The announcement Tuesday morning that Microsoft was buying the Nokia phone and smart device business initially struck me as a last gasp at joint relevancy in a market where both have lost their way and share. In thinking more, it was both inevitable and mandatory for Microsoft.
Over the last 3 years, two distinct models have emerged in the smart device market. Apple has focused on a closed vertical integration model where the device value is high and is based on a combination of software and hardware, and the cost model reflects that value. In addition, the closed nature of the ecosystem extends the control and the overall price (and underlying costs).
On the other hand, Google has created a very different model. In their desire to have as many devices as possible allow users to consume Google cloud services, they have opened up Android to a large set of device vendors, driving a market where the software has little to no cost and reflects lower product costs and prices.
Over the last 3 years, the Google model has succeeded to the point where Android is now over 75% market share. And the emergence of a new option in Mozilla WebOS, enabling a lower hardware price point, will make the market even less focused on software monetization. If your business is selling device software and device software is free, you need to go somewhere else for monetization, either to the cloud or to vertical device integration.
The challenge that Microsoft faced was that they were caught in the middle of this bifurcation of the market. While they definitely believe that their software should have a significant to dominant cost component in the end device (Microsoft software often accounts for 25% or more of the cost of a new PC), their model of open devices did not yield the control and ecosystem management that Apple enjoyed. The hardware manufacturers had, seemingly en masse, chosen the Android option instead of the Microsoft one. While the technology was a component in this decision, the pricing did not hurt.
The result has been clear: While Apple has maintained a focused success (at least as measured in pure volume, not share) of the market, Android has grown dramatically in share. In the end, Microsoft had only two options: Go the route of Android and attempt to gain value in "Cloud" services and business as Google does; or move to the Apple model of vertical integration. Obviously the vertical integration option won. In this option, the only clear path was to acquire Nokia and move to an Apple-like model in this smart device market.
On the Surface (pun intended), this merger opens the door for Microsoft/Nokia (Microkia?) to drive a differentiated value proposition in the smart device market. With Windows the dominant desktop, linking Windows to Smart Devices and apps to provide a cohesive experience could provide persuasive options, especially in business. As Apple has shown in the iPhone/iPad and iOS space, controlling the software and hardware can yield performance and usability results. While these results are not all sustainable, they have led to a strong user loyalty to the Apple products.
By having the device products in house, the Microsoft sales organization can sell them. By potentially integrating devices and discounts into the Enterprise licensing program, the impact of iPads and other devices in enterprises can be curtailed. However, Microsoft faces two battles in this quest for relevancy.
The first challenge is that Microsoft must prove they can out-innovate both an Android open ecosystem and the much vaunted Apple. Back in the late '80s and early '90s, Microsoft won against Apple for the desktop by using an open ecosystem with rapid innovation in devices, cards, and software, to effectively out-flank Apple. Today, the Google Android ecosystem appears to be repeating that same scenario vs. the new Apple and iOS products. While Apple has dramatically shrunk the cycle time between iPhone (23 months 3G to 4, 16 months 4 to 4S, and 9 months for 4 to 5), these rollouts are dwarfed by more than 126 current Android products. If we assume the average product life in the Android space is 15 months, then that is 9 new products per month.
So, to have an impact, Microsoft must create an innovation culture, something that has been lacking over the last few years. When I say innovative culture, I do not mean just re-arranging the deck chairs or tiles--they must truly innovate and create products that are not only different, but lust-worthy. The innovation must be reflected both in differentiated value as well as a regular release stream of devices. And that innovation will be directly compared to Apple now. While Apple has been somewhat drifting of late, the team is still strong and will drive new innovation.
The challenge for both companies is that the market is now expecting innovation on a regular, even shortening, schedule. When your latest product is replaced by the next shiny object in 3-4 months, innovation becomes challenging.
The second challenge is the user ecosystem. Microsoft has two major user ecosystems, Skype and Lync (Lync Federation specifically). Both are based in the communications domain (unlike Facebook in social). Unlike the Face Time eco-system that Apple created, both Skype and Lync depend on open integration of smart devices. In fact, earlier this year much of the noise in the Lync world was about new mobile clients for a variety of smart devices.
Microsoft is now faced with a difficult challenge. In the emerging cloud ecosystem world, Microsoft has been out-flanked for two of the cloud pillars, search and social. While Microsoft has a reasonable position in the gaming pillar (Xbox Live), it has minimal positions in entertainment (Netflix, Amazon Prime, MSOs). So Microsoft's strength is in communications and productivity apps (Office 365).
The challenge now is the balance between the open nature of Lync and Skype relative to smart devices, and the need for Microsoft to vertically integrate the new Microsoft smart devices into the ecosystem as superior devices. This is only made more complicated by the advent of WebRTC, a technology that may dramatically reduce the community demands in communications. When every website can host communications without the need for over-arching communities, is the community still valiable?
In the end, I believe that Microsoft had no choice but to buy Nokia. The Windows 8 mobile market, while growing somewhat, has merely become a competitor to BlackBerry, not to either Apple or Samsung or the general Android market. While the partnership with Nokia was yielding results, they were not fast enough to see a path to market success (remember Jack Welch's comment that you need 20% share to succeed).
The challenge now is to out-innovate both Apple and the Android ecosystem, and create products that are differentiated and valuable. And finally, to convince both business and consumers that they should move into this new vertical system, while not breaking the communications clouds of Skype and Lync for the 95% of users that do not use Microsoft smart devices today.
