Nokia’s Lumia: Microsoft’s Visible Surface or Invisible Fascia?

The last few months have been momentous for Microsoft. An acknowledged leader in software with annual revenues of USD 79 billion and market capitalization of USD 235 billion, Microsoft is a formidable player in the global technology space, notwithstanding the emergence of new Internet technologies and new players, and the changing business models. There have been two momentous decisions the corporation has made over the last two months. Firstly, the corporation has decided to transform itself from a software DNA to a devices and services play. Secondly, it has made its most ambitious acquisition yet of acquiring Nokia’s mobile business including all of its design, manufacturing and sales organization, along with long term 10 year licenses to Nokia’s patents, maps and the Nokia brand itself.  The author has analyzed the Microsoft-Nokia deal from a strategic perspective, and has found it to be a win-win for all, as declared by Microsoft CEO Steve Ballmer. Interested readers may see the blog post titled “Connecting with Nokia: Microsoft’s Timely Idea?” in Strategy Musings, September 9, 2013 (http://cbrao2008.blogspot.in/2013/09/connecting-with-nokia-microsofts-timely_9.html).

The above referred blog post analyzed the acquisition from a strategic and business perspective that could be interesting for students of management and strategy. Typically, strategies and businesses are built around products and technologies. In this context, it would be appropriate to take forward the analysis of the previous blog post in terms of product and technology management in a rapidly evolving industry. Such analysis is bound to throw up valuable insights into how the new Microsoft could be stacking itself up in the devices and services space, and what could be the challenges and opportunities for the acquiring Microsoft and the acquired Nokia division. The analysis could also throw light on the options available for other troubled software and hardware behemoths and embattled handset makers. That the acquisition is taking place at a time when the barriers for entry into the handheld mobile phone industry have sharply fallen makes the analysis even more interesting and relevant.

Microsoft product divisions

Microsoft has indeed evolved from the business model of providing only operating system software to personal computers to four other areas. Microsoft’s  current five divisions are windows, servers & tools, online services, business, and entertainment & devices. These five divisions account for approximately 22, 28, 4, 35 and 10 percent of the total annual revenues, trending from the Q4, 2013 data. Of these five divisions, three are profitable (Windows at 25, Servers and Tools at 42 and Business at 68 percent of divisional revenues) while two are loss making (online services at 50 and Entertainment and Devices at 5 percent of divisional revenues), again trending from Q4 results. These, however, are not watertight product or service divisions, and except the entertainment division, the other divisions are interrelated to personal computing software. To understand Microsoft’s perspectives on these divisions, it would be best to consider extracts from Microsoft’s official website as below.

Windows Division develops and markets operating systems for computing devices, related software and online services, Surface RT and Pro devices, and PC accessories. This collection of software, hardware, and services is designed to empower individuals, companies, and organizations and to simplify everyday tasks through seamless operations across the user’s hardware and software. The general availability of Surface RT and Windows 8 started October 26, 2012. The general availability of Surface Pro started on February 9, 2013.

Server and Tools Division develops and markets technology and related services that enable information technology professionals and their systems to be more productive and efficient. Server and Tools product and service offerings include Windows Server, Microsoft SQL Server, Windows Azure, Visual Studio, System Center products, Windows Embedded device platforms, and Enterprise Services. Enterprise Services comprise Premier product support services and Microsoft Consulting Services. Microsoft also offers developer tools, training, and certification.

Microsoft Business Division (“MBD”) develops and markets software and online services designed to increase personal, team, and organization productivity. MBD offerings include the Microsoft Office system (“Office,” comprising mainly the core Office product set, Office 365, SharePoint, Exchange, and Lync), which generates over 90% of MBD revenue, and Microsoft Dynamics business solutions. The general availability of the new Office started on January 29, 2013.

Online Services Division (“OSD”) develops and markets information and content designed to help people simplify tasks and make more informed decisions online, and help advertisers connect with audiences. OSD offerings include Bing, Bing Ads, and MSN. Bing and MSN generate revenue through the sale of search and display advertising, accounting for nearly all of OSD’s revenue.

Entertainment and Devices Division (“EDD”) develops and markets products and services designed to entertain and connect people. EDD offerings include the Xbox entertainment platform (which includes the Xbox 360 gaming and entertainment console, Kinect for Xbox 360, Xbox 360 video games, Xbox LIVE, and Xbox 360 accessories), Skype, and Windows Phone, including related patent licensing revenue. Microsoft acquired Skype on October 13, 2011.

The above does indicate that Microsoft has been seeking to diversify its offerings and be in step with, though not step ahead of, times. The acquisition of Hot Mail and Skype platforms as well as development of Azure cloud and the launch of Xbox gaming consoles were some success stories. However, the best what Microsoft could marshal was not good enough for the corporation to be on top of the dramatic changes in computer and connectivity technologies and the immensely growing popularity of tablet and mobile products.

Scratching the surface

The first sign that Microsoft took the tablet revolution seriously, though belatedly, came when the company launched innovative looking Surface tablet in RT version in October 2012 and in Pro version in February 2013. Surface, on paper, had additional ports, micro SD card and USB drive. It had also a sleek magnetic cover which doubles as a QUERTY keyboard and a capacitive touch screen on which a pen could be used. In addition, unlike iPad, it could provide an ability to utilize a complete Office suite. It appeared as though Microsoft found a niche in tablet computers with Surface that could do content creation as opposed to iPad which was primarily developed for content viewing. That was because Surface as mentioned above had additional functionalities which would enable a more compatible notebook performance.

Sales of the two sleek Surface models have anything been but tepid, with Microsoft having to take a USD 900 million inventory adjustment charge in the last quarter. The reasons lie in the complexity of Surface. Market favored the simplicity of iPad while the gap between content creation and content viewing was bridged by accessories and applications for iPad.  The high price set by Microsoft for Surface reflected Porter’s classic entry deterrent price level for a new player seeking a foothold in a hotly competed tablet computer industry. What was a clear USP in terms of keyboard magnetic flap was elusive, coming as it does with additional price. The other reason for lackluster performance of Surface, probably, was a lack of emotional connectivity of consumers with Microsoft as a device maker.  Microsoft is reportedly working on a successor model of Surface but whether and how it would make a different mark remains to be seen.

Mobile phone pecking orders

Given that Surface could not even scratch the surface, in a manner of speaking, in the battle of the tablets Microsoft had to go back to the drawing board particularly in the context of the publicly declared objective of becoming a devices and services company. The indications that the inroads made by Xbox One in the gaming console business are getting finally halted or even rolled back by Sony’s PS4 in the battle of the eighth-generation gaming consoles (again due to a typically Microsoft desire to aim high-end with price premium), Microsoft really has been facing a real strategic challenge in quest of viable and dominant devices business objective. The recent acquisition of Nokia’s mobile handset business with its products and people (along with a 10 year licensing of Nokia brand, patents and maps) for USD 7.2 billion, in the context, emerges as a timely strategy to redouble the devices effort.

Nokia’s mobile handset business achieved a turnover of USD 15 billion in 2012, with a physical sales of 336 million units, of which 35 million units were smartphones, with market shares of 19.3 percent in total mobile sales and 4.9 percent in smart-phones worldwide (for Nokia, smartphones were just 10.4 percent of its total sales). Samsung has been the market leader in mobile phones with an estimated turnover of USD 20 billion in 2012, with a physical sales of 406 million units, of which 236 million units were smartphones with market shares of  23.4 percent in total mobile phone sales, and 30.3 percent in smartphones worldwide (for Samsung, smartphones were 57.7 percent of its total sales). Apple, the original smartphone pioneer and leader is the second dominant player with a turnover of USD 15 billion in 2012, with a physical sales of 136 million units, of which all the 136 million units were smartphones, with market shares of 7.8 percent in total mobile phones and 19.1 percent in smartphones worldwide (for Apple, smartphones were 100 percent of its total sales). Worldwide, total mobile sales were 1736 million units, of which smartphones were 713 million units (41.1 percent to total).

Excluding Samsung, Apple and Nokia all other phone manufacturers (including but not limited to such names as ZTE, HTC, LG, BlackBerry and Sony) sold 858 mobile phones worldwide, of which 326 million were smartphones, with market shares of 49.5 percent in total mobile phones and 54.3 percent in smartphones (for other manufacturers, smartphones were 45.1 percent of total mobile phones). In terms of operating systems, of the 713 million units of smartphones sold, Android led the pack with approximately 70 percent share, followed by iOS at 21 percent, BlackBerry at 3.5 percent, Microsoft Windows at 3 percent and all others at 3 percent in 2012. All these statistics point to the enormous challenge as well as opportunity that Nokia has under Microsoft ownership. The challenge is one of uphill battle in terms of operating system share and overall market order. The opportunity is one of being able to maintain and enhance the overall Nokia share in feature phones, and increasing the share in smartphones several times over, to the levels of Apple and Samsung, as an aspiration.  

Beyond classic theories 

The answer to this lies in likely environmental trends and competitiveness of smartphones (which did not exist a few years ago but have taken center stage now).  Would the ratio of smartphones to basic phones which has reached an almost equal share increase even higher, to say 75 percent, in favor of smartphones? Or, will all mobile phones will only be smartphones in one scenario and new range of feature phones with simpler operating systems revive the feature phones in another scenario? Will Microsoft-Nokia follow these trends or shape these trends? Will, in an anxiety to push up the Windows operating system, Microsoft ignore the still formidable franchise that Nokia has in feature phones and cause its decline, with or without a commensurate increase in smartphone sales? Would Microsoft be better off making Windows OS as its proprietary OS for its Nokia/Lumia phones, much as Apple iOS is for iPhones? On the other hand, in an increasingly commoditizing smartphone technology market, what would be the differentiating feature of Windows OS?   

Students and practitioners of strategy have, therefore, an excellent case study coming up in the Microsoft-Nokia deal. The technological and competitive dynamics of the computing and communications industries are so multifaceted that no single management paradigm, be it competitive strategy, core competence, lean or reengineering alone can provide a solution. However, all of these need to be collectively applied by Microsoft to achieve cost leadership, product differentiation and mass customization on the strength of current and additional core competencies.  On the face of it, Microsoft brings a world-class operating system and considerable finances while Nokia brings world-class hardware and worldwide marketing. The combination should have every chance of success. The only hurdle to the achievement could be any misjudgment on the part of Microsoft on the future evolution of industry and competition. The misjudgment could arise from an unwillingness to understand the necessity of addressing the full market spectrum in terms of multiple products and value points, a strategy already undertaken by Nokia in recent times. Appropriate judgment will reinforce and expand this process.

Industry evolution

Porter’s theory of competitive strategy considers industry evolution and the definition of industry to operate in, and the definition of industry boundaries. The computer and connectivity industries are undergoing a tremendous industry evolution. Hitherto, personal computers were the target of cannibalization by tablets.  According to IDC, the device industry research firm, phablets, which are smartphones with larger screens, will start to cannibalize into the market share of tablets over the next 12-18 months. Generally, phablets are smartphones with screen size that ranges from 5-8 inches and are designed to combine the functions of a phone and tablet. IDC expects a new round of device cannibalization to kick in, but this time with large-screen (5-plus inch) smartphones beginning to impact the smaller (7-8 inch) tablet market. Also, cost will continue to be a key parameter. IDC expects lower-cost devices will drive global interest and aid in increasing uptake among first-time buyers in commercial sectors like education. That said, the overall device industry would continue to offer great potential for Microsoft, in terms of both operating systems and a range of products, with the twin strategy being possible with the Nokia device technology with IP and organizational strengths (engineering, manufacturing and marketing) now acquired.  

According to IDC projections, globally, smart connected devices -- PCs, tablets and smartphones -- will continue to surge with overall shipments surpassing 2 billion units by the end of 2015 with a market value of USD 735.1 billion. Shipments of desktop PCs are expected to touch 134.4 million units by 2013 and 123.11 million by 2017, while, that of portable PCs are expected at 180.9 million units by 2013 and 196.6 million by 2017. In the case of tablets, shipments are projected to touch 227.3 million units by 2013 and 406.8 million by 2017. Smartphone shipments are expected to touch 1,013.2 million units by 2013 and 1,733.9 million by 2017 (double the current level in just four years!). In terms of device mix, total PC shipments accounted for 28.7% of the smart connected device market in 2012 while tablets accounted for 11.8% and smartphones for 59.5%. By 2017, total PCs are expected to drop to 13%, while tablets and smartphones will contribute 16.5 % and 70.5%, respectively to the overall market. The shift in demand from the more expensive PC category to more reasonably priced smartphones and tablets will drive the average selling price (ASP) for the collective market from USD 462 in 2012 to USD 323 in 2017.

Visible surface; invisible fascia

In the communication and computer industries, the product is the visible surface. Without any pun, Microsoft thought, for good reasons, that its Surface tablet computer would lead the visible product revolution in the device strategy. Despite the setback, a new generation of Surface may still click. That said, Microsoft should fight against the temptation of using Lumia as just another Surface, that is just as a premium product. Lumia range could be highly visible products but their contribution to Microsoft has the potential to be internal and expansive, in terms of device engineering, technology and hardware. Rather than being a mere skin or surface of the device strategy, Lumia could be the fascia of a new Microsoft, both in terms of corporate anatomy and corporate visibility. Anatomically, fascia is the thin fibrous tissue under the skin that covers and ties the muscles together. Technologically, it also signifies the dashboard of a motor vehicle which provides an interactive platform that connects the motor vehicle with the external world. The fascia analogy perfectly fits Nokia/Lumia in/for Microsoft; it presents itself as a unique techno-marketing opportunity for Microsoft. The reasons lie in the likely dramatic evolution of the computer, tablet and smart-phone industries as discussed above.

The strategic opportunities for Microsoft lie in leveraging the acquired Nokia/Lumia technological capabilities to develop a full range of basic and feature phones, smartphones, phablets and tablets, with screen sizes from 2 to 10 inches. This should be accompanied by reinforcement of high-end and low-end manufacturing strengths, deploying premium manufacturing and low cost manufacturing simultaneously. It should be a grand expansive strategy, rather than an incremental niche strategy. A matching organizational strategy that reinforces and builds upon Nokia’s proven global distribution, sales and marketing strategies, rather than reformats them in a Microsoft format, would also be called for. Microsoft, clearly, has no time or need to rediscover the wheel, and worse still discover in an expensive manner a wrong wheel after considerable effort, time and cost! And in this nimble and agile expansive strategy, Nokia Lumia would be both the visible and invisible fascia.  India, as a country of low cost mobile phone development and manufacturing for Nokia India would offer great opportunities for driving Microsoft’s new device and services strategy, increasing Microsoft revenues manifold in the process.

Posted by Dr CB Rao on September 15, 2013