Microsoft's Windows Phone lost a hardware partner this week. Source: Microsoft.
This week, Chinese hardware partner Huawei shocked investors when it announced it was discontinuing its relationship with Microsoft's (MSFT 1.57%) Windows Phone after this product cycle. In surprisingly frank language, its head of consumer business, Richard Yu, stated:
We have tried using the Windows Phone OS. But it has been difficult to persuade consumers to buy a Windows phone. It wasn't profitable for us. We were losing money for two years on those phones. So for now we've decided to put any releases of new Windows phones on hold.
Many in the U.S. aren't familiar with Huawei, but let's not discount their importance. By specializing in Africa, the Middle East, and Latin America, they've grown to be the third-largest handset maker in the world -- trailing Samsung (25.2%) and Apple (11.9%) in this year's second quarter with a 6.8% market share. And for Microsoft, what does it mean when the third-largest handset maker abandons your product?
The operating system duopoly... or should we just say monopoly?
For all intents and purposes, the smartphone operating system market is essentially a duopoly. According to IDC's smartphone operating system report, Google's Android and Apple's iOS captured 96.4% of all shipments. To be fair, Windows Phone placed third -- but with only a 2.5% market share. And that's down from last year's corresponding quarter, in which it had a 3.4% market share.
And perhaps the word "duopoly" is a stretch when discussing worldwide smartphone operating system market share -- of the 96.4% that Android and iOS had last quarter, 84.7% was Android. Not only that, Google's Android has gotten larger by growing from "only" 70% in 2012's second quarter to that near-85% total in 2014's corresponding quarter.
And it appears Huawei has gotten the memo: The company appears to carry only a couple of Windows OS phones among its rather large line (20+) of Android phones. For an original equipment manufacturer, it pays to go with the known and accepted operating system.
Huawei has competition in its own country
Huawei needs to focus to address a constant threat in its home country, courtesy of upstart Xiaomi. Although Huawei performed well in China due to 4G LTE expansion with national carriers subsidizing 4G handsets, Xiaomi has a cult-like following in the Middle Kingdom. As a matter of fact, because of its tremendous growth in China, Xiaomi is now the fifth-largest cell phone maker -- two spots below Huawei, according to Strategy Analytics.
It should be noted that Xiaomi uses a forked version of Google's Android -- its MIUI operating system -- that looks similar to Apple's user interface.
Microsoft's problem
On the surface, this is a black eye for Microsoft, and the company should watch for contagion. However, it's more than that -- Microsoft needs to determine what type of strategy it wants to approach with its smartphone line.
After buying Nokia's hardware business, many thought Microsoft was going to pursue a closed-platform approach to compete at the high end with Apple. And in a way, that made sense; Nokia was the dominant Windows Phone device maker, and Microsoft paid $7 billion to buy the business. However, it also appears to continue its open-platform approach as well with no OEM fees for its Windows Phone OS.
This "hybrid-platform" approach presents upside -- by having multiple handset producers (including yourself) you are able to release a variety of phones with differing specs, form factors, and features. As an investor, you hope that one or two of those phones becomes immensely popular -- like the Google Android/Samsung Galaxy partnership.
However, it presents risks as well. Original equipment manufacturers don't want to compete with their software partners -- that's especially true when your market share is so low. To smartphone OEMs, the choice is rather simple: Do you want to design a unit for Google's 85% market share or for Microsoft's 2.5%?
And that's where Microsoft finds itself, fighting an external battle to grow operating system market share and potential internal battles between its own hardware unit and its various OEMs. To be fair, HTC recently announced a new Windows Phone -- the HTC One (M8) -- but that's merely a repackaged Android phone. Perhaps its fate will be better than Huawei's.
Final thoughts
Google abandoned its hybrid-platform approach when it sold its Motorola Mobility unit to Lenovo, keeping only a patent portfolio. In the end, the company wasn't able to make the division profitable even with owning the lion's share of the worldwide operating system market.
Microsoft appears to be attempting to mimic this failed strategy with a minuscule 2.5% of the OS market. Investors should hope for a different outcome.
