A most peculiar thing has happened to the Microsoft-Nokia relationship over the last two and a half years. Whereas Nokia was only a peg in Microsoft's wheel in early 2011, the hunter has now become the hunted. It is a most amazing story about a shift in the balance of power. Let me explain.
When Nokia hired Microsoft executive Steven Elop as its first non-Finnish CEO in the second half of 2010, the company was in free-fall, and there were no great options. Nokia could continue to develop its own OS, use Android, or Windows Phone.
Elop picked the Windows Phone path, exclusively, and announced this in February 2011. It's not relevant to this discussion, right now, as to whether this was the right decision or not. For all I know, it was the right thing to do.
That said, at that stage of the game, it was easy to see one of the key weaknesses of Nokia's chosen Windows Phone strategy. By spring 2011, it looked like the Windows Phone market would be structured just like the Windows PC market. Basically, Microsoft had all the power – and all the profits – while a bunch of box makers made commoditized devices.
For example, in the Windows PC market for 25 years, did you care – and do you still care – whether your PC is a Dell, HP, Sony, IBM/Lenovo, Asus, Acer, Samsung or whatever? Most people would say no. It's the same software, these hardware guys operate at near-zero margins, and Microsoft collects all the profits.
The reason Microsoft collects almost all the profits in the Windows PC world is because there are so many of these box makers, competing against each other. When basic PCs start at $399 or below, there is not much room for computer box maker profits. It's simple price pressure coming from massive competition.
When Windows Phone launched in 2010, there were several credible entries in the handset world: Samsung, LG and HTC to name the more prominent ones. Acer and Huawei were also planning to launch. Nokia would be just one of the many, just like in the Windows PC world.
Shortly after Nokia launched its first Windows Phone in the U.S. in 2012, however, something earth-shattering began to quietly happen: The non-Nokia Windows Phone licensees begun to falter.
Basically, all non-Nokia licensees of Windows Phone gave up, or almost gave up. LG Electronics surrendered after an initial launch. Samsung offers a couple of models but doesn't seem to bother marketing them. HTC offers a great model, mostly so they can reduce the impact from Microsoft's patent lawsuit. Acer... well, they were supposed to launch a model, but... Huawei? They showed a model at some trade shows, and then...
The bottom line is that Nokia is now – depending on whose survey you count – around 80 per cent of all Windows Phone shipments, and is rapidly racing to 100 per cent. Unless something changes quickly, Microsoft's licensing program for Windows Phone will become a joke with only one customer.
It's gone so far that many analysts now estimate that Microsoft makes more money from Android phones than Windows Phones! After all, Microsoft gets a royalty from a very large percentage of the Android smartphone market.
With Nokia now at 80 per cent of the Windows Phone market, rapidly approaching 100 per cent, the two dangers to Microsoft's smartphone business are:
1. Nokia switches emphasis to Android – or something else, for that matter:
Whoops! Nokia has been saying that they don't have a "Plan B" – beyond Windows Phone. Maybe they hadn't – in 2011 or early 2012. But now? If you don't believe Nokia has an active Plan B in place, you are naive.
Most likely, such a Plan B would involve Android. Perhaps it involves acquiring BlackBerry. Perhaps it would involve acquiring Research in Motion and making a great Android phone with a BlackBerry keyboard. The possibilities are endless. Either way, Microsoft is screwed.
2. Nokia gets acquired.
Whoops again! Whether Huawei, Lenovo, Samsung or HP, Microsoft's only remaining outlet for Windows Phones may be gone. Microsoft would be screwed.
In this light it doesn't take a lot to scare Microsoft into acquiring Nokia. Problem is, even if Nokia isn't acquired, it can still abandon Windows Phone.
On the other hand, Microsoft doesn't want to acquire Nokia. Buying a large European company such as Nokia could be a huge nightmare. Thousands of people may need to be fired, unions would have to be negotiated, the government of Finland could declare war on the city of Seattle, or worse. The whole thing could be a mess dominated with endless EU bureaucrats, lawyers and strife.
This is why Microsoft has never denied the suggestion that it will make its own smartphone. One year ago, Microsoft stunned the world when it announced it was building its own PC – the Surface. If you don't believe Microsoft is hard at work engineering its own phone, you're naive.
Think about it from Microsoft's perspective: Everyone but Nokia has effectively abandoned Windows Phone. If Nokia shifts direction to Android or something else, or if Nokia gets acquired by someone with similar thoughts, Windows Phone is over. Good-night! That is, unless you as Microsoft do what Apple and BlackBerry do – and for that matter Google now too, effectively – and go vertical: make your own line of phones. Surface PCs; Surface smartphones – who cares?
Microsoft's other option: BlackBerry
Windows Phone and BlackBerry now each have around 3 per cent to 5 per cent of the smartphone market, far behind Android (70 per cent) and Apple's iOS (21 per cent). It's almost inevitable that these two forces – BlackBerry and Windows Phone – must merge in order to have a viable Number 3 player in the portable computing market.
In other words, BlackBerry must join either of two camps: Microsoft or Nokia. Alternatively, there would have to be a friendly "let's join together all three of us" event, which seems almost impossibly difficult to work out given valuations, politics, unions and worse.
I have no idea what will actually happen here. But something MUST happen. The current situation – where Nokia is 80 per cent (and rising) of Microsoft's Windows Phone sales – is not sustainable. Each party is in a prisoner's dilemma, looking to turn the other party in. Those parties combined, even in a happy scenario, is a 3 per cent to 5 per cent market share player with an unsustainable position against Google and Apple.
The Microsoft-Nokia (and BlackBerry) parlour game is exciting, sure, but what it really tells you is how far ahead Google and Apple are. For those of us who have been using Windows Phone for the last two years, we know there is much to like about Windows Phone – but clearly not much enough.
Rumours abound that Steve Ballmer is about to launch a massive "restructuring" – whatever that means here, practically speaking. After a dozen years of stagnation and massive market share losses to Google and Apple, this would appear to be Ballmer's last chance.
Fundamentally, a company's place in the computing market is nothing if it doesn't include mobile. At this point, it's hard to see Microsoft's place in the mobile world without solving the Nokia and BlackBerry dilemmas in their common quest to offer an alternative to Google and Apple.
If Ballmer fails to get a "grand solution" to the Nokia and BlackBerry questions, perhaps it will be time for Microsoft's board to revive those age-old talks with Yahoo! again. It looks like it would take an ex-employee from Google and Apple to figure out a future for Microsoft, and at this point Marissa Mayer may hold the highest rank of anyone realistically available for the job.
At the time of publication the author was long GOOG, AAPL, MSFT and NOK.