Microsoft should have given up on Windows Phone while the getting out was good, an analyst argued last week.
Instead, the technology giant, rocked by a slump in PC sales and playing catch-up in mobile, decided to double down with a $7.2 billion deal to buy Nokia's handset business and license much of its patent portfolio, a move that will probably make the Redmond, Wash. firm the only smartphone manufacturer to rely on Windows Phone.
Ben Thompson, an industry observer and independent analyst who writes on his Stratechery.com website, was blunt in his take on the Nokia acquisition.
"The tragedy in the deal is that I think Microsoft ought to abandon Windows Phone," said Thompson. "The war is over, and iOS and Android won. It would be far better for Microsoft to focus on serving and co-opting those devices, instead of shooting the most promising parts of their business in the foot for the sake of a platform that is never going to make it."
Others have agreed with parts of Thompson's argument.
"My initial reaction, like many, was that this changes nothing," said Benedict Evans, an analyst at U.K.-based Enders Analysis, of the Nokia purchase. "Windows Phone is failing because of a classic vicious circle: consumers will not buy it because it has very few apps, and developers will not target it because very few consumers own one."
Both Thompson and Evans pointed out that with Microsoft's acquisition of Nokia -- the Finnish handset maker responsible for 84% of all Windows Phone sales -- other OEMs, lukewarm to Windows Phone at best, will simply drop the OS to focus fully on Android.
"Ownership by Microsoft will not of itself change the sales of Windows Phones. If anything, it will decrease them, since it prompts other OEMs to give up on it entirely," wrote Evans in a post to his personal blog last week. "It will not make more developers make Windows Phone apps or more consumers buy the devices. And it does little or nothing for Windows on tablets."
Absent a truly radical solution, Microsoft's hand was likely forced by Nokia's weak financial status, analysts have said. Microsoft was afraid that Nokia would fail, and take Windows Phone down with it. That theory got a big credibility boost on Friday when Nokia immediately drew on $2 billion in convertible bonds that Microsoft offered to buy as part of the agreement.
CEO Steve Ballmer, who last month announced he would step aside in the next 12 months, had the support of the Microsoft board of directors and its chairman, company co-founder Bill Gates, in the Nokia deal. Alternative strategies were either dismissed -- after all, Ballmer has been the driving force behind the pivot to a new "devices-and-services" strategy, again with the board's support -- or simply quashed. Doing anything else would have been unthinkable to the board, and if he had pressed it, it's likely Ballmer would have been immediately fired.
That didn't stop Thompson from advocating for Windows Phone's demise, positing that as a more viable long-term strategy than what Microsoft is now pursuing.
At first glance, the Nokia acquisition made sense, said Thompson in an interview Friday. "The acquisition of Nokia is certainly not a black-and-white situation, but on the surface if you are committed to a devices and services strategy, which Microsoft says it is, it does makes some sense, even if they had Nokia under their thumb earlier," he said, referring to the 2011 agreement under which Nokia bet everything on Windows Phone. "There are efficiencies that accrue [with owning the hardware], as Apple has demonstrated. But the problem with the acquisition is that I disagree with the underlying strategy that drove [the Nokia purchase]."
As Thompson saw it, Microsoft had a choice: It could either try to sell hardware -- the "devices" part of the strategy -- to a fraction of the potential market, or try to sell services to anyone and everyone with a connected device.
But Microsoft wanted all the cake. "Instead of choosing one or the other, Microsoft wants to do both," said Thompson.
And that's a bad move. Not simply because by doing all, Microsoft risks doing nothing well, but because its strengths clearly lie in the services side of the strategy.
"It's never been a hardware company," said Thompson. "I don't see any reason to expect that they now will become one. The danger is that the services that ought to be pushed, like Office 365, which could run on every platform, are going to die on the vine because of the emphasis on [Microsoft's own] devices."
Thompson was high on Office as a platform, in part because of its importance to the company's revenue -- in the most recently reported quarter, the division responsible for Office accounted for 36% of the firm's total, the most of any group -- but also because of Office 365, the software-by-subscription service Microsoft significantly expanded earlier this year.
"Over time, value moves up the stack," said Thompson. "First from the chip to the OS, then to the software, and on to the services. That's just the way technology goes. I think there's room for a premium service ecosystem built on their Office layer. Office is further up the stack than the OS, and they could leverage that to be the major player in the cloud."
In a post to Stratechery last week, Thompson was more specific in his advice. "They ought to pursue a strategy -- services -- that entails being everywhere," he wrote.
The problem is that while "services" is part of Microsoft's new slogan, the purchase of Nokia makes Thompson suspect that that half will not be the one calling the shots.
"The issue for Microsoft is that a services strategy and a devices strategy are fundamentally opposed to each other," he said [emphasis in original]. "Your services will be forever paying a strategy tax to support your devices, which won't even be fully differentiated."
The most prominent example of that "strategy tax" has been Microsoft's refusal to offer Office on Apple's iPad or Android tablets. Most experts believe that Microsoft has withheld Office from rivals' tablets as a strategic move to protect Windows and the tablets that it and its OEM partners sell. Microsoft also gives preferential treatment to Windows Phones, bundling Office Mobile, a subset of Office on the desktop, free with handsets running the operating system. But Android and iOS users must, if they want the same functionality, subscribe to Office 365.
In other words, Thompson sees Microsoft continuing to withhold services from rival platforms or making customers with Android or iOS phones pay for something Windows Phone owners get for free, missing out on the revenue the services would generate if the company wasn't using them as a carrot for its own hardware.
And the temptation to continue the practice will be enormous. Not only will Microsoft have reason to sacrifice service ubiquity -- it will naturally want its $7.2 billion investment to pay off -- but the revenue per unit from sales of a device will always be higher than the revenue per user from sales of services. It will be simply too tempting to drive devices at the expense of services.
Long before Microsoft bought Nokia, or even announced its corporate restructuring this summer, clues abounded that the company would try to mimic Apple -- with its high margins on hardware -- rather than Google, which relies on a service-based business model, in its case, advertising, to generate revenue.
"It's incredibly telling," said Thompson, "that [Steven] Sinofsky was not allowed to go to Apple or Google, but was allowed to go to Box, which could threaten [Microsoft] five years down the road.
As part of an agreement he struck with his former employer, Sinofsky -- who led Windows 7 and Windows 8 development -- was barred from working for Apple, Google, Amazon, EMC, Facebook, Oracle or VMware. Last month he signed up as an advisor to Box, a cloud storage vendor that has aggressively courted enterprise clients, the same customers Microsoft's after for its cloud-based services like SkyDrive and SharePoint Online.
Thompson obliquely blamed Microsoft's culture and history for what he saw as its shortsightedness. "The OS layer was a great place to be [because] it has high prices and high margins, but that layer doesn't exist in mobile. It's been eliminated in mobile, where things are much lower-cost [than PCs].
"From a cultural perspective, I don't think Microsoft has really processed the fact that owning the OS layer, and profiting from it, is no longer an option," Thompson continued.
Most analysts, however, have taken a much more conventional view of the Nokia acquisition.
"Ballmer said Microsoft would become a device and services business. And buying Nokia is the most logical way to get into the mobile device business quickly," said Jack Gold of J. Gold Associates, in an email.
"This purchase will enable Microsoft to better integrate hardware and software, in keeping with its strategy to deliver devices and services across multiple form factors," added Charles Golvin of Forrester Research in a note to clients. "Committing to a vertically integrated approach to smartphones is a logical step in line with Microsoft's stated new strategy."
So said researcher IDC, too. "IDC believes that the deal fits into Microsoft's new and broader strategy articulated by Mr. Ballmer in July. This post-PC strategy has shaped Microsoft's latest reorganization and the Nokia transaction provides the first glimpse of the new Microsoft in action," wrote analyst William Stofega in a client note.
Not surprisingly, Thompson didn't agree with the consensus opinion -- that Microsoft's move was necessary, rational in the light of its expressed strategy and ultimately correct.
"Microsoft ought to have their entire weight behind protecting their business turf and winning in the cloud and premium consumer services," said Thompson. "Clearly, Microsoft can't let go of their OS fixation. I think their Internet Explorer victory in the '90s has fooled them into thinking they have a chance today. The problem is that Web pages, theoretically, work anywhere; apps don't."
Gregg Keizer covers Microsoft, security issues, Apple, Web browsers and general technology breaking news for Computerworld. Follow Gregg on Twitter at @gkeizer, on Google+ or subscribe to Gregg's RSS feed. His email address is firstname.lastname@example.org.
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This story, "Kill Windows Phone or Risk Dying, Analyst Tells Microsoft" was originally published by Computerworld.