The right deal for Nokia, but the wrong deal for Microsoft? What the $7.1bn deal really means

Ronald Klingebiel, assistant professor of strategy at Warwick Business School, discusses today's announcement that Microsoft has purchased Nokia for $7.1bn.

Microsoft’s takeover of Nokia’s mobile phone division is a surprise that wasn’t. For two years now, my class on strategic management has discussed the 2011 decision of Nokia and Microsoft to partner on smartphones. Students often questioned the feasibility of Microsoft’s strategy to partner with Nokia while not treating any other vendor less favourably. Today’s announcement goes to show that they were onto something: Nokia’s dominance of the Windows Phone market suggests that other vendors lost interest (e.g. Samsung, HTC). Students also queried Nokia’s rationale for dropping one unsuccessful Linux system for another unsuccessful proprietary system, while closing the door on other options such as Android. In a winner-takes-all market with substantial network effects around app-store ecosystems, Windows Phone, a distant challenger to more established players, proved hardly the boost to the hardware business that Nokia was hoping for. Some students connected the dots and asked whether Microsoft was really preparing to take over Nokia. This is where we are today.

It seemed inevitable but it should not have. Limited-commitment moves such as the initially intended strategic partnership between Nokia and Microsoft are usually to test the waters, and intensify only if found satisfactory. To most bystanders, however, the performance of Windows Phone on Lumia handsets did not appear overwhelming. That’s why the takeover now smacks of escalation of commitment, i.e. the persistence and intensification of a (failing?) course of action, rather than of shrewd strategising.

The handset market is commoditising. There is little that differentiates one black, rectangular touchscreen phone from another black, rectangular touchscreen phone. Value is captured through apps; they are the main reason why consumers choose one phone model over another. The control over application ecosystems is what drives Apple profits up and Nokia profits down. Network effects mean that fewer people want to have access to Microsoft’s app store, because fewer apps by fewer developers are available on it, which in turn is because fewer consumers attract fewer developers.

Cross-platform applications such as those on hmtl5 stand to prise apart the tight lock between handsets, operating systems, app stores, and apps. Standardised protocols such as html5 supposedly work on any device, irrespective of the operating system running on it. Currently, html5 apps still need a bit of customisation, but one day in the not so distant future, developers will create one piece of software, and it will work on any phone and system – especially if it is running in the cloud, and the tile on your phone just a link. That day, consumers can buy any one of the black, rectangular touchscreen phones on offer, use any operating system, and still access any app they want.

It will then become tricky to convince someone to pay four times more for an Apple device than a Lenovo device, if the Lenovo one can do the same job. Beyond price, handset vendors might compete on screen quality and perhaps battery life, but little else. Even computing power will matter no longer, as apps and indeed, operating systems, can run in the cloud.

So where does this leave our protagonists? Nokia is right to divest its phone business, because, put crudely, Apple or Android apps currently do not work on Lumias. In the future, they will, but then there will be less room for handset differentiation and ultimately, profits. So getting out of the business seems savvy.

As for Microsoft, full control of Nokia will not provide many more benefits than the preceding partnership. Attractive Nokia handsets are presumably meant to entice users to switch to the Windows Phone ecosystem. For the above reasons, this has had limited success to date. What could tilt the game a bit is a harmonisation of Microsoft's operating systems across stationary and mobile devices. Some consumer might find it convenient to get everything from the familiar Microsoft software suite on all their devices. Windows 8, designed with touchscreens in mind, was a first move in this direction and should be pursued further. Microsoft would be well advised, however, to make its software available to all brands of phones and devices, not just Nokia’s.

So if not for the handsets themselves, maybe for the patents? Google acquired Motorola in part to beef up its patent portfolio. This has bolstered its defences in the proxy fights between Apple and handset manufacturers using Android. Microsoft may wish to use Nokia’s patents similarly to defend Windows Phone. Unfortunately, Nokia seems to merely licence many of its patents to Microsoft, rather than handing over ownership. Infringements would thus be fought by Nokia, not Microsoft. Therefore, Nokia’s patent portfolio is unlikely to the same for Microsoft as it did for Google.

If you will, there is a silver lining to a deal that seems questionable: it is cheap. 30,000 employees and a sophisticated mobile device operation are changing hands for half the price that Microsoft paid for fledgling software company Skype. In a way, it is less of a gamble than the 2011 decision to form the original Nokia-Microsoft partnership.

Ronald Klingebiel is Assistant Professor of Strategy at Warwick Business School, UK. He advises and researches companies in the telecommunications industry, with particular expertise in the management of innovation under uncertainty.

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