Microsoft Scared of iPhone Domination

Jul.10.07 | About: Microsoft Corporation (MSFT)

By Carl Howe

With the iPhone released and selling like hot cakes across the nation, people are speculating excitedly over how many units Apple (NASDAQ:AAPL) and AT&T (NYSE:T) have actually sold to date. One group of people who's speculating over that not so excitedly is Microsoft (NASDAQ: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.