Microsoft's (MSFT +4.64%) decision to purchase Nokia's (NOK 3.33%) handset business will prove to be yet another costly blunder.
By acquiring Nokia's hardware assets, Microsoft has put itself in total control of the Windows Phone ecosystem. Unfortunately, that isn't exactly a great position to be in. Although the popularity of Windows Phone has increased in recent months, the operating system continues to lag far behind iOS and Android, and there's no reason to believe that it will ever catch up.
The Android and iOS duopoly
In terms of smartphone operating systems, there are only two that matter: Apple's (AAPL +2.91%) iOS and Google's (GOOG +1.28%) Android. Together, the two accounted for 92.5% of the smartphones sold worldwide last quarter.
Google's Android took the lion's share, with almost 80% of the market. As Google maintains Android as an open-source operating system, it has dominated in developing markets, such as China and India , where customers are budget-constrained.
Apple, meanwhile, has seen its share of the smartphone market drop dramatically in recent years, down to just 13.2% last quarter, a decline of 20% from the prior year. But iOS still controls a large chunk of the market in many developed economies, including the U.S.. Moreover, it continues to be the preferred platform for mobile app developers.
Most apps start on iOS, and then (assuming they're popular), eventually make their way to Android. Examples of this abound -- Mailbox, Tinder, Instagram, to name a few. But support for other platforms is low. Windows Phone isn't as bad as BB10, but still lacks numerous, high-profile apps such as Flipboard, Google Maps, and HBO Go, not to mention lesser-known niche apps that users of particular mobile operating systems may have grown accustomed to.
No niche for Windows Phone to fill
Fundamentally, there just isn't a market niche for the Windows Phone platform to occupy. iOS offers a great mobile experience with a wide selection of apps. Android keeps most of things people love about iOS, but is available on handsets of all shapes, sizes, and price points. But Windows Phone? Outside of a better interface (debatable), Windows Phone brings nothing new to the table.
Microsoft believes that having one operating system across all devices is an advantage to users -- consider Windows 8, an operating system designed to work on both tablets and PCs -- but there's no evidence to suggest that this is the case. To date, Apple has kept its PC and mobile operating systems separate (and plans to do so for the foreseeable future), and remains one of the largest manufacturers of both tablets and smartphones. Meanwhile, Microsoft's Surface has sold poorly, and reception to Windows 8 has been tepid at best.
In its presentation on the Nokia deal, Microsoft projects that Windows Phone can capture 15% of the smartphone market by 2018. Given that it's currently at 4%, but growing rapidly, 15% in five years might appear to be a realistic goal.
But the economics just don't support it. Operating systems are a platform business that benefit from network effects. That is to say, the more people use a particular operating system, the more useful it becomes. More developers focus on it. More software is written for it. In the past, Microsoft benefited from this phenomenon -- Windows controlled the bulk of the traditional PC market, with Mac OS maintaining a minority position.
Windows Phone existing as a second, major minority player would stand in stark contrast to the history of platform-dependent businesses.
Windows Phone grows among feature-phone users
Of course, looking purely at Windows Phone's growth, one might be inclined to believe it has a shot. Recent growth has been great -- Windows Phone is up 78% on a year-over-year basis -- but it's worth considering where that growth is coming from.
Mostly, it's coming from owners of feature phones. According to Kantar, most Windows Phone buyers are first-time smartphone owners -- 42% to be exact. Intuitively, this makes sense -- if at this point, a user hasn't made the jump to a smartphone, he or she probably isn't too technically inclined, and therefore wouldn't see the value in a robust app ecosystem.
Moreover, the markets where Windows Phone is showing promise -- the U.K., Mexico, France and Germany -- aren't the most important. Windows Phone remains a distant third in the U.S., and is almost non-existent in key emerging markets.
In China, Windows Phone accounts for just 2.2% of the market. Android, meanwhile, accounts for 70% of sales, and is now installed on more than half of all existing smartphones in the country. It's largely the same story in India, where vendors like Samsung and Micromax dominate with their Android-based smartphones. IDC put Nokia's market share at just 5% in the second quarter.
Microsoft morphing into Apple-light
By buying Nokia's handset business, Microsoft is more or less becoming "Apple-light" -- adopting a strategy of building integrated devices, creating both the software and the hardware. While this strategy has worked well for Apple, there's no reason to believe that it will work out for Microsoft.
Indeed, the economics of the operating system business suggest that Microsoft's modest 15% market-share target is too much. Android and iOS already receive the bulk of developer support, and as long as that's true, Windows Phone will continue to offer an inferior experience.
Nokia shareholders should cheer the deal, but Microsoft's efforts amount to throwing good money after bad. The mobile operating systems business is a two-horse race, and that isn't going to change anytime soon.
