Microsoft's Assumptions Are Wrong


Nokia just released its fourth-quarter and annual earnings report, and the smartphone shipment numbers aren't so great. The Wall Street Journalreported that in fourth-quarter 2013 Nokia shipped 8.2 million Lumias, compared to 8.8 million in the previous quarter. Microsoft is purchasing Nokia's devices division for about $7 billion, so the quarter-to-quarter drop isn't good news for either company.

Microsoft is building its smartphone future on the Nokia deal, and the latest numbers show that may not be a wise move.

This shouldn't surprise Microsoft
Back when Microsoft made its bid for Nokia, it released a presentation showing that it would need to sell about 50 million Nokia smart devices to make the operating income for the devices division break even.

Here's a look at that slide in the presentation:

Source: Microsoft.

Obviously, with Nokia selling 30 million units this year, the company fell far short of that. But that shouldn't' have been that big of a surprise to Microsoft. Let's assume for a minute that Nokia had a great quarter of Lumia sales and moved 10 million-12 million devices. That still would have only put the company at 32 million or 34 million units shipped for the entire year, still far short of the 50 million.

Microsoft's projection a few months ago was an estimate of where the company needs to be after it has fully taken over Nokia's devices, and not necessarily a number Nokia needed to hit before that. Of course, increasing shipments from 30 million to 50 million won't be an easy task for the company, but at this point it doesn't have much of a choice.

The real problem
One of the glaring issues with Nokia's fourth-quarter results is that the holiday season usually spikes consumer interest in smart devices, but that wasn't the case here. Though fourth-quarter Lumia sales were up from the same time a year ago, they dropped sequentially -- even though Nokia introduced new Lumia devices just before the holiday season.

This drop in in smartphone shipments is part of a bigger problem that's starting to take shape for Microsoft. Back when it proposed the deal to buy Nokia's devices business, Microsoft estimated that it would be able to take 15% of the smartphone market by 2018. For comparison's sake, Strategy Analytics estimates Apple held just more than 13% worldwide smartphone market share in the third quarter of 2013.

Here's another slide from Microsoft's presentation:

Source: Microsoft.

Based on the estimate of total worldwide smartphone shipments of 1.7 billion in 2018, Microsoft would need to ship about 255 million units that year to hit the 15% mark. So that means that over the next four years, Microsoft is going to go from having about 30 million Windows Phones shipped to 255 million. Not a likely scenario.

To help boost its market share, Microsoft is reportedly lowering the Windows Phone licensing fee so that companies like Sony, Samsung, and ZTE will sell devices running the OS. Samsung recently said it's working on a flagship Windows Phone to be released this year and Sony has said it wants its phones on more than just the Android OS.

But even if Microsoft is able to get a few OEMs on board, achieving the 15% market share is still going to be near impossible. With the Nokia deal expected to officially close sometime this quarter, Microsoft investors may be wondering if the company overpaid for a devices business that may never achieve the tech giant's lofty goals.

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Originally published