A Brief Assessment of the Microsoft-Nokia Alliance

Back story
There was a flurry of news out of Finland last week. Nokia has finally awaken from its deep slumber to realize just how far behind it has fallen in the smartphone market relative to Apple, Google, Motorola, HTC, and others. On Tuesday, the CEO distributed what’s now being called “the burning platform memo.”

A snippet from the memo, courtesy of Engadget –

“I have learned that we are standing on a burning platform…The battle of devices has now become a war of ecosystems, where ecosystems include not only the hardware and software of the device, but developers, applications, ecommerce, advertising, search, social applications, location-based services, unified communications and many other things. Our competitors aren’t taking our market share with devices; they are taking our market share with an entire ecosystem. This means we’re going to have to decide how we either build, catalyse or join an ecosystem.”

A few days following the distribution of this memo, Nokia and Microsoft announced a broad strategic alliance that would draw on the two companies’ complementary resources to create a “new global mobile ecosystem.” Here are details of the partnership from Microsoft’s perspective, and a related release from Nokia. Essentially the alliance pairs Microsoft’s resources in mobile software (Windows Phone 7) and cloud services (e.g., Bing) and Nokia’s assets in hardware development (mobile handsets).

Criticism and Questions
Critics quickly jumped on this announced alliance, suggesting it primarily benefits Microsoft’s struggling mobile operating system, Windows Phone 7 (WP7), and provides little advantage for Nokia.

Some questioned the objectivity of the decision-making around the partnership, since the current Nokia CEO, Stephen Elop, worked as the head of the business division for Microsoft up until September 2010.

Others questioned how an alliance between two struggling giants can possibly solve either company’s main challenges in the quickly evolving smartphone market.

Updates
Following the announcement about the Nokia-Microsoft alliance, there was significant unrest at Nokia. Reports suggested 1,000 workers based in Finland walked out, concerned about their job security.

Intel, which was partnering with Nokia on the open source mobile platform MeeGo, restated its commitment to the project, despite Nokia’s strategic shift away from the operating system.

On Sunday, facing rising criticism about the logic of the partnership with Microsoft, Stephen Elop indicated that Nokia will receive significant payments from Microsoft to adopt WP7 as its primary mobile operating system.

Implications
What are the implications of this strategic alliance for Nokia, Microsoft, Symbian, and MeeGo?

Despite any payments from Microsoft, placing all its chips with Microsoft’s WP7 poses extraordinary risks for Nokia. Given the network effects in smartphones, especially related to the application markets, it’s a reasonable scenario that WP7 is unable to significantly increase its market share in the face of stiff competition from Android, iOS, RIM/Blackberry, and HP/Palm. As WP7 struggles to gain share, so will Nokia and its handsets. This move also seems to discount Nokia’s substantial strength in feature phones, which is still a significant market (80%) that is likely to persist for a long period, especially in emerging economies.

This announcement also poses risks for Microsoft. It seems to elevate Nokia above Microsoft’s other handset partners, such as HTC. This may cause handset manufacturers, other than Nokia, to reallocate resources away from WP7 to Android development. The net effect is that Microsoft may reach just as many consumers with Nokia as it would with a broader array of partners. Note that Nokia is fairing especially poorly in the U.S. market, one of the largest current markets for smartphones. Microsoft could allay concerns raised by this Nokia partnership by quickly allying with other handset manufacturers, but this could jeopardize any special relationship with Nokia.

Although Stephen Elop indicated Nokia was shifting most of its resources away from Symbian and MeeGo towards WP7, it’s likely that Symbian will persist for some time at Nokia. Nokia’s largest market is still feature phones running the Symbian operating system. WP7, in its current state, is not a viable operating system for feature phones. The future of MeeGo, however, is an open question. MeeGo is of strategic importance to Intel because it’s a possible route back into the smartphone market, which is currently dominated by the ARM architecture. Despite the importance of MeeGo to Intel, I suspect the company will reconsider its strategic options over the next several months. Without Nokia and other software and hardware partners, MeeGo seems like a dead end for Intel.

Conclusion
This strategic alliance between Microsoft and Nokia may accelerate WP7’s market share gains, but it poses significant risks to both companies, especially Nokia. With this move, Nokia could be placing all its resources behind a losing mobile platform. Because the smartphone market is still quickly evolving, Nokia should invest in a parallel program around Android. As uncertainty is reduced over time regarding the success of the different platforms, Nokia can reallocate its resources accordingly. If Nokia places a singular bet on WP7 and it turns out that this platform fails to gain significant market share, it may destabilize the entire company.