Here’s why Microsoft is buying Nokia’s phone business

September 3, 2013

(Robert Galbraith / Reuters)

Microsoft CEO Steve Ballmer may be on his way out, but he's planning to make a final big move before calling it quits. In a letter to employees released late Monday evening, Ballmer announced that Microsoft was acquiring Nokia's smartphone business. Microsoft will pay €3.79 billion ($5 billion) for the Finnish company's "Devices and Services" division and another €1.65 billion ($2.2 billion) to license the company's intellectual property.

The deal cements a partnership that has been central to Microsoft's mobile device strategy in recent years. Two years ago, Nokia announced that it would adopt Microsoft's software for its smartphones. The new deal would make that alliance permanent.

Why does Ballmer want to do that? His argument for the transaction is spelled out in a 30-page slide deck released in anticipation of a Tuesday morning conference call. The Redmond giant believes that deeper integration between devices, software, and services will be needed to compete effectively with Apple and Google's mobile ecosystems.

"Devices help services and services help devices," the presentation says. The company believes that more closely integrating the two will improve the user experience and help to "build a large user base." Such vertical integration, of course, has been essential to Apple's business model for the iPhone, and Microsoft has adopted a similar strategy for its Surface line of tablets.


(Microsoft)

Microsoft also believes that vertical integration will make it easier to finance the development of the Windows Phone platform. Right now, when Nokia sells a Windows Phone, Microsoft gets a "gross margin" of around $10 from the deal, while much of the profit from the sale flows to Nokia. That limits Microsoft's incentive to invest in the Windows Phone platform, since its partners capture a large share of the upside when the platform grows.

That will change once Nokia's phone business is part of Microsoft. Because the combined company will be supplying both hardware and software, Microsoft estimates it will enjoy a gross margin of $40 per phone sold. Microsoft plans to plow that extra cash into additional "innovation and marketing" to expand the platform's market share. Microsoft estimates that it needs to sell about 50 million phones to achieve "operating income breakeven."

Microsoft says it's not worried about getting a thumbs-down from regulators with authority over the deal, which is slated to close early in 2014. "The acquisition will promote competition," the presentation argues. "Integration of hardware and software will help Microsoft offer competitive alternatives to Google and Apple." The company argues consumers will benefit from lower phone costs and "more choice and innovation."

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