Many people claimed for many months that Microsoft (MSFT) was working on a smartphone of its own. When the idea came up last summer, I pointed out that the only way for Microsoft to build its own smartphones would be by acquiring Nokia (NOK) and building phones under Nokia's brand name. Until recently, I kept insisting that Microsoft wouldn't be building its own smartphones. This is very similar to how I said Nokia shouldn't and won't build tablets while everyone else was saying that it makes perfect sense for Nokia to complement its smartphones with a tablet. On Tuesday, Microsoft finally announced that it wasn't interested in building a smartphone at the moment.
Why The Decision Makes Sense
This is in line with what I've been predicting and this makes perfect sense. Last month, when Nokia announced its annual 20-F, the company mentioned a possibility of a Microsoft smartphone "Microsoft may make strategic decisions or changes that may be detrimental to us. For example, in addition to the Surface tablet, Microsoft may broaden its strategy to sell other mobile devices under its own brand, including smartphones. This could lead Microsoft to focus more on its own devices and less on mobile devices of other manufacturers that operate on the Windows Phone platform, including Nokia." I am sure that Microsoft studied the pros and cons of building a smartphone and decided against it. After all, if Nokia sells 4 out of 5 Windows Phone devices in the market, there isn't much Microsoft can do to top that. Besides, a company needs more than a production plant to build a product as complicated as a smartphone.
First, there are tens of patents that go into a smartphone. Microsoft would have to sign patent treaties with many companies and pay them license fees and royalties. Of course, Nokia would get a big chunk of such money as the company owns many technologies that are essential to build a smartphone.
Apart from the patented technologies, Microsoft would also need to build a distribution network. Today companies like Samsung (GM:SSNLF) and Nokia are set apart from the competition because they can distribute their products in almost every country in the world. These companies can deliver their phones to African towns in the middle of the desert that most people wouldn't even notice on the map. It takes a lot of time, patience and investment to build such a successful distribution network and Microsoft certainly doesn't have time for that.
Furthermore, Microsoft doesn't have much of a brand name in the eyes of consumers. Out of all the products launched by the company, Xbox was the only one that caught the attention of consumers. Microsoft's Surface tablet still struggles to gain any meaningful market share as we speak.
Microsoft Holding onto Its Partnerships
Terry Myerson, a vice president at Microsoft responsible for the Windows Phone products said that the company would only consider building a smartphone if its partners such as Nokia and HTC were unable to provide the consumers with a great Windows Phone experience. Interestingly enough, companies other than Nokia don't really make much money on Windows Phone and they have to fund Windows Phone project from the profits they make on Android (GOOG) phones. Just 10 days ago, HTC announced that it was barely breaking even as the company announced its all-time low profit of $2.6 million. The company's numbers would have been a lot better if it wasn't for the money invested in a Windows Phone. If companies like HTC and Samsung were to step out of Windows Phone project and focus on Android for financial reasons, Microsoft will have to support Nokia with whatever it takes. This is pretty much hinted when Mr. Myerson acknowledges that Microsoft will have to step in if some of the partners fall short on delivering high quality Windows Phone devices. By stepping in, Microsoft might mean multiple things, including paying certain companies to step up their game, acquiring certain companies to take the matter into its hands or forming new partnerships.
Now what? I am happy with Microsoft's decision of not building a smartphone, not because it confirmed what I had been saying, but because this is for the better. By deciding on not building a smartphone, Microsoft gave its partners the right kind of message (that it is behind them), allowed itself to focus on what it does best (software) and ended the speculations. Now Nokia's investors can sleep more comfortably at night knowing that Microsoft will not try to play games behind Nokia's back. Microsoft's investors can sleep (relatively) comfortably at night knowing that Microsoft will not ruin a partnership that's been working so well.
As for me, I will continue to hold my shares for both Nokia and Microsoft. I have been holding Microsoft shares for a long time and I made most of my money by collecting dividends and writing covered calls. In the last 10 years, Microsoft has been pretty much flat. Waiting for Microsoft to appreciate sharply is a game that can last for years and years. This is why I suggest Microsoft to two kinds of investors: 1) investors that are nearing retirement and want to collect income through call writing and dividends, 2) investors that are many years away from retirement with a very conservative mindset who will keep reinvesting dividends to see their portfolio grow. In addition, Microsoft could be a good addition to those portfolios that are full of highly volatile stocks for diversification purposes.