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Is It Time for Microsoft to Exit the Smartphone Business?

By Daniel B. Kline – Feb 2, 2016 at 9:15AM

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The company has succeeded with its Surface hybrid but has struggled to establish its Lumia phone line.

Microsoft (MSFT 1.97%) had a solid idea when it tried to become the first company offering a single operating system across computers, tablets, and phones.

The strategy was sound, as it made sense that people -- business users specifically -- would want to move seamlessly between devices without any changes to how they work. It seemed logical, and it may have been before the general public became accustomed to using a Windows PC at work paired with either Apple (AAPL -1.26%) or Android phones and tablets.

Essentially, by making Windows 10 work across desktops, laptops, tablets, and phones, Microsoft offered a solution that people may have embraced in 2010, when tablets first took off, or maybe even earlier, when using a PC paired with an iPhone was still a bit awkward. Now, however, it's normal and not difficult to use one platform (probably Windows, but maybe iOS on a Mac) at the office and another (iOS or Android) on phones and tablets.

One operating platform for all devices was a good idea that was no longer needed by the time Microsoft introduced it. That, unfortunately for the company, could, and probably should, be the death knell for the Lumia smartphone line. The one Windows strategy was essentially the company's final bullet -- a last, somewhat desperate Hail Mary to become a player in smartphones.

But as we saw in the company's Q2, 2016 earnings release, Microsoft's final effort wasn't merely stopped short of the end zone -- it was intercepted and run back for a touchdown. Microsoft has found a market for its Surface hybrids, and maybe Windows tablets still have a place in the market, but as a smartphone maker, the company has failed.

How bad was it?
After a 45% decline in revenue in fiscal Q1 2016 versus the same period in 2015, the Lumia Phone line was down nearly 50% year over year in fiscal Q2. That's especially bad news when you consider that the period included the holiday season. Microsoft sold 4.5 million Lumia smartphones worldwide in the holiday quarter, down from 10.5 million a year earlier, according to GeekWire, while Apple sold nearly 75 million iPhones during the same period.

The Lumia 950 XL. Source: Microsoft.

Microsoft said in its earnings release and during a conference call with analysts that the decline reflects a change in strategy announced last July. That change was to focus on a smaller number of flagship Lumia devices rather than its previous broader line of handsets.

That strategy made sense, as Apple has certainly done well with a very limited lineup, but it's hard to imagine that Microsoft's goal was to see sales cut in half. Making fewer phone models was logical from a manufacturing and marketing point of view, but the result of actually doing it was disastrous.

It's not all a loss
It's very clear that consumers -- even the enterprise customers who have been loyal to Windows -- will not embrace the Lumia Windows Phones, or Windows Phone in general, in significant numbers. A few years ago, that would have been a major blow to the company, a complete shutout from the phone market.

Now that is no longer the case. Yes, if Microsoft exits the smartphone business it will be a blow for Windows, but that blow is softened by the use of the company's software products on iOS and Android devices. CEO Satya Nadella broke with previous Microsoft strategy and stopped making using a Windows a prerequisite for using the company's software.

That means Microsoft can leave smartphones to Apple and the many Android handset makers while partnering deeply on the software side. That may not be a total victory, but it's not a complete defeat, either.

Windows Phone simply has not worked. The company has delivered good hardware, a good OS, and excellent interoperability between phones, PCs, and tablets. That hasn't been enough to win over consumers, and it's time for Microsoft to admit it has lost this battle so it can refocus on the broader war.

Daniel Kline owns shares of Apple and Microsoft. He wishes WIndows Phone were popular because he enjoyed when he used an older version of it. The Motley Fool owns shares of and recommends Apple. 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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