The Future of the Mobile Wireless Device Market (Part 2)

 |  Includes: MSFT, NOK, VZ
by: Logan Smyth

<<<Return to Part 1

Nokia (Symbian OS, MeeGo OS)
Nokia (NYSE:NOK) is, in my opinion, in one of the most challenging positions of any company competing in the mobile device market. This might sound crazy to some readers because Nokia is the largest manufacturer of mobile phones worldwide. However, Nokia’s management team has failed to navigate recent changes in the mobile device market, placing the company in a very challenging position. Nokia’s business is currently being kept afloat by high-volume sales of low-margin devices, which explains the company’s anemic 2-3% profit margin. However, the entire mobile device market is quickly shifting to higher-end smartphone devices. Even Nokia’s smartphone sales are skewed towards cheaper, lower-margin models rather than its higher-margin flagship devices. Further, the massive increase in competition is causing Nokia to hemorrhage market share at an alarming rate.

I believe this problem stems from a lack of focus and not fundamentally understanding the future of the mobile device market. Take for example the launch of Nokia’s Ovi store, the company’s attempt to compete with rival app stores. Nokia claimed that at launch the Ovi store would include 20,000 “items”, though, that was a gross overestimate. Apparently “items” was referring to apps, widgets, music, videos, wallpaper, and ringtones, which a Nokia executive referred to as a “jambalaya.” In my mind, this was an attempt to claim the Ovi store had more offerings than rival app stores, but in reality it was padded with poorly organized clutter. Further, after launch, the store was plagued with problems worldwide prompting Nokia to issue an apology to users. Of particular interest, George Linardos, head of products at Nokia’s media group, said that the Ovi Store “has been outpaced by Apple” and that the company has “screens up in [their] offices running Twitter feeds [of gripes] all day long.”

While the Ovi store debacle may just be one example of Nokia’s lack of focus, I think it is a good example of a broader problem. Nokia’s lack of focus is also affecting the future of its mobile operating system. Software developers are crucial to the success of a mobile operating system, but they are unlikely to develop software for one whose future is uncertain. Currently, Nokia has two mobile operating systems in development, Symbian and MeeGo. Nokia’s current smartphones run on Symbian, although Nokia has stated that future high-end N-series devices will make the switch to MeeGo going forward. Adding further complexity, Nokia has said that it will not abandon Symbian altogether, opting instead to use Symbian for mass-market devices. By singling out MeeGo for higher-end devices, Nokia is gambling its flagship products on the assumption that developers will be willing to create software for yet another new mobile operating system. Given the number of competitors already on the market, this seems like a rather large assumption.

Frankly, at this point Nokia’s plan for high-end devices seems to be in disarray. They desperately need a newer, more competitive mobile operating system, but they are taking a large risk by trying to start anew with so many competitors already in the space. I believe that is why Nokia is attempting to develop both mobile operating systems simultaneously, though, I suspect this will diminish developer interest in either. Nokia has restructured their management teams and is even in the process of searching for a replacement CEO because of how poorly their smartphone business has been managed. In my opinion, Nokia is a company that has spread itself far too thin. They have plenty of expertise in manufacturing the phones themselves, but fail to outline a clear vision for future products. The company has over 100 different models currently in use and 5 different form factors. While that may help Nokia to sell phones in every possible market segment, it makes it far more difficult for developers and more complicated for users seeking compatible software. They would greatly benefit from narrowing their focus and ensuring a cohesive user experience, however, they seem unwilling to do so. This is reminiscent of the next company I would like to look at in depth…

Microsoft (Windows Mobile, Windows Phone 7)
Microsoft (NASDAQ:MSFT) is quite possibly the quintessential example of a company that had the first-mover advantage, excess cash, and massive development resources, yet, squandered their unique market position. While the smartphone market may not have gone mainstream until recent years, Microsoft has been active in the space for the past decade. Its original offering, Pocket PC 2000, was succeeded in 2003 by their current offering, Windows Mobile. Yet despite their massive head start, Windows Mobile made up only 8.7% of smartphone shipments worldwide in 2009, down from 11.8% in 2008.

Microsoft is attempting to combat its massive failure with Windows Mobile by starting completely from scratch and releasing a new mobile operating system dubbed Windows Phone 7. The new mobile operating system was announced in February at the Mobile World Congress expo, although it won’t be available on devices until the end of the year. Bare in mind, this is almost a full three and a half years after the original iPhone went on sale. This slash and burn approach of creating a completely new mobile operating system is very similar to Palm’s (NYSE:HPQ) departure from its Palm OS, to the completely new webOS. There are certainly differences between the two, but my guess is they will have similar results.

One of Microsoft’s largest advantages is its massive network of industry partners (Dell (NASDAQ:DELL), HTC, Samsung (OTC:SSNLF), LG, etc) and its longstanding relationships with them. Microsoft definitely intends to leverage these partnerships to make sure there are plenty of Windows Phone 7 devices when the platform launches this holiday season. However, simply because there are phones on the market does not mean consumers will buy them. Microsoft is planning on keeping its licensing model used for Windows Mobile. This means that carriers will have to pay a license fee for each phone running the new Windows Phone 7 mobile operating system – likely between $5 and $20. This begs the question, will consumers be willing to pay a premium for a Windows Phone 7 device when Google (NASDAQ:GOOG) is giving away its Android operating system for free? Competing mobile operating systems already have vast libraries of apps, large installed user bases, and more of consumer’s mindshare.

Adding to the difficulty, legacy Windows Mobile apps will not run on Windows Phone 7. This means Microsoft will desperately need to court developers to design and build apps for their new mobile operating system. Microsoft is in a very difficult position because the new mobile operating system will not succeed without software, but developers may not be interested because it has no installed user base. Take for example this quote from Skype’s VP Dan Neary, “We try and focus not only where the need is but where the best experience is, and we feel that the best areas for us to develop are on the operating systems that we currently support – [iOS], Symbian, BlackBerry and now Android.” If other major developers share this same sentiment, the future does not bode well for Windows Phone 7. Considering Apple (NASDAQ:AAPL) already has north of 200,000 apps and Google has over 100,000, I would hardly be surprised if Microsoft is forced to pay developers to create apps for Windows Phone 7 simply out of necessity.

Despite launching a new mobile operating system with 5 competitors already on the market, I think Microsoft may actually have an even bigger hurdle. Few may have heard of Microsoft’s new duo of teen-focused social networking phones, the Kin One and Kin Two. However, they may go down in history as one of Microsoft’s biggest flops of all time. After 48 days on the market and lackluster sales, Microsoft effectively pulled the plug on the project and diverted its resources to the Windows Phone 7 team. While this may seem like a smart move, a little background information here reveals a much larger problem.

The Kin was a result of Microsoft’s acquisition of Danger, the company that made the popular Sidekick phone. During the Kin’s development, Microsoft decided the phone’s OS should be rewritten based on Windows CE, pushing the launch date out about 18 months. Originally, Microsoft had negotiated bargain-basement data plans for the Kin with Verizon (NYSE:VZ). However, as a result of the delays Verizon soured on the deal and the Kin launched with Verizon’s standard $30 smartphone data plan. This has apparently created a tiff between the two companies, prompting Microsoft to possibly snub Verizon as a launch partner for Windows Phone 7 and launch exclusively on GSM carriers. That’s right…it is possible that Microsoft will not be launching Windows Phone 7 on Verizon or Sprint (NYSE:S), at least initially.

I cannot emphasize how truly massive a mistake this would be for Microsoft. Much of Android’s success is due to Verizon embracing the platform and heavily promoting it as a viable competitor to the iPhone. If Microsoft plans to launch Windows Phone 7 without Verizon and Sprint, that leaves only AT&T (NYSE:T) and T-Mobile in the US. Ignoring last-place T-Mobile, Microsoft would effectively be launching a first-generation product on AT&T against the fourth-generation iPhone. Unless Microsoft can mend its relationship with Verizon in the coming months, they should prepare to get slaughtered when this product hits the market.

Another critical issue for Microsoft is their tablet computing strategy. Once again, this is an area that Microsoft actually pioneered at the beginning of the decade, yet, failed to achieve mainstream success with. Originally marketed as Windows XP Tablet Edition, Microsoft’s tablet strategy consisted of modifying its Window’s operating system to allow stylus input. The hardware built to support this version of Microsoft’s Windows operating system left much to be desired. The most prominent form factor was the convertible laptop, a laptop whose screen could be rotated and closed to allow use of the stylus. However, the overall package was simply too cumbersome. Full-fledged desktop operating systems were never intended for stylus navigation. Further, convertible laptops weigh too much to hold with one hand for extended periods of time, limiting their mobility. While these devices offer tablet functionality, they are not tablets in the truest sense of the word. Nowadays, tablets are thought to be lightweight, portable devices that rely solely on a large touch screen for all input and navigation.

In early June, Microsoft unveiled several prototypes of true tablet devices at the Computex trade show in Taipei. Also unveiled at this trade show was another mobile operating system dubbed Windows Embedded Compact 7, or Windows CE 7 for short. Microsoft is pitching this poorly named mobile operating system as an additional solution for the tablet form factor. Microsoft has stated that it will not be capable of running Windows 7 applications and it seems unlikely that it will be able to run Windows Phone 7 apps. This would mean that developers would need to create software for yet another mobile operating system, which would only be available on tablet devices. Also a mystery is whether there will be an app store of any kind, although this seems necessary to be competitive.

What is interesting here, though, is how Microsoft’s tablet strategy differs from its smartphone strategy. Windows Phone 7 has one consistent user interface that will be identical on all devices, regardless of manufacturer. With Windows CE 7, however, manufacturers are able to design their own user interfaces. While this may provide a greater variety of tablet options, it will no doubt create an entirely different user experience than Windows Phone 7. One of the devices revealed alongside this new mobile operating system was the Asus Eee Pad. However, Asus has already announced that when the device ships, it will be running Google’s Android instead.

As I outlined earlier, there are three factors that I believe will decide the fate of a company’s mobile strategy – software, scalability, and fragmentation. Despite neither mobile operating system actually shipping yet, Microsoft seems determined to fail. By creating two entirely different mobile operating systems for smartphones and tablet devices, they are creating two distinctly different user experiences. This simply seems counterintuitive given the similar nature of both mobile devices. Further, the lack of software compatibility between the two platforms practically ensures a fragmented user experience. It seems like Microsoft is in for quite the uphill battle, although the company has brought much of it upon itself. I’m sure there will be some software available for these mobile operating systems when they launch, but I expect the selection to be rather minimal. It also seems unlikely that many software titles will be available for both platforms at launch. The only way I can see this strategy working is if Microsoft can create a very cohesive experience across all devices by the time products hit stores. However, based on the information available so far this seems extremely unlikely.

I understand that Microsoft is a software company and they try to provide hardware manufacturers and end users with a variety of options. It seems to me, though, that Microsoft is providing too many options, instead of focusing on delivering one familiar user experience across all devices. For years it has been my belief that the writing is already on the wall for Microsoft. In the past decade they have been too complacent and far too slow to deliver desirable products to market. I believe much of this failure falls on the shoulders of Steve Ballmer. As a CEO he is simply too reactive for a technology company, an industry defined by innovation and forward thinking. One needs to look no further than Microsoft’s stock’s performance over the past decade relative to its peers for confirmation of that. Since Steve Ballmer took the helm at Microsoft in January of 2000, Microsoft’s stock is actually down 55%, despite growing revenues from $23 billion to $54 billion. In the same time period, Apple and Google’s stocks have returned 920% and 354%, respectively. It is my belief that while he may be an effective CEO from an operational standpoint, he will eventually be ousted as a result of Microsoft’s failure to extend its dominance into the crucial mobile device market.

Analysts’ recommend Microsoft for many reasons, namely its massive market share, cash flow, and cash reserves. Given Microsoft stellar earnings announcement for the most recent quarter, this may be sound advice. However, I struggle with the notion of investing in a company that fails to understand the future of its market and relies heavily on legacy products. I believe I’m not the only one who feels this way, either. HP’s recent acquisition of Palm may as well have been a vote of no confidence in Microsoft’s mobile offerings. With that in mind, let’s delve deeper into HP’s acquisition of Palm and what it means to their future product lineup…

>>> Go to Part 3

Disclosure: Long GOOG, Long AAPL