Microsoft's Nokia Deal, Analyzed

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Rumblings about a Microsoft-Nokia acquisition have been around for months. Microsoft made the news a reality Tuesday and announced a $7.2 billion deal for the company's devices division. Talks between the two companies started as far back as February, but took off in earnest in July. According to the deal reached today, Microsoft is acquiring just the handset business from Nokia, as well as the "Lumia" and "Asha" brands. Nokia's networking business, services business and Here mapping teams will remain in Espoo under the Nokia brand.

In a letter to Microsoft employees, CEO Steve Ballmer said the move is "a bold step into the future." It's also the "next big phase of the transformation" the company announced in July. "We are very excited about the proposal to bring the best mobile device efforts of Microsoft and Nokia together," continued Ballmer. "Our Windows Phone partnership over the past two and half years has yielded incredible work. Our partnership has also yielded incredible growth. In fact, Nokia Windows Phones are the fastest-growing phones in the smartphone market. Now is the time to build on this momentum and accelerate our share and profits in phones."

All the rah-rah aside, it's a move that makes sense from a number of angles. Consider Apple and BlackBerry.

Apple makes not only the platform for its smartphones, but also the devices. iOS and the iPhone are fully under Apple's control. That means all the costs and all the profits are born and won by Apple. This strategy has worked well for Apple during the past six years. BlackBerry operates the same way, though its fortunes have headed south. BlackBerry makes both the operating system and the smartphones that run the OS. Though it stumbled (mostly due to bad leadership), its business model let it maintain control and own all the profits (when it actually made some).

To date, this is not how Microsoft has operated. It makes the operating system, and its hardware partners -- HTC, LG, Nokia, Microsoft, Samsung, ZTE and others -- make the hardware. There's been a seismic shift in the Windows Phone ecosystem during the last few quarters, though. At last check, Nokia was responsible for 87% of all Windows Phone handset sales. That's an incredible number that Microsoft could no longer ignore. With Nokia's design and manufacturing businesses under its purview, Microsoft can create more seamless products that work even better with its developing ecosystem.

Of course, we only have to look at the Surface debacle to know how badly Microsoft can screw up a hardware business.

One key aspect of the deal noted by Microsoft Tuesday is that the company will continue to license Windows Phone to other hardware makers, despite its new position as a hardware maker. (Microsoft is now in a position similar to Google, which bought Motorola's handset division, though it also licenses Android to other OEMs). Just because Microsoft says it is going to license Windows Phone, though, doesn't mean it is going to happen. This is one of the big risks being taken by Microsoft.

The purchase of Nokia's hardware business may scare off the few remaining Windows Phone vendors. Windows Phone is the third horse in a two-horse race between Android and iOS. Android is three-quarters of a length ahead while Windows Phone has barely left the gate. Why should HTC, Samsung and the others bother to make new WP8 devices given how few they were selling in the first place? There's little incentive for them now. Android is a cheaper and more popular option. If Microsoft loses these partners, it will be a blow to the company. HTC, for example, has been making Windows-branded hardware for 10 or more years.

Another sticking point of the deal is that Microsoft did not acquire the "Nokia" brand. It acquired the Lumia and Asha brands, which Nokia calls its smart devices. Nokia is holding onto its feature phone business and the Nokia brand. That means "Lumia" smartphones will no longer be Nokia devices, but Microsoft devices. Microsoft may have worldwide brand recognition, but Nokia's equity in the phone market is still invaluable. Nokia was smart enough to realize that and retain control over its brand. The problem this generates for Microsoft is that it will automatically lose some of the appeal Lumia devices carried with them.

Microsoft is certainly gaining a solid business. Nokia has done an admirable job turning around its smartphone division during the last two years. Though it still has a long way to go, perhaps Microsoft's ownership of the devices team will provide the resources it needs to keep churning out attractive, usable smartphones. In other words, let's hope Microsoft doesn't change anything about what Nokia's doing, especially if it means taking things in a more Surface-y direction. Microsoft will do well to let Nokia's designers keep doing what they're doing. There's a real chance the synergies created by having the hardware and software teams under one roof will (eventually) play off.

Microsoft is taking a big risk in alienating its existing partners, though. Some may throw in the towel, and no one would blame them for doing so.

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