Nokia Numbers Show Microsoft’s Mobile Madness

Every Windows Phone 7 device Nokia shipped in Q4 cost Microsoft $250, minus a royalty. But Microsoft is burning this cash with good reason.
What's the world's priciest smartphone? Hints: It's got nothing to do with fruit or robots, it comes from Europe, and it carries a 10-figure price tag.

Kudos if you guessed Windows Phone--specifically the variety produced by Redmond's Nokia division. Okay, Nokia is still an independent company, at least on paper and for now. But its Q4 report showed, along with a $1.25 billion loss, the extent to which it is now functioning as Microsoft's de facto mobile manufacturing arm.

In a filing, Nokia revealed that Microsoft paid it $250 million last quarter to churn out Windows Phone devices like the Lumia 900, and that it expects to receive billions more in Windows Phone "platform support" payments. That makes the Lumia line the most expensive phone going, at least from the standpoint of Microsoft.

Microsoft's alliance with Nokia is essentially an OEM relationship, except in this case the OEM keeps all the money but for the paltry "minimum software royalty commitments", estimated by some analysts to be as low as $15 per device, that Nokia hands back to Microsoft.

Nokia said it "sold" 1 million Lumia devices in the quarter (in quotations because there is no easy way to tell how many units actually made it to consumers or are simply idling in channel inventories). That means every Windows Phone 7 device Nokia shipped in Q4 cost Microsoft $250, minus the royalty. That's for phones, like the Lumia 710, that can be bought for $50 or less with a standard carrier contract.

Ordinarily, this would be madness. Even a kid with a lemonade stand knows you're supposed to sell stuff for more than it costs to make. But these are not normal times at Redmond. Microsoft's willingness to extend what is basically a billion-dollar bribe to Nokia, still the world's biggest handset maker by volume, to ditch Symbian and use Windows Phone as its default OS shows how desperate the software maker is to get back into the mobile race, where it badly trails Apple and Google.

There's good reason for that desperation. Microsoft's ownership of the desktop allowed it to dominate the computer industry through much of the 1980s and '90s. But in the so-called aughts and beyond, study after study shows that mobile is becoming the new desktop--for everyone from consumers to knowledge workers.

And Microsoft's presence in mobile is miniscule. Gartner estimates that Windows' share of the U.S. market is just 1.5%. Google, meanwhile, has already got more than half of the market sewn up.

That's a huge problem that goes well beyond the fact that Microsoft is making little or no net revenue from its mobile OS. The real value of any mobile platform nowadays is that it's a gateway to where the real money will be made--the cloud. It is from mobile devices that more and more consumers and businesses access lucrative online services like search, social networking, e-commerce, and entertainment. That's why Windows Phone is designed to put Bing right in your face, where it must be to override most users' instinct to Google what they're looking for.

The cloud also is where advertisers and merchants want to be. Amazon is selling the Kindle Fire at a loss-leading $199 because the device is merely a portal that individuals use to buy Amazon goods and services.

Microsoft's ability to generate revenue from cloud services, the source of most of the tech industry's growth over the coming years, will be severely crimped if it can't drastically increase its presence on mobile clients, and that includes tablets as well as smartphones.

Hence, CEO Steve Ballmer's willingness to use his biggest weapon--cash. Microsoft's got a ton of it, $51.7 billion, including short-term investments, to be precise. And it's becoming increasingly clear that Ballmer will employ that war chest to buy his way into strategic markets where Microsoft has fallen behind. Mobile is about as strategic as it gets right now.

So is it madness for Microsoft to pay Nokia $250 per device to make Windows Phones that might generate as little as $15 each in license fees? Sure, but it's not the sort of madness that implies lunacy. It's more in line with Webster's second definition of the word: "frenzied behavior." The company's efforts to become a legit mobile player had better be frenzied, otherwise its cloud ambitions could all but evaporate.

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