Microsoft’s Nokia Acquisition a Deal It Had to Make

The day after Labor Day weekend, Microsoft dropped a smartphone bombshell on the mobility crowd—well, at least among tech geeks. Microsoft bought Nokia’s smartphone business, intellectual property and licenses to its patent portfolio for $7.17 billion, which some consider to be a cheap price tag for a company with a five-year sliding stock price and dwindling market share.

At first, the deal didn’t make a lot of sense for Microsoft since Nokia already makes Windows Phone smartphones, notably the Nokia Lumia. Nokia’s sales account for 80 percent of all Windows Phones. When word of the deal hit Wall Street, Microsoft’s stock dropped six percent (which is typical, given that the acquirer is taking on debt) and Nokia’s stock rose 35 percent.

Yet the question remained: Why would Microsoft buy its largest partner in the smartphone business?

In an interview with AllThingsD, Steve Ballmer says he expects to reap marketing and operational efficiencies, as well as the capability to innovate better from a hardware-software perspective. Think Apple’s iPhone and iOS under one roof.

The acquisition will also allow Microsoft to make business decisions and take advantage of market opportunities more quickly in a rapidly shifting mobile landscape.

Microsoft Needed to Do Something

It’s clear Microsoft needed to make a move in the smartphone market. Its market share is a paltry four percent. Meanwhile, Android phone sales are soaring. Apple is expected to unveil the next-generation iPhone, as well as cheaper iPhones targeted at the middle- to lower-end of the market, next week.

Microsoft’s margins will rise considerably with the combination of Microsoft’s and Nokia’s margins on a single smartphone sale, as Microsoft pushes forward into the hardware game. The Nokia deal is another nail in the coffin for Microsoft’s old business model; in today’s disruptive mobile world, you simply cannot make profitable software on commodity hardware, writes Slate’s Farhad Manjoo.

“We know, as we scale, we need to invest behind this business,” Ballmer told AllThingsD. “It simplifies the business decision-making and thinking having the economics be more unified.”

Nevertheless, boo birds were quick to sound off. Many cited Microsoft’s poor track record in mobile hardware acquisitions and branding as a foreshadowing of things to come.

“Although Nokia’s mobile hardware development capabilities and [intellectual property] library are still best-of-breed, Microsoft’s real mobile challenges are internal, not external,” says Hyoun Park, principal analyst at Nucleus Research.

“Microsoft is the company that turned the wildly popular Sidekick into the Kin and turned Windows RT into a $900 million tablet write-off. For Microsoft-Nokia to succeed, Microsoft has to make sure that it doesn’t destroy Nokia’s strength as it transitions from partner to owner.”

Bonus: Microsoft Gets Top Exec and CEO Candidate

One of the keys to success will be Nokia CEO Stephen Elop, who will be giving up the mantle to interim CEO Risto Siilasmaa to run what’s left of Nokia, now a shadow of its former self. Elop will become Microsoft’s executive vice president of devices and services.

“Microsoft typically doesn’t do mergers well, and this is a large one,” says tech analyst Rob Enderle. “However, Elop knows the ropes and likely helped orchestrate [the deal] in order to fix the rift between hardware and software that was adversely affecting his execution.”

Elop’s arrival in Redmond also signals a potentially larger role in the making. Late last month, Ballmer announced he would be retiring as soon as Microsoft finds a replacement, and the Nokia deal puts Elop on the short list for the top spot.

“Even if he doesn’t get that, he will be in a strong position to protect Nokia, so I think this is an improvement over what they had,” Enderle says. “Unless Elop leaves, which is doubtful given Ballmer’s departure, this one should improve Microsoft’s position sharply.”

Tom Kaneshige covers Apple, BYOD and Consumerization of IT for CIO.com. Follow Tom on Twitter @kaneshige. Follow everything from CIO.com on Twitter @CIOonline, Facebook, Google + and LinkedIn. Email Tom at tkaneshige@cio.com