Microsoft reveals bankruptcy of devices strategy by dumping Nokia feature phones

Microsoft was right to ax the feature phone business it inherited when it bought Nokia’s handset business for $7.2 billion, analysts said today.

But while it was the smart move, it was also incredibly dumb: The vast portion of Nokia’s unit sales were not in Lumia smartphones, as Microsoft might have people believe, but in the ultra-cheap old-style phones that are still used by billions around the world.

“In my opinion, most, if not all, of the investment in Nokia went for naught,” said Jack Gold, principal analyst at J. Gold Associates, in an email reply to questions today.

Why? Because there’s little money to be made in so-called “dumb” phones, which in polite company are called “feature” phones, or even simply “mobile” phones to differentiate them from touch-based, computing-in-a-pocket smartphones.

“I don’t think the new management has the desire to be a full-service competitor in the smartphone market, and certainly not in the volume feature phone market where it’s even harder to make money,” said Gold in explaining his take. “Nadella and company looked at the business model for phones [of any kind] and decided, rightly so in my opinion, that there is very little if any money to be made there.”

Along with the job cuts Microsoft announced last week — showing the door to about half of the former Nokia employees — the company also said it would bail out of the feature phone business. On Thursday, BGR India published what it said were excerpts from a memorandum penned by Jo Harlow, who heads Microsoft’s phone side, part of the Devices group led by former Nokia CEO Stephen Elop.

“With the clear focus on Windows Phones, all Mobile Phones-related services and enablers are planned to move into maintenance mode, effective immediately,” Harlow wrote. “This means there will be no new features or updates to services on any Mobile Phones platform as a result of these plans.”

No services means no phones, not the kind of feature phones that Nokia has sold, and still sells.

The replacement for the dumped feature phones will be Lumia-branded, low-priced smartphones running Windows Phone. “We will be particularly focused on making the market for Windows Phone,” Elop said in his public message to the Devices group on July 17. “We plan to drive Windows Phone volume by targeting the more affordable smartphone segments, which are the fastest growing segments of the market, with Lumia.”

He didn’t mention the feature phone side of Nokia; nor did CEO Satya Nadella in a separate, shorter email to employees.

None of the analysts contacted by Computerworld was surprised by the vanishing act. “I’ve expected this,” said Sameer Singh, of Tech-Thoughts. “Nokia’s feature phone business did have high volumes, but the profit margins had become razor thin because of strong competition.”

“Dumping the mobile phone business makes a lot of sense,” echoed Charles Golvin, founder of Abelian Research and a former Forrester analyst. “Microsoft’s interest is in driving the Windows platform and Microsoft services, and while it might have been a possibility to customize those services to work on feature phones, they’re not a growth market. So the likelihood of doing that on more basic phones was dim, and not worth the effort.”

The exit from Nokia’s feature phone business was not what Microsoft talked about last year when it announced it would buy the Finnish firm’s handset division and license its broad patent portfolio. Then and later, lame duck CEO Steve Ballmer described the feature phones as potential “on-ramps” to more capable, and presumably more expensive, smartphones.

“I’ve never believed in feature phones being an on-ramp for Microsoft. Emerging market consumers have been dumping Nokia feature phones for Android smartphones for a while and I’m not sure that could have been reversed without incurring major expenses,” said Singh.

Golvin concurred. “It’s been demonstrated that customers in emerging markets are interested in and willing to use smartphones, providing they’re priced appropriately and the associated operator services are priced reasonably,” he said.

A huge part of that switch from feature to smartphones has been driven by device makers selling Android-based smartphones for less than $100, sometimes considerably less, drastically narrowing the price differential between those models and a Nokia feature phone, which Singh said sold for an average of $35.

In other words, Microsoft saw the writing on the wall and got out while the getting was, if not good, then better than if it had stuck to the feature phone guns.

“Given the hand Microsoft’s new leadership team was dealt, I think it’s a very smart move,” said Singh. “Best to cut your losses now before the unit starts to bleed money.”

Nor was it a shock to the experts that Microsoft decided to shutter Nokia’s feature phone division rather than, say, try to spin it off or sell it.

“Is there a possibility of selling off the core of that business? Perhaps, but it would likely have to go ‘on the cheap,’ as who wants to buy a business that you don’t want to run?” asked Gold. “An acquiring company could get the Nokia brand and a distribution channel, which could be very valuable for a newcomer in the market, perhaps one from the Far East who wants to go worldwide. But they would pay far less than the price Microsoft bought it for.”

But by dropping such a huge part of Nokia — half its employees, the biggest driver of unit sales — Microsoft showed the bankruptcy of the “devices and services” strategy that Ballmer used to justify the acquisition.

“Ballmer had the idea of being a devices and services company to compete head-to-head with Apple, and to a lesser extent Google,” said Gold. “This was not a well thought-out plan, and the new management rightly understands it won’t work.”

“I never thought that the move [to acquire Nokia] was the right move,” asserted Golvin. “I understood the logic and motivation, that Microsoft and Windows and its services need to be on mobile phones and tablets, but Microsoft believed it was faced with a choice of either buying Nokia or not having a presence in mobile. I don’t think that was really the choice. There were other things they might have been able to do.”

Among those alternate universe options, said Golvin: Foregoing Windows Phone licensing fees, as it ended up doing months later, but making that policy permanent, which the current practice may not be, and doing it much earlier.

As it turned out, Microsoft spent billions to buy Nokia, then 11 months after the announcement, three after the deal closed, it must spend another big chunk of money shuttering most of the acquisition’s assets.

“They got a few engineers and some technology, but mostly they got burdened with a manufacturing organization that was in decline,” said Gold. “And now Microsoft will have to spend even more shutting down plants and laying off workers.”

In a a filing with the U.S. Securities and Exchange Commission (SEC) last week, Microsoft said it expects to book pre-tax charges of $1.1 billion to $1.6 billion over the next four quarters to account for its downsizing. The bulk of that — $750 million to $800 million — will go for severance and related benefit costs, while between $350 million and $800 million will take care of what it called “asset-related charges.”

Microsoft declined to comment when asked about the purported Harlow memo. “Microsoft Devices does not comment on market rumors or speculations — right now we can only confirm what Microsoft announced publicly regarding their plans for the future,” a spokeswoman said via email today.

Nadella, is expected to reveal more about his future plans during Tuesday’s earnings call with Wall Street analysts. That call will start at 2:30 p.m. PT, 5:30 p.m. ET

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 gkeizer@computerworld.com.

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