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Microsoft Corporation Trims Some Fat

By Evan Niu, CFA - Jul 17, 2014 at 12:20PM

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Microsoft announces its biggest round of layoffs in its history. Most of those will come from the Nokia business that it just acquired, and investors are obviously happy.

The rumors were true! Following reports that Microsoft ( MSFT -2.87% ) was preparing to cut thousands of jobs, the software giant has announced plans to do exactly that. In fact, the magnitude of the layoffs is surprisingly large: Microsoft is cutting 18,000 jobs over the next year. That translates into a total headcount reduction of 14% and will be Microsoft's largest in its history.

Investors are clearly pleasantly surprised, as shares opened 3% higher this morning. That's on top of the nearly 4% gain Microsoft enjoyed yesterday.

Most of the layoffs, approximately 12,500 unlucky workers, will be Nokia ( NOK -2.00% ) employees that Microsoft inherited through its acquisition of Nokia's devices business. At the same time, it's not as if Nokia employees had a lot of job security to begin with; Nokia had been laying off thousands of workers for years as part of its own turnaround.

Microsoft will incur $1.1 billion to $1.6 billion in pre-tax charges as a result of the layoffs, most of which will come from severance and other benefit costs. The company didn't outline how much in annual operating expenses it expects to save once the cuts are complete.

Farewell, Nokia X. We hardly knew thee.
Nokia X, the product lineup built on Google Android, was already in development when Microsoft announced its intention to acquire the devices business. It launched just two months before the Nokia deal closed, and there had been much debate over whether or not Microsoft would continue along the forked Android path.

Microsoft is indeed axing the lineup, and future Nokia X product designs will be "shifted" to the Lumia family that runs Windows Phone. The company will continue to support existing devices already in the market.

While there was some inherent optionality in Nokia X, allowing Microsoft to piggyback on Android's larger app selection while feeding into Microsoft's cloud services as opposed to Google's, that optionality would have come at a cost. More than anything, Microsoft needs to streamline and integrate Nokia's devices business as quickly as possible, given its ambitious financial targets. In the words of Stephen Elop, Microsoft needs to focus its efforts.

But will it work?
Reducing operating expenses is a clear positive, but the larger question that remains is whether or not Microsoft's new vertically integrated smartphone strategy will prove successful. The company knows that it's coming from behind, and that its best shot at gaining unit share is by targeting the low end. That's where Nokia had been making the most progress, particularly within European markets. For instance, the Lumia 520 that retails unsubsidized for just over $100 comprised nearly a third of the global Windows Phone installed base in June.

The challenge is that low-end devices don't offer much in the way of margins, and competition is so intense that even Samsung is feeling the heat in that market segment. Microsoft is also mostly on its own at this point, since Nokia is 94% of the global Windows Phone installed base right now. The company is trying to incentivize third-party OEMs in various ways, but those OEMs have not had luck with Windows Phone in the past.

Still, CEO Satya Nadella is taking the opportunity to make other strategic cuts. He will also detail where Microsoft is investing in innovation when the company reports earnings next Tuesday. Overall, these cuts had to be made. Now let's see if they pay off.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Microsoft Corporation Stock Quote
Microsoft Corporation
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Nokia Corporation Stock Quote
Nokia Corporation
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Alphabet Inc.
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Apple Inc.
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