphasis added.]
Whitman appeared to be discussing tablets --particularly Microsoft's Surface product -- and Microsoft's poor Windows 8 rollout, but the delicate relationship between OEMs and operating systems is in the very least similar. If OEMs perceive Microsoft's Nokia line of phones as a threat to their success, they could abandon the relationship.
Microsoft finds itself in the midst of a turnaround. Shares of the newly invigorated company are up nearly 40% over the last year on the back of a new CEO and a continued push into the cloud. However, Microsoft needs to solve its mobile phone strategy. As is, its illogical strategy paints a picture of a company at odds with itself.
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