Why Nokia Should Stick With Microsoft

| About: Nokia Corporation (NOK)

Nokia (NYSE:NOK) Chief Executive, Stephen Elop, has come under increased scrutiny for Nokia's lackluster performance. With smartphones booming around the globe, Nokia is struggling to sell its Lumia line of smartphones. The decision to abandon its in-house Symbian platform was widely seen as a smart decision, but choosing Windows Phone over Android has received the opposite reaction. Elop was spot on in claiming that we are no longer in the era of smartphone vs. smartphone; we are in a battle of ecosystems. But Elop's decision to choose the Microsoft (NASDAQ:MSFT) ecosystem has received much criticism. This criticism is overblown, however, and Nokia is positioned for long term success. With over 400 million Windows users worldwide, Nokia chose a partner that has huge potential to expand its desktop domination to the mobile world.

Nokia partnered with Microsoft just as Windows Mobile became Windows Phone. Nokia chose an unproven platform as their exclusive smartphone operating system. In exchange for choosing Windows Phone, Microsoft granted Nokia special access to change certain parts of the OS, as well as supporting them with around $1 billion a year in payments. Nokia made the right decision for its short and long-term health. Google (NASDAQ:GOOG) does not support its vendors in the way Microsoft does. Microsoft spends a significant amount on advertising, while Google only advertises its own "Nexus" line of devices. Over $400 million dollars was spent advertising WP7 and this has continued with WP8. Even though sales of Lumias are beginning to pick up at Nokia, many have argued that adopting Android would be more beneficial to the company.

What if an Android Switch Occurred

Let's suppose Nokia does make the switch to Android. First, Nokia's large investment in its HERE mapping platform would be nearly worthless. Users of Android love Google Maps, and even if Nokia put its own maps on Android, the integration with Google's services would not be the same. HERE maps offer better mapping data in the smaller emerging markets where Google has not spent significant resources. Second, Nokia would be responsible for its own marketing. With the company burning through cash, Nokia's financials are not exactly sound at the moment. While Elop has done an excellent job cutting costs, the company is in no position to spend the hundreds of millions of dollars on advertising that Microsoft currently does. Third, Nokia would owe large amounts of money to Microsoft. This one may seem counterintuitive, but it is true. Windows Phone is not a free operating system, and Nokia pays Microsoft for using its software; however this is more than offset by Microsoft's payments to Nokia which total around a billion dollars annually. If sales ever pick up, these payments may reverse and have a net benefit to Microsoft (these payments are structured so the net benefit goes to Microsoft only if Nokia sells above a certain amount of phones). But if Nokia's phones used Android, they would owe a far larger amount to Microsoft. Both HTC and Samsung pay an estimated 10-12 dollars for every Android device they sell because of Microsoft's broad intellectual property portfolio. So Nokia would pay Microsoft regardless of what platform it uses, but only Windows Phone would allow Nokia to receive the net benefit.

Nokia's Niche

Nokia is begging to find its niche in an incredibly competitive smartphone market. Nokia makes a very capable phone in the Lumia 920, but it simply does not sell in the numbers that Samsung and Apple devices do. Despite this failure at the high end of the market, Nokia is beginning to have success elsewhere. While its flagship Lumia does not sell like the iPhone, its lower end Lumias are starting to take off. Take the Lumia 521, for example, which is selling at Walmart (NYSE:WMT) for $129 off-contract. It is a fully featured smartphone with a camera that is normally reserved for high end products. It offers excellent value and is aimed at those looking for a budget smartphone. Good luck finding one though; they sold out nearly one hour after online release at Walmart. The same situation is occurring in brick and mortar stores. I have checked 20 Walmart stores across the country and each was sold out. Nokia has found its niche in the market. By offering high end features at a very low price point, Nokia finally differentiated itself in a meaningful way.

Nokia followed Microsoft in its risky new product that is Windows Phone. The road has been incredibly difficult so far (Nokia's shareholders can attest to that), but the path ahead is much clearer. Nokia does not have to win the battle for the best smartphone, but they need to continue offering excellent value to the budget consumer that is not interested in Apple or Samsung's expensive phones. With Microsoft's financial support and differentiated software, Nokia has found a partner that just might be able to bring it back to life.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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