Microsoft Is Shooting Itself In The Foot By Acquiring Nokia

| About: Microsoft Corporation (MSFT)

Steve Ballmer might be in his final few months as Microsoft (NASDAQ:MSFT) CEO, but the man certainly knows how to go out in style. After announcing Microsoft's "One Microsoft" strategy to focus on devices and services in July, Ballmer dropped a bomb last month when he said he would be resigning within the next 12 months.

Microsoft shares jumped on the announcement, but it seems Ballmer had one card still left in his pocket. On Sept. 2, Microsoft announced that it would be acquiring Nokia's (NYSE:NOK) "devices & services business, license Nokia's patents and mapping services" for a total of $7.17 billion. This is the final piece of the puzzle in Microsoft's new strategy as the company has now bought a device maker and it can now focus on its operating system, cloud computing initiatives, devices and apps.

The acquisition also brings former Microsoft executive and Nokia CEO Stephen Elop back to the Windows maker, who has been touted as one of the candidates to take over from Ballmer going forward. All of this -- the reorganization, Ballmer's resignation and now Nokia's acquisition -- looks like a well-tailored move to change the direction of the company to devices and services.

Wrong move

But what Microsoft is essentially doing is that it is turning itself into a Google (NASDAQ:GOOG) and Apple (NASDAQ:AAPL) hybrid, which looks dangerous. After Microsoft's own foray into making devices floundered (remember the Surface tablet and the $900 million write off), it looks like the company took the easy way out and decided to acquire a struggling smartphone maker.

This is probably not going to help Microsoft much and it won't be surprising if we see another big write off down the line. The reason is very simple -- Nokia is being beaten left, right and center by various competitors. According to Gartner, Nokia's mobile phone sales fell to 61 million units in the second quarter of 2013 from 83 million units in the year-ago period.

Feature phones were Nokia's stronghold at one point in time but the rise of Chinese smartphone makers such as Xiaomi and Indian brands such as Micromax have hurt sales. In China, Xiaomi has been making huge strides growing its business and its flagship Mi 2S beat Samsung's Galaxy S4 in the first half of the year as reported by TechCrunch. To put things into more perspective, Xiaomi's valuation is now put at $10 billion, which is substantially more than what Microsoft is paying for Nokia.

China is the world's fastest growing smartphone market and Nokia's device and services revenue in the region fell 57% in the second quarter. The company is expecting its low rung Lumia devices such as the Lumia 520 to drive sales, but the presence of strong competitors such as Xiaomi, Samsung, and Apple's expected iPhone 5C will limit room for growth.

Nokia's share of worldwide mobile phone sales fell to 14% in the second quarter from almost 20% in the year-ago period according to Gartner, while Microsoft's share of the mobile OS market inched up to just 3.3% from 2.6% in the year-ago period. This statistic is enough to show that Microsoft's latest acquisition might prove to be unwise, since Nokia is the primary user of the Windows Phone OS and it hasn't been able to move the needle substantially so far.

Too late to the party

If Microsoft thinks that it can turn Nokia's business around by integrating it into its own structure and making cutting-edge devices, then it needs to just look at its Surface fiasco once.

By acquiring Nokia, Microsoft is closing its OS, and is probably looking to take a page out of Apple's playbook by taking over its operating system and devices completely.

But it is probably too late now for such a strategy to succeed. Apple's OS is now in its seventh generation and the company has a wide customer base. It set out early to integrate the user experience across devices -- iPhone, MacBook, iPod, iPad etc. So what Microsoft probably intends to do now is already executed, and executed very well, by Apple.

Apple has created an ecosystem and locked in users. That's one of the reasons why users like me would think twice before switching platforms considering the effort and cost. In addition, Apple is looking to expand its reach further by introducing a mid-range iPhone to capture the emerging markets such as India and China.

Nokia was earlier expecting good sales of its budget Lumia devices in China but that proposition looks to be in danger now. Apple has been rumored to be in talks with China Mobile (NYSE:CHL). A deal will open up more than 700 million subscribers of China Mobile for Apple and a budget iPhone for China looks like the right way to benefit from smartphone growth in the country.

But Apple is not beating Microsoft only in smartphones. Microsoft's Windows software sells on the back of Windows-powered laptops and notebooks, but there's a change that's happening here as well.

Apple's MacBook Air has been beating Windows Ultrabooks in sales. Through the end of May, Apple's MacBook Air captured a whopping 56% of thin-and-light laptop sales in the U.S. Moreover, it is expected that the Intel Haswell powered 2013 MacBook Air will further push back its Windows-powered rivals. A cheaper iPhone and greater sales of Apple's MacBooks will certainly widen its ecosystem.

Even though Windows PCs dominate the world, the Windows Phone OS hasn't caught on and is growing at a snail's pace. Tough competition from Apple and Google has been too much to handle for Microsoft so far and spending more than $7 billion on Nokia might not change things further as the company has its legs in two different boats.

Another distraction

Getting ahead of Apple, Samsung and other Android-using smartphone makers looks like a far-fetched idea right now. Microsoft might have further difficulty in competing against Google in various services as it will have one more acquisition to integrate and its recent history (the aQuantive and the Surface write down) doesn't look good either.

Microsoft thought that it would be able to compete better against Google by acquiring aQuantive in 2007, and it shelled out $6.3 billion for it. Five years later, it wrote down $6.2 billion. Microsoft's Bing commands just 17.9% of the search engine market in the U.S. while Google leads with 67%. A look at the mobile search engine market reveals more polarized results as Google commands a staggering 90% of the market and Bing sits at a lowly 2.83%.

Now, with Nokia's market share in mobile phones falling and Windows Phone market share growing at a very sluggish pace, Microsoft's acquisition won't probably enable it to make much headway in mobile search either. The advantage that Google has is that it licenses its software to various smartphone makers and this has worked well for it.

Google's various services -- Gmail, YouTube, Google Maps etc. -- are very popular and this has helped sales of Android phones, while Microsoft's own apps aren't that cutting-edge according to me. Microsoft has already tried the Google way of licensing software and didn't succeed. And now, the company is trying the Apple way but it is probably too late. Has Microsoft shot itself in the foot once again with its Nokia acquisition? You are welcome to weigh in with your comments below.

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.