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Does Microsoft’s Nokia Purchase Now Look Silly?

By Ashraf Eassa – Feb 2, 2014 at 12:00PM

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With Google throwing in the towel on Motorola Mobility, will Microsoft realize that buying Nokia's handset business was a mistake?

It was incredibly interesting to see Google (GOOGL -0.55%) throw in the towel on Motorola Mobility and sell it to mobile up-and-comer Lenovo. For all of the hoopla that industry observers and investors alike made of Apple's (AAPL -0.34%) highly-profitable, vertically-integrated model of using hardware to sell a software ecosystem, it is starting to look like the horizontal model may be the better move for the vast majority of companies.

Microsoft's Windows Phone dilemma
Google's Android is free -- save for the royalties that the various Android vendors have to pay -- and highly customizable. While Google doesn't actually profit from the sale of any mobile devices with its software on it, it does hook users into its broad and deep ecosystem in a bid to capture that sweet ad revenue. Microsoft, on the other hand, is used to selling licenses of its Windows operating system for a pretty handsome up-front fee.

Unfortunately, while Google's Android is free and highly customizable  -- meaning more differentiation is possible for the hardware OEMs -- Microsoft's Windows Phone is neither customizable to any large extent, nor is it free. Given that Microsoft also owns many services in the vein of Google, it really looks like Microsoft is trying to double dip, once for the OS license and then for the service/ad revenue following that.

"Oh, I know," said Microsoft, "let's compete with Samsung!"
Instead of mimicking Google and, at the very least, forgoing profits on the Windows Phone license and just viewing it as an ecosystem-builder and gateway to search/ad revenue, Microsoft goes out and buys a failing smartphone vendor!

By no means was Nokia particularly successful with its Windows Phone efforts, which were probably largely driven by Microsoft. But Microsoft believes that under its wing, the former Nokia handset division can take 15% of the entire smartphone market.

That's a wonderful goal, but does Microsoft realize the following?

  • Microsoft will now be competing with companies that live and breathe low-margin, high-volume products like Samsung (NASDAQOTH: SSNLF), as well as technology's fashion diva, Apple (AAPL -0.34%)?
  • Does Microsoft also realize that Apple has been successful principally because it has owned the high end, and that Samsung has been successful because it has the cost structure -- Samsung builds almost everything in-house -- to be the lowest-cost producer in a commodity market?

It's great that Microsoft has its own OS -- of course, with Android as a springboard, other handset vendors can essentially roll their own de facto OS, too. But unless it can succeed in the same way that Apple has, and this is very unlikely, this venture is doomed to be a money loser for many years to come. Don't forget, Nokia's handset business was a money loser as a stand-alone unit.

Google just gave up
Google, which owned the arguably more successful Motorola Mobility, threw in the towel. Note that Google owns its own OS that the world already loves. The problem here is that the Nokia purchase seemed to be designed to ape the trend of vertical integration that we were seeing in the industry.

However, as these software-only companies have been finding out, hardware is tough business and not as easy as some may think from both a "getting the product right" standpoint and an "actually generating real profits" standpoint.

Google realized that it was better to be the ecosystem steward, and it is likely that after a year or so of dealing with Nokia, Microsoft may come to the same conclusion. However, it will take a bold leader, one unafraid of upsetting Wall Street in the short term, to realize that Microsoft needs to follow its own path rather than try to copy others. Microsoft's billions in free cash flow don't come from selling cell phones, and in the future, they won't need to, either. There are other, arguably more lucrative, markets that play to Microsoft's core competencies.

Foolish takeaway
Did Microsoft make the right choice in buying Nokia's handset business? Frankly, probably not. It seemed like a reaction to Google buying Motorola Mobility, Apple raking in untold billions, and Wall Street having unrealistic expectations for what the growth profile of a mature, highly profitable company like Microsoft should look like.

It'll be interesting to see how this all shakes out. 

Ashraf Eassa owns shares of Microsoft. The Motley Fool recommends Apple and Google. The Motley Fool owns shares of Apple and Google. 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.

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