Microsoft gives Windows phones one last shot

But analysts see the $7.6B write-off as a step toward an inevitable exit from mobile hardware

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Credit: Microsoft

Microsoft will continue to manufacture smartphones for its Windows 10 Mobile operating system, but the company has thrown in the towel on the devices strategy pursued by its former CEO and will probably give up entirely unless Windows 10 reverses years of missteps in mobile, analysts said.

After Microsoft wrote down $7.6 billion of its investment in Nokia and again reorganized, it will turn to a revamped, two-part strategy, one piece older, the other relatively new, the experts argued.

Microsoft's smartphones will follow the trailblazing of the more successful Surface tablet line, which after two years with little return hit its stride in 2014 with the debut of the Surface Pro 3. "We are moving from a strategy to grow a standalone phone business to a strategy to grow and create a vibrant Windows ecosystem that includes our first-party device family," CEO Satya Nadella told employees in an all-hands email Wednesday [emphasis added].

In plain English, the Lumia line will be relegated to a peripheral position -- the spot the Surface Pro 3 now occupies in comparison to the broader personal computing device market and best exemplified in smartphones by Google's "hero" Nexus handsets.

"Microsoft will have something very similar to where the Surface line is now," said Patrick Moorhead, principal analyst at Moor Insights & Strategy, in a Friday interview. "The idea will be to create inspiring hardware that motivates their ecosystem. They'll go after the 'halo' effect."

The second piece of the strategy kicked off more than a year ago when Nadella began a push to bring his company's services and software to the mobile platforms that matter: Android and iOS.

It's not over, yet

Windows phones will not disappear. Not yet. "I am committed to our first-party devices including phones," asserted Nadella, showing that, at least for now, Microsoft won't scrub Windows smartphones from its portfolio.

The reality, however, is stark: Even with billions poured into mobile, Windows powered just 2.7% of the handsets shipped worldwide last year, down from 3.3% in 2013, according to IDC. And because Microsoft was responsible for more than 95% of all Windows smartphones in 2014, a pull-back by the firm means there's little chance of changing the OS's fortunes.

Analysts have zero confidence that other makers will step up to fill the hole.

"Microsoft owns 95% of the business, and I don't see that changing," said Jan Dawson, chief analyst with Jackdaw Research, in an interview Wednesday. Although Microsoft made much last year about bringing in new partners -- in China and India -- that talk has gone quiet. Others, such as Samsung and HTC, have shown little interest in boosting their Windows line-ups. "Why would anyone get into [the Windows smartphone] business?" Dawson asked.

Jack Gold, principal analyst at J. Gold Associates, agreed. "The issue for me was always, if Microsoft owns Nokia, why would others want to make Windows phones? You're basically telling your OEMs [original equipment manufacturers], compete directly with us," Gold said.

Dumping the Ballmer strategy

Nadella inherited that scheme from his predecessor, Steve Ballmer, who oversaw the launch of the Surface tablet line in mid-2012, trumpeted a pivot to a "devices and services" strategy later that year and in the next pushed through the Nokia acquisition during his final months.

While Nadella repudiated Ballmer's strategy within months of taking control, Wednesday's write-off of almost all of the Nokia acquisition was a much bigger walk-back, with the current CEO putting his firm's money, so to speak, where his mouth was.

Even if Nadella wanted to bury the phone business, he can't. Not yet. There's been too much work put into Windows 10 in general -- Windows 10 Mobile specifically -- too much expended on emphasizing the goal of a single OS that runs on all platforms, too many resources devoted to making it easier for developers to port existing Android and iOS mobile apps to Windows.

Really pull the plug and all that would have flushed away.

"The timing just doesn't seem right for abandoning either Microsoft's first-party phone business or Windows Phone as a whole," said Dawson on his research firm's blog, where he elaborated on his analysis.

In effect, Microsoft is giving its phone business and the inextricably-linked Windows 10 Mobile one more chance to change the narrative.

"What was the point of the deal?" asked Dawson. "Was it to buy another couple of years or was it about driving significant growth? If it was the former, then maybe it gave Microsoft time to launch Windows 10. They're clearly banking on Window 10 for mobile."

Too little, too late?

But many analysts, including Dawson, remain unconvinced that Windows 10 can pull Microsoft's mobile chestnuts from the fire. "I continue to be very skeptical of Windows future on smartphones," Dawson said, calling the challenges "insurmountable."

"It was a mistake to begin with, a monumental mistake," echoed Gold. "But give Nadella a lot of credit for stepping up and realizing that 'If we're going to be in mobile, where can we leverage it?'" Microsoft has already answered his question, Gold added. "Microsoft's goal is to provide the back-end services to all devices. You don't need a big phone ecosystem of your own for that."

"It's going to very, very hard for them," added Moorhead, who agreed that Windows 10 was a "last step, or close to the last step," for Microsoft.

If that's the case, what's the end game for Microsoft and its former Nokia assets?

"I don't think [the new strategy] will make a significant change in Microsoft's fortunes," said Dawson.

He cited Nadella's email. "We plan to narrow our focus to three customer segments where we can make unique contributions and where we can differentiate through the combination of our hardware and software," Nadella wrote. Those segments: business customers, value-oriented buyers and loyalists, in this case those dedicated to running Windows.

But that's no focus at all, Dawson argued. Those are the customers all smartphone makers, excepting Apple, target; they're the very customers Microsoft has itself chased for years.

In the end, Dawson foresaw Microsoft discarding all its phone hardware business. Gold said the same. The write-down, Windows 10 and a truncated portfolio are only way-stops to the inevitable. "I suspect [Wednesday's] move is just another step along the road that eventually leads to an abandonment of this business, even if Microsoft isn't ready to concede defeat today," said Dawson.

That's not necessarily a bad thing. "If they really shut it down, it could be a positive long-term," said Gold. He contended that exiting the low-margin hardware business and devoting resources to software and services, with their bigger profits, would do Microsoft's balance sheet good.

"If Microsoft does [exit the smartphone hardware business], I think it is diminished," said Moorhead. "It will have lost a position of power. With the device and the OS, you can call a lot of the shots, as opposed to chasing the other ecosystems."

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