) announced that it would pay EUR 5.44 billion, or $7.17 billion,
in cash to buy
) devices and services business and license Nokia's patents and
The question, of course, is, why?
Well, Microsoft spells it out plainly in the press release:
Microsoft aims to accelerate the growth of its share and profit
in mobile devices through faster innovation, increased synergies,
and unified branding and marketing.
But the bigger news, which isn't receiving enough attention, is
Microsoft's disclosure of a dark truth about its Windows Phone
business: In its current state, it is never going to make any
Way back in June 2010, I wrote an article entitled
Microsoft's Mobile Mathematics
, within which I did some rough eighth-grade math to determine how
much money the company can make in smartphones.
Figuring out a royalty rate for smartphones using Microsoft
operating systems is much trickier, but I'll use a range between
$20 and $30 as a very rough guesstimate here. Windows PC royalties
are thought to be about $65 per unit, and netbooks about half that.
I'd imagine that
) free Android giveaway could make it hard for Microsoft to get
anywhere near top dollar.
So here are the best- and worst-case scenarios laid out using
600 million smartphone units, 25% market share, $30 royalty rate =
400 million smartphone units, 10% market share, $20 royalty rate =
The good news is that software-derived revenue can be extremely
high margin, and both numbers could be boosted by ancillary
businesses like apps and mobile search. There's also a strategic
benefit to keeping customers away from the iPhone and Android
The bad news is that even a few billion dollars in high-margin
revenue isn't all that much for a company as big as Microsoft.
As it turns out, the reality was much worse than even my worst
case scenario. Note that at the time, these guesstimates were for
Smartphone growth has outpaced expectations, but Microsoft has not
built meaningful market share and its royalty rates are at
As of Q2, Microsoft had 3.3% smartphone market share, in third
place behind Google Android and
Additionally, we learned this morning that Microsoft is making
almost no money from its Windows Phone. In its
Microsoft disclosed that under its current partnership agreement
with Nokia, it was making a gross margin of less than $10 per unit
while spending what was probably a lot of money on marketing.
This was an unsustainable arrangement.
As of April 2013, Gartner forecast global smartphone shipments of 1
billion in 2013. At 3.3% of the market with a $10 per unit
(rounding it to $10 to keep it simple) gross profit, Microsoft
could be expected to generate $330 million in gross profit from
Windows Phone royalties this calendar year.
Heck, bump the market share number up to 5% and it still does not
come remotely close to moving the needle, as Microsoft had $14.3
billion in gross profit
. When factoring marketing and development costs into the equation,
Windows Phone almost certainly loses money.
With the Nokia deal, Microsoft aims to bump that gross profit per
unit number to over $40.
Assuming that a combined Microsoft/Nokia would help build market
share through a more concentrated marketing effort and better
hardware/software/app integration, the company at least gets a
chance at building meaningful profitability in smartphones.
So while there are an awful lot of naysayers out there hating on
this deal -- Microsoft's stock has now given back all of the gains
Steve Ballmer retirement announcement
-- the company has no choice. It has to go for the whole enchilada
because $10 per unit will never pay the bills.
However, this deal is no obvious home run. In fact, it may not be
the best way, but simply the least worst way, to move forward.
Let's break it down.
Nokia accounts for about 80% of Windows Phone shipments, with other
(TPE:2498) accounting for the remainder.
Since Microsoft is more or less choosing itself over its hardware
partners, the Windows Phone platform could lose third-party
support, and this would hurt its growth, which is currently the
fastest in the industry (largely the product of growing off of a
And the smartphone market, while growing rapidly (+46.5% in Q2), is
actually a fairly rough environment in which to compete. Even
Apple, while better than average in this regard,
is seeing falling average selling prices
, and the leading Android phonemakers Samsung, HTC, and Motorola
all struggling with rampant competition