Microsoft’s Mobile Comeback: Fantasy or Possibility?

It was one of worst predictions in recent memory. In a 2007 interview, former Microsoft CEO Steve Ballmer said, “There’s no chance that the iPhone is going to get any significant market share. No chance.”

It reminds us of when Sir William Preece, an official with the British Post Office, weighed in on an earlier incarnation designed by Mr. Bell, not Mr. Jobs: “The Americans have need of the telephone,” said Sir William, “but we do not. We have plenty of messenger boys.”

To make matters worse, Ballmer predicted that Android would also fail, since Google wasn’t charging a licensing fee to its OEMs. Of course, he was talking his own book. But it still stands out as intensely blind to what customers really wanted.

However, today Microsoft has thrown everything the company has at mobile. It’s dropped the pen and embraced touch in every version of Windows (poorly, many have said). It’s spending millions advertising its phones, and billions to acquire the only notable company still making them. Is it all too late? Or can Microsoft rise from the ashes and find another multibillion-dollar business to add to its stable?

A Two-Man Race

A look at the market-share numbers illustrates just how spectacularly wrong Ballmer was about the iPhone and its operating system (iOS) and Android.

As you can see, Android and iOS currently control over 90% of the US and global markets, forming a true duopoly, with both systems having a meaningful share.

With global share of less than 8% in 2010 and deteriorating to less than 4% in 2013, Microsoft is currently irrelevant in the smartphone market. Is this because the company was late to the party?

Not really. Microsoft actually got a head start in the market, launching its first smartphone (the Pocket PC 2002) in 2001. New models under a new name (Windows Mobile) were launched annually in four of the following five years and, incredible as it might now seem, the company actually became a market leader in those halcyon days. By Q1 2004, Windows Mobile had captured 23% of worldwide smartphone sales; and in 2007, US market share peaked at 42%.

However, shortly thereafter, the wheels started to come off. In 2008, US and global share fell to 27% and 14% respectively. By 2010, Windows Mobile was a bit player with US share of 7% and global share of 5%.

What Happened?

So how did Microsoft lose its place in one of the biggest and most explosive markets in history? It wasn’t because of timing: the company was a smartphone pioneer. It wasn’t because of a lack of resources: when Windows Mobile’s share peaked in 2007, Microsoft had $21 billion in cash and equivalents, free cash flow of $15 billion, and an R&D spend of $9 billion… surely enough financial wherewithal to at least maintain, if not gain, share.

“They had everything they needed to execute,” said tech analyst Raven Zachary in a Wired article. “It was theirs to lose and they lost it.” Well, something was lacking—what was it? In a word, vision.

While Apple was designing a consumer-centric product that would redefine the utility of the mobile phone from a mere communication device to a lifestyle product, Microsoft remained PC- and enterprise-centric in its development of smartphones. This tunnel vision was on full display when in 2007, Ballmer based his prediction of failure for the iPhone on the fact that it lacked a physical keyboard. And it caused Microsoft’s product developers to miss the importance of mobility, touchscreens, and an extensive apps ecosystem. By the time the company realized its error, it was way behind the competition.

A Lost Cause?

Should Microsoft just give up on the devices market altogether? Yes, say some industry analysts, including Chetan Sharma. “(T)here is little appetite or need for another platform”, says Sharma. “Microsoft might be better off giving up on its device dream and just focus on services on top of the platforms that dominate.”

It could be that Microsoft will do just that. Abandonment of, or perhaps apathy toward, the developed markets, particularly the US, appears especially sensible. In those maturing markets, brand loyalty among users is highly developed, users are “locked in” to platform ecosystems, and carrier (e.g., Verizon) support is firmly established. Since these factors are self-reinforcing, the incumbent systems (i.e., Android and iOS) aren’t apt to be seriously challenged in the foreseeable future. Persuading significant numbers of users to switch to a smartphone with a Microsoft platform (now called Windows Phone) would be a tall and expensive order. With Microsoft’s flagship Office programs now arriving for iPhone and iPad alike, there are signs the company may be admitting it has lost the battle for the OS, and relegating itself to app provider alone.

But all may not be lost in the OS war, either, which would be good news for the Windows Phone and any other platform provider that missed out on the developed markets. There’s a next wave of smartphone uptake that will be coming from emerging markets over the next three to five years. Stoked by growing economies and increases in real income, there will be mass migration from feature phones to smartphones in these markets. And the numbers will dwarf anything we’ve seen before.

It’s a second chance for Microsoft in the platform business, and if it can execute, the impact on the company’s revenues could be significant. For example, if Windows Phone can capture share of 15% in emerging markets by 2017, with an average sales price of $150 per device, the resulting revenue would be well over $20 billion. That’s almost 25% of fiscal year 2014’s total revenue of $87 billion.

But is there any reason to believe Microsoft will succeed this time? Some people think so, and here’s why:

• Nobody is entrenched: Smartphone uptake is still in the early stages in the emerging markets, so brand loyalty and the app lock-in phenomenon have not yet taken hold. This means no platform providers are yet entrenched (such as Android and iOS are in the developed markets) and that challengers have a window of opportunity in these emerging markets.

• The Nokia factor: In April of this year, Microsoft closed the deal on its $7.2 billion purchase of Nokia’s phone and tablet business. Strategically, the purchase was a move by Microsoft to expand its presence in emerging markets, for while there’s little recognition of the Microsoft brand in these markets, the Nokia brand is well known and established. Microsoft will be attempting to leverage the Nokia brand to attract users of competitive phones as well as to move, over time, Nokia’s feature phone user base to the higher-end Windows Phone. Nokia possesses other capabilities that will be useful in establishing Windows Phone in emerging markets—capabilities that were previously missing at Microsoft. They include: relationships with carriers; a distribution network; manufacturing capacity and know-how; and a staff of talented hardware engineers.

In the February 2014 report titled Mobile Platform Wars, GSMA Intelligence analysts state their belief that a duopoly, or perhaps an oligopoly, of smartphone platform providers will form in the emerging markets, much as has happened in the developed markets. And they believe this will happen in short order: “[A]ny challengers would need to establish a minimum share (5%) in the next 1-2 years to have a chance of being a long-term competitor.” So the bar is set. We’ll be watching. If Microsoft starts to make progress in the mobile space, it could be a worthwhile investment. In the meantime, we’re looking elsewhere.

Thankfully for Microsoft, the onslaught of the tablet—another market in which the company fell woefully behind despite being first to market by many years—has subsided. Desktop PC sales have leveled off, and should end 2014 up for the first time in three years, as businesses give up on the tablet as a productivity device (try typing out a three-page memo on an iPad, and it’s obvious why) and refresh their aging PCs. The end of support for Windows XP this year should help that upgrade cycle. That’s good news for Microsoft shareholders, and buys the company a lot of cash to continue its seemingly Sisyphean push up the mobile market share hill.

In the next issue of BIG TECH, due out September 2, we’re recommending a stock we believe is undervalued and poised to rise over 30% in the next 12 months or so, thanks in part to that PC sales rebound. For access to this recommendation, simply sign up for a risk-free trial, and you’ll be the first to hear about it. If you decide to keep your subscription, it will cost a mere $99. If for any reason you’re unsatisfied, simply cancel to receive a prompt, courteous, and complete refund of the entire subscription price. You have 3 full months to make up your mind.