Why Microsoft's $1 billion payment to Nokia is money well spent

Many people seem appalled that Microsoft will be paying Nokia more than $1 billion as part of a deal to put Windows Phone 7 on Nokia devices. That payment may sound like profligacy, but in fact, it's a good bet --- and the only way that Microsoft can possibly succeed in the smartphone market.

Bloomberg reports that Microsoft will pay Nokia more than $1 billion as part of the deal in which Windows Phone 7 will replace MeeGo and Symbian as the operating system of choice for Nokia phones.

That certainly sounds like plenty of money, and it is. But a closer look shows that it's not nearly as big a figure as it sounds. First off, the deal lasts for five years, which means that $1 billion translates into $200 million-plus each year. Microsoft spent $13.2 billion on sales and marketing and $8.7 billion on research and development in fiscal year 2010, and the company took in $18.7 billion in profits last year, according to GeekWire. So that $200 million a year, although a sizable expenditure, certainly isn't out of line with spending for what is perhaps the company's most important strategic product over the next five or more years.

In addition, Bloomberg notes that Nokia will pay Microsoft a fee for every copy of Windows Phone 7 it puts on Nokia devices. Given that Nokia, despite its current woes, is still the world's largest smartphone maker, with 37.6 percent of the market, Microsoft will be getting a significant revenue stream from the deal.

Business Insider did the math, and found that Microsoft will probably easily get enough revenue from licensing Windows Phone 7 to pay back its entire investment:

Nokia will have to sell more than 60 million phones, as Microsoft is estimated to charge no more than $15 per handset for Windows Phone.

That's quite likely, assuming Nokia's business doesn't collapse between now and 2012, when the deal is likely to start: Nokia sold more than 100 million Symbian handsets in 2010.

And beyond those licensing fees, it will be getting ad revenue as well.

The upshot? This is a very smart gamble for Microsoft. Without the Nokia deal, Windows Phone 7 was going to be an afterthought, crushed by the iPhone and Android onslaught. With the deal, Microsoft becomes a major player. The more than $1 billion it's spending will like prove to be a good investment. Without a successful mobile presence, Microsoft would be relegated to milking yesterday's technology; with a successful mobile presence it can compete against Google and Apple in tomorrow's most important market.

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