When you think of smartphones, Apple (NASDAQ:AAPL) and Samsung are the first two names that come to mind, but Microsoft (NASDAQ:MSFT) has made another attempt to become a major player in the smartphone market by acquiring Nokia's (NYSE:NOK) handset business and patents for $7.2 billion. Microsoft investors' initial reaction to this acquisition has been negative, causing the company's market value to drop over $15 billion. But, with the rising importance of mobile products, Microsoft's acquisition might not be as bad as its investors' initial reaction.
Over the past two years, Nokia's hardware supported the Windows mobile platform, a match that has been disappointing for both companies. Nokia is drowning in the Apple and Samsung ocean, with a current smartphone market share of only 3%. The company recently had a quarterly revenue decline of 24.50% year-over-year, which led to a net loss of $1.64 billion. The company's mobile phone volume experienced a 4% decrease in the last quarter, which led to a 12% decrease in net sales for the division. Nokia's phone business is clearly in need of rescuing.
Nokia is Microsoft's main partner in the mobile battle, and with its new purchase the company will be able to control both software and hardware aspects of its phone business. According to Microsoft CEO, Steve Ballmer, the acquisition is about accelerating Microsoft's share position, improving the company's agility in innovation, and creating a clear position for one brand. The acquisition will act as a springboard for Microsoft, as the company now controls every aspect of its phones for the first time.
According to a study done by professors Gerard Tellis and Abhishek Borah, when companies attempt to buy innovation, they tend to experience negative returns. This is in contrast to companies that innovate internally or ally with another company to innovate, which tends to result in positive returns. Microsoft has experienced the negative effects of acquiring innovation when it bought Skype for $8.5 billion in 2011. Skype was an easy-to-use, "freemium" program that allowed users to call each other. Microsoft changed that by adding in-call ads, much to the dismay of users. The once-unique program now faces competition, like Google Hangouts, while Microsoft continues to integrate it into other products. Microsoft is not finished with Skype, but the performance so far has been less than stellar. While this is certainly not a prediction of failure, it adds another layer of doubt for the company's mobile branch.
In addition to receiving Nokia's handset business, Microsoft is getting Stephen Elop. Elop ran Microsoft's business division before becoming CEO of Nokia three painful years ago. He is returning to Microsoft as a potential replacement for Ballmer, who has announced that he will be stepping down within a year.
At Nokia, Elop tried to keep the sinking ship afloat by making several cuts. He cut tens of thousands of jobs, downsized the research and development department, and closed Nokia's last remaining handset factory in Finland. None of these efforts brought the company back to prosperity, but instead helped give Elop the nickname E-flop.
Under Elop's direction, Nokia exclusively used Microsoft's mobile platform for its handsets before being acquired. Because of this, and his previous history with the company, Elop is already favored by Microsoft. Elop has not been named as Ballmer's replacement, but he has moved from being an external candidate to an internal one.
At the top
While Microsoft tries to figure out a way to improve its mobile business, Apple and Samsung continue to battle for the top spot.
Samsung recently unveiled its Galaxy Gear Smartwatch. The watch, released on September 5, will work with smartphones that run Android operating systems, and will officially make you feel like James Bond. The innovation is expected to sell modestly in the beginning, with an estimated 1.2 million units to be shipped in 2013 and seven million in 2014.
Apple continues to improve its smartphone and recently announced new iPhone products. These include the iPhone 5S and the iPhone 5C. The 5S is made of high-grade aluminum and is the first 64-bit smartphone. The cheaper 5C is made of plastic and is targeted toward emerging markets like India and China. While these upgrades aren't completely new products like Samsung's Smartwatch, they show that Apple is continuing to improve its current phones.
The fierce competition between Apple and Samsung means that neither company will become complacent. This will make it even more challenging for Microsoft to retake market share.
Despite the negative reaction to Microsoft's recent acquisition, the company needed to make a move to improve its mobile market standing. While I'm not convinced that taking its struggling relationship with Nokia to the next level was the right decision, it's a move nonetheless. By acquiring Nokia, Microsoft has made a commitment to advancing in the mobile industry. If Microsoft can use its new mobile business to spark innovation and develop creative products that consumers want, then the acquisition will be a success. For now, stay away from Microsoft and Nokia, but keep an eye on what the company does with its new handset manufacturing capabilities.
Ben Popkin has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.