Microsoft Scared of iPhone Domination

With the iPhone released and selling like hot cakes across the nation, people are speculating excitedly over how many units Apple (AAPL) and AT&T (T) have actually sold to date. One group of people who's speculating over that not so excitedly is Microsoft (MSFT), who since day one of the iPhone's announcement in January have shown tremendous fear — but not on the surface.

It all started with Steve Ballmer's response to the iPhone on CNBC-TV. When asked what his first thought was after Jobs unveiled the device, Steve Ballmer laughs it off saying "500 dollars for a phone, fully subsidized? That is the most expensive phone in the world!"

Of course, you can expect Ballmer to ignore the LG Prada that comes with an $800 price tag, fully subsidized. But the real issue isn't the price. What's really telling of Ballmer's response is his typically somewhat-nervous laugh: as CEO of Microsoft, he knew best of all people how serious a threat the iPhone was to them.

Continuing the interview, Ballmer states "[Microsoft] is selling millions and millions and millions of phones a year, Apple is selling zero phones a year" (remember, this was January 17th). Millions and millions and millions — that sounds about right, given Microsoft's roughly 0.4% market share in the worldwide cellphone industry.

Remember: Apple's target goal for their first full year in the market, a market that Microsoft has tried to break into for many years now without much success, is a full 1%.

Microsoft has about 5.6% market share in Smartphones, which is a mere 6-7% slice of the overall cellphone industry. Translation: they sold about 4 million cellphones running Windows Mobile (any version) in 2006. That figure is up from 2 million in 2005. They've been around a few years longer, but thanks to people buying newer models replacing their existing ones, it's fairly safe to say that there are only, in total, no more than 7 million Windows Mobile phones in the world.

Apple's stated 10 million goal seems a lot more aggressive already.

Yet, the real kicker is what the iPhone really is: a fierce attack on many industries, companies and platforms. Above all, though, the iPhone is an attack on proprietary formats, one of Microsoft's core competencies.

The iPhone attacks:

The cellphone industry at large. Customer satisfaction in this industry is beyond miserable. As Steve Jobs himself said, Apple got into making a phone because everybody they talked to hated their phone. The iPhone is Apple's very profitable and clever way of saying "fix your act, guys". By gunning for a great deal of control in the industry, Apple's giving them no other choice but to.

Companies ranging from carriers to handset makers to OS makers to Opera. Aside from AT&T, what other companies are currently involved in the iPhone platform? Exactly none (other than the component manufacturers of course, of which one — Samsung — is amusingly also a competitor in the handset maker space). But the iPhone threatens several dozen by creating a new market space that they're all locked out from. Adobe in particular is being hit hard; iPhone's Safari doesn't support Flash; in addition, Adobe's Flash Lite — found on the LG Prada for instance — is being pushed as a great new mobile OS, but Flash Lite is years behind the version of OS X running on iPhone.

Proprietary codecs. Flash is used a lot on the web for video, but it requires a proprietary codec. The iPhone doesn't do Flash, instead, it supports h.264 — not just a superior codec for video, but also a vendor-agnostic one from MPEG. H.264 is an open format, just like AAC — which is pushing the proprietary WMV out of the market.

Microsoft's overwhelmingly dominant position in the desktop OS market has let it go ahead with proprietary systems and formats time and time again, keeping users locked in without being too obvious about it. And time and time again, Apple has had to fight them — both for its own survival, as well as the benefit of the user.

Now that Apple no longer needs to fight for its survival, it can be much more aggressive with new enterprises, such as the iPhone. Rather than being reactionary to whatever new proprietary scheme Microsoft may be concocting, Apple proactively wedges itself in a market that will play a key role in the future of computing and thus both companies: the mobile industry.

Portable devices are getting more powerful and widespread, and it's an industry where Microsoft would love to gain the same kind of market share they enjoy in the desktop world. By their very nature, these devices are becoming a simple extension of the desktop itself — the iPhone being the perfect real example of that. Not only that, it's also the first real threat to Microsoft from a desktop point of view: Linux-based cellphones (about 17% of all smartphones) weren't really convincing people to leave Windows behind and switch to Linux, but the iPhone may very well convince people to switch to a Mac.

Oh, and it would of course be terribly frustrating for Microsoft to see Apple enter a market and, in their first year, walk all over Microsoft's minimal success in that same market, despite many years of trying. If Apple were to manage only 10 million iPhones sold in 2008, they would strongly surpass Microsoft's sales of Windows Mobile phones, but if sales continue to go as well for the iPhone as they have so far, combined with the phone reaching Europe this fall, Apple may well sell over 10 million iPhones by the end of 2007; a mere six months, and even before a worldwide release at that.

All in all, Microsoft has a lot to lose if the iPhone does well. Their Windows Mobile is no competitor to the iPhone, their proprietary formats don't work on the iPhone, and their whole way of doing business — control by dominance and lock-in, rather than an emphasis on quality — is being threatened by it.

Microsoft may have been mocking the iPhone in public since its unveiling, but behind the scenes, there's almost no doubt that Microsoft is working hard to fight this new threat.

Disclosure: the author owns Apple stock at the time of writing.

Comments

[Tom B:]

The nice thing about the iPhone is that Apple makes money on each unit sold.

In the game console biz, Sony will be feeling pain for several more years before they defeat MSFT's Xbox, because both Sony's PS3 and MSFT XBox are sold at a loss, and MSFT has deep pockets (and, apparently, no brains). Hopefully, XBox's hardware issues will accelerate the decline of that platform.

2007 Jul 10 09:35 AM

[Daveed:]

I mostly agree with your points, but Apple is no angel when it comes to "open" vs. "proprietary". It's just that since the second coming of J. they've gotten quite competent at leveraging "open" infrastructure to boost their "proprietary" assets (like the iTunes store, the iPod connector, the middle and upper layers of MacOS X, etc.). You could say that while Microsoft goes the "embrace and extend" route, Apple goes the "embrace but wrap up" route. Both start off with "open" technology, and both end up with proprietary products.

Admittedly Microsoft's approach is more objectionable because its quasi-monopoly in desktop operating systems ends up polluting intrinsically open things (like public web pages) with non-open cruft (like IE-specific HTML). Apple's quasi-monopoly in the digital music commerce doesn't seem to have had an equivalent nefarious effect.

2007 Jul 10 10:45 AM

[sbmarshall:]

I'm sorry but take off the rose tinted glasses. There is no "good" or "evil" here, only self-interested parties pursuing "open source" when it benefits them most. Try managing your i-pod's library with a media program other than i-tunes, or swapping the battery on your i-phone if dies. Apple, for the most part, is a hardware company, therefore they favor "open source" software solutions. Microsoft, again for the most part, is a software company, therefore they favor "open source" hardware solutions (they don't much care what kind of phone or phone parts for that matter run their software).

2007 Jul 10 10:08 PM

[jbelkin:]

this isn't about who is or who isn't evil - after all both are for profit companies. The main difference is Microsoft tries to surround the market so you have no choice but them - except in the age of the internet, it's a non-starter strategy. Apple on the other hand simply decides what they want to do, if you want to use their products, this is our choice of a 'standard,' good or bad we don't care what you think, we picked on for whatever reason, you should trust us - if you don't, that's fine - we don't care - that is how they see LInux, Firefox or Flash. We are not going to publically attack them, we simply dismiss them as un-interesting or unworthy of our mention.

A separate issue is this again proves how inept MS is now - along with the billion dollar XBox writeoff. MS shareholders are suckers and idiots for not caring that the XBox has cost them a minimal $18 BILLION dollars loss in revenue and at least that in equity - even presuming they invested it with zero returns versus massive losses.

2007 Jul 11 02:42 AM

[Tom B:]

"this isn't about who is or who isn't evil - after all both are for profit companies."

Agreed. "Good" vs "Evil" is emotion-- not a basis for a sound investment strategy. The important thing is Apple has good PRODUCTS and MSFT doesn't-- and, even more importantly, the world is beginning to take note of that fact.

2007 Jul 11 09:55 AM

[Swampthing:]

IMO, both companies are living in a cloud.

Once 'ONE' of big companies buys up Neomedia Technologies, a company that has developed a 'one click navigation tool to find content on the mobile web' for the physical world, it will signal the others competitors demise.

When 'ONE' offers interaction with products around us. Once they wake up and truely go mobile, ONLY ONE, will be king.

Who will it be? In the mean time let them sling mud.

2007 Jul 11 01:36 PM

[Neil Anderson:]

Microsoft is right to be afraid. They’ve seen the future and it doesn’t involve them any way near the past’s extent.

2007 Jul 11 09:39 PM