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Could Microsoft Be Taking a Hit?

By Renjit Ebroo - Feb 21, 2014 at 4:00AM

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Microsoft is set to buy Nokia's mobile phone division. With Google set to sell the Motorola handset business, Microsoft’s deal with Nokia raises questions.

News about Microsoft's (MSFT -0.26%) new CEO came alongside the announcement that Google (GOOGL -1.77%) is selling its Motorola handset division. Google unsuccessfully attempted to restructure the Motorola mobile handset unit, and after only two years, the owner of the world's most popular smartphone operating system seems to have given up.Suddenly, Microsoft's deal with Nokia (NOK -2.13%) raises doubts about the possible long-term success of the acquisition.

Windows Phone isn't growing fast enough
For Microsoft, things don't seem to have improved, considering the latest figures about phone shipments. For 2013, in the smartphone OS category, Google's Android commanded a healthy 78.4%, while Apple's (AAPL 0.88%) iOS took second place with 15.6%. The Windows Phone OS has grown, but commands only 3.2% of the market. However, in the smartphone hardware market, the market share leaders are Samsung, Apple, and Huawei. Lenovo, with the fourth-largest market share, is buying the Motorola unit from Google, and Nokia's share is even further behind.

In mobile phones, profits lie in hardware. This may explain why Google generates less revenue than Samsung from Android's market share. Samsung makes the hardware and licenses the OS from Google. Apple, on the other hand, makes both the hardware and the OS, resulting in more revenue per device sold.

Most Windows smartphones are currently manufactured and sold by Nokia. Market share for the Windows Phone OS may not be growing at rates fast enough to attract other OEMs. Consequently, Nokia may release an Android phone later this year.

The numbers look worth it now, but...
Like Google's deal in 2011, Microsoft's purchase of Nokia's handset business includes a huge number of patents. Microsoft is already believed to make significant revenue from the Android platform via patents. More Android phones will mean more revenue. Additional patents could strengthen Microsoft's position. As part of the purchase, the company has an agreement with Nokia for over 30 thousand patents and patent applications. 

Going forward, Microsoft is likely to release more Windows Phone handsets. It could also develop phones based on its own version of Android, similar to what Amazon (AMZN -1.85%) has done. Amazon's Kindle devices run the Fire OS, which is the company's own branded version of Android. But, primarily focus of the Kindle has been to sell digital content like books and movies, and draw more customers to Amazon's retail business.

Whether it's more Windows Phones or new devices with a branded version of Android, Microsoft needs to get the right hardware at several price points and attract app developers to the platform. Samsung, the largest manufacturer of Android phones, has a marketing budget that provides an idea of what it may take to sell phones for every segment. Considering the aggregate costs of hardware development, the OS, marketing, and apps, more phones from Microsoft without valuable and distinguishing features don't appear to be a very good idea.

A widening consumer gap
Microsoft's previous CEO described the company as a "devices and services" company. Historically, it has never remained static or dependent on only one major source of income. After its Disk Operating System came Windows, followed by Microsoft Office, as well as enterprise software, development tools, and consumer software like Encarta, in addition to hardware like the Xbox. Today, the company has several revenue streams in excess of $1 billion.

Windows and Office have been Microsoft's most successful consumer products. Arguably, this was due to Microsoft's position of advantage. The company's services business is growing at healthy rates. However considering the results from the release of Windows 8, Windows Phone, and Xbox One, the company clearly faces a huge challenge in consumer-oriented products.

What comes next?
Alternatively, Microsoft could enter entirely new markets with the added capabilities acquired through the deal with Nokia. Over the years, Microsoft has showcased interesting concepts (i.e., introducing tablet computers long before Apple released the iPad), but failed to capitalize on those innovations. A sense of market timing and deeper insights about the consumer is critical for Microsoft's devices business to grow faster.

Foolish bottom line
New growth potential could be created if Microsoft takes on entirely new markets before competitors. Consumers need products that Steve Jobs would call "insanely great."

Renjit Ebroo has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, Apple, and Google. The Motley Fool owns shares of Amazon.com, Apple, Google, 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.

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Stocks Mentioned

Apple Inc. Stock Quote
Apple Inc.
AAPL
$174.55 (0.88%) $1.52
Nokia Corporation Stock Quote
Nokia Corporation
NOK
$5.06 (-2.13%) $0.11
Microsoft Corporation Stock Quote
Microsoft Corporation
MSFT
$291.32 (-0.26%) $0.77
Alphabet Inc. Stock Quote
Alphabet Inc.
GOOGL
$119.55 (-1.77%) $-2.15
Amazon.com, Inc. Stock Quote
Amazon.com, Inc.
AMZN
$142.10 (-1.85%) $-2.68

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