Microsoft's sale of feature phone biz erodes smartphone commitment

Sells the bare-bones feature phone part of the disastrous Nokia deal for $350M

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Microsoft today continued to undo its disastrous 2014 acquisition of Nokia's phone business, announcing that it is exiting the feature phone market, which it had once trumpeted as a critical component of its mobile strategy.

The sale of its feature phone business for $350 million prompted analysts to again question Microsoft's commitment to smartphones. "There won't be any more Lumia [smartphones]," said Jan Dawson, chief analyst at Jackdaw Research, in an email reply to Computerworld's questions today. "It does leave the door open for a new, narrower, phone strategy in the future."

In a statement Wednesday, Microsoft said it had sold its remaining Nokia assets, including its factory in Hanoi, Vietnam, to FIH Mobile Ltd., a subsidiary of Taiwanese contract manufacturer Hon Hai, better known as Foxconn, and to Finnish firm HMD Global.

The factory will go to Foxconn, as will most of the rest of its feature phone assets, including software and services, and customer and supply contracts. HMD Global will, as part of a larger deal with Nokia, acquire rights to use the Nokia brand, as well as some design rights. HMD will manufacture and sell Nokia-branded phones and tablets, all of which will be powered by Android.

In return, Microsoft will receive $350 million.

Microsoft has had to unwind the mammoth $7.9 billion acquisition of Nokia's phone business, which proved a monumental mistake on the part of former CEO Steve Ballmer.

Since Satya Nadella took charge at the Redmond, Wash. company two years ago, he has been walking back the deal.

In mid-2015, Microsoft wrote down the entire Nokia acquisition. According to filings with the U.S. Securities & Exchange Commission (SEC), the company recorded a charge of about $10 billion against earnings, an amount that included an accounting scrub of the purchase along with billions in reorganization and severance fees.

At the same time, Nadella spelled out what the repudiation of Ballmer's strategy meant for the company. "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," Nadella told employees in a July all-hands email. He also tapped three markets for a much reduced mobile device division: business customers, value-oriented buyers and Windows loyalists.

With the unloading of the feature phone component, the second of Nadella's sell-to segments was struck off the list.

Sales, whether of feature models or smartphones under the Lumia brand, have not only been disappointing since Microsoft struck the deal with Nokia, but have more recently gone into free fall. In Q1 of this year, Microsoft sold just 2.3 million Lumia smartphones, down 73% from the same period the year prior. The company sold 15.7 million feature phones in the first three months of this year, a 36% decline.

Phone hardware revenue was down 47% year-over-year.

How Microsoft explained the sale caught the eyes of analysts, particularly the omission of any statement of confidence in the Lumia line of smartphones, which continue to represent the vast bulk of Windows-powered phones.

The lapse made Dawson question Microsoft's vow to stay in the business. "It does seem odd that Microsoft didn't commit to launching smartphones in [the] future in this press release," Dawson said. "That suggests that there's at least some uncertainty about whether Microsoft continues to be committed to making smartphones."

Dawson left Microsoft a small window of opportunity. "[Microsoft's comments] fit with reports that we might see a Surface phone in 2017," he said, referring to rumors that Microsoft will double down on the Surface brand with a phone to match its tablets and 2-in-1s.

For its part, Microsoft said only that it would "continue to develop Windows 10 Mobile and support Lumia phones such as the Lumia 650, Lumia 950 and Lumia 950 XL, and phones from OEM partners like Acer, Alcatel, HP, Trinity and VAIO." But it was silent on any future Lumia models, and less surprisingly, didn't say anything about a Surface phone far down the road.

Carolina Milanesi of Creative Strategies had a somewhat similar take to Dawson. While she was expecting Microsoft to exit the smartphone hardware market entirely, she contended that the rumored Surface-branded phone might be positioned much like the original Surface and Surface Pro tablets: as a design benchmark to strut the capabilities of Windows 10 Mobile.

"Anyway, there are different ways to skin a cat in getting consumers," Milanesi argued, ticking off Microsoft's cross-platform apps for iOS and Android, and the services it's pitched to all comers, like OneDrive and Office 365.

Microsoft never seemed that enthusiastic about feature phones, although it did position them as a gateway to more expensive, expansive smartphones. As part of Ballmer's initial strategy, feature phones were to lead at least some consumers from those bare-bones devices to more sophisticated, if still inexpensive, smartphones. And from there to Microsoft's services portfolio, where they could be monetized.

That didn't pan out, perhaps because the approach was more an ex post facto rationale of the Nokia deal than a viable plan.

"Microsoft took the feature phone business [from Nokia] because it was only offered an all-or-nothing deal by Nokia," said Dawson. "It then had to justify acquiring a business that had no connection to the rest of Microsoft, hence the funnel rationale. But it always seemed like a stretch, and that's been borne out in reality."

"When they did the deal, there was some value to feature phones," said Milanesi. But that turned out to be a mirage, as very-low-priced smartphones from smaller manufacturers, many of them feeding local markets in the People's Republic of China, India and elsewhere in Asia, flooded the market.

No matter the details of today's sale announcement, the overall result remains gloomy for Microsoft in mobile hardware. "It's certainly the latest indicator of how Microsoft's commitment to its smartphone business has waned over the last couple of years," said Dawson in an analysis he posted to his research firm's blog today.

How Microsoft exits the market, assuming it does, will be just as telling. If Microsoft decides to halt smartphone sales -- as other analysts have expected for more than a year -- and can't convince third-party manufacturers to build and sell more Windows-powered devices, the company's overarching strategy of Windows 10 and its "Universal" app model, will be called into question.

And that cuts to the core of Microsoft's foundation for the future.

Copyright © 2016 IDG Communications, Inc.

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