A deeper look at Nokia’s decision to partner with Microsoft

Within a year, Google overtook Nokia to become the leader in the smartphone market. A 132,430 employee company was brought to its knees by a relatively smaller sized Google (24,400 employees). Size is really less of a factor here but rather  an environment that promotes innovation and entrepreneurship and a culture that may care less about competition but has its pulse on the market.

On January 27th while announcing Nokia’s Q42010 earnings Stephen Elop discussed the following

Lack of pulse on the market: “The game has changed from a battle of devices to a war of ecosystems and competitive ecosystems are gaining momentum and share. The emergence of ecosystems represents the broad convergence of the mobility, computing and services industries. Today, the winning ecosystems at the high-end to mid range deliver great hardware, compelling user interfaces and the coherent aggregation of search, advertising, ecommerce, social networking, location-based services, entertainment and unified communications, just to name a few. At the same time, we see a different type of ecosystem building around mid-range to low end devices and developing markets involving very low cost components and manufacturing processes. In this range, brand, scale, price, design, distribution and speed are critical.  It is on this basis of ecosystems that Nokia must now compete.”

Lack of innovation: “In addition to changes in the competitive landscape, there are challenges that are specific to Nokia. For example, our experiences are not competitive in all markets. As a result, we witnessed a pattern of disappointment in those markets. Asia-based suppliers have made it possible for new handset vendors with limited R&D capabilities to enter this part of the market. In addition, in Q4, we were challenged by component constraints and the lack of competitive dual SIM products in our portfolio.”

This is a rapidly evolving market and standing still is not an option.  To fix its eroding market share, Nokia announced a plan to make Microsoft Windows Phone 7 its high end smartphone operating system, reducing MeeGo to a research platform while still keeping Symbian for mid range and low range products. Android seems to be the most obvious choice that Nokia should have made. However, this choice wouldn’t have provided Nokia a sustainable competitive advantage.  Huawei shipped over 3 million smartphones in 2010, and it plans to ship more than 10 million in 2011, mainly based on Android software. Its Ideos phone sells for about $100, unsubsidized!!! If Nokia has component issues as Elop pointed out, a price war will not cut it for Nokia. But why would Nokia partner with a company that saw a 20% decline in market share and has only 9000 apps in its marketplace? Could Nokia have gone with any of the other platforms such as RIM, Palm Web OS?

Elop used to work for Microsoft from January 2008 to September 2010 as the head of the Business Division, responsible for the Microsoft Office line of products, and as a member of the company’s senior leadership team. He was also the 8th largest Microsoft individual shareholder at the time this partnership was announced. I cant blame him for having faith in Micorosoft’s ability to deliver. Additionally Microsoft sweetened the deal by paying Nokia $1 billion to promote and develop Windows-based phones.

But a billion dollars will go only so far for a company that makes $17.5B revenue / $1.225B operating profit in a quarter. And Nokia will pay Microsoft a royalty for each phone sold which may be offset by a cut in R&D spend. The deal is non exclusive, so microsoft has nothing to lose. Nokia on the other hand has made a gamble.  Many have written off this partnership. However I am excited to see how this gamble plays out