Why a Microsoft Smartphone Just Can’t Happen—Not Yet, Anyway

10/10/12Follow @curtwoodward

As Microsoft gears up to show off the newest generation of its smartphone software, there are growing questions about whether the software pioneer might start cranking out its own handsets, too. Microsoft’s certainly helping to stoke that idea by recasting itself as a “devices and services” company, as CEO Steve Ballmer just wrote in his annual shareholder letter.

It’s thought of as the start of a new era, where the tech company everybody loves to hate finally gets with the Apple paradigm and makes streamlined products instead of farming its hardware production out to others. Microsoft is already building its own iPad competitor with the upcoming Surface tablet, right?

Well, not exactly. Microsoft simply can’t be producing its own serious attempt at a smartphone right now—not if the company has its head on correctly.

Note the emphasis on the word serious. Sure, Microsoft might build its own smartphone sometime in the near future. But let’s be clear about the landscape right now: There is nothing to suggest that Microsoft can or should build its own smartphone with the intent of making a serious dent in the current retail market for handsets.

“If Microsoft builds their own Windows phone within the next three or four months, I will call this the most insane thing that Microsoft has ever done,” says Charlie Kindel, a former Microsoft general manager, entrepreneur, and mobile consultant.

Here’s why.

THE CARRIERS

Most smartphones in the U.S. are sold through the stores of the wireless carriers. Even Apple, with its vaunted chain of retail stores, moves most of its iPhones through AT&T and Verizon stores. Throw in the small chunk selling via Sprint, and you’ve got 56 percent of all iPhone sales, according to research by Consumer Intelligence Research Partners.

That means Microsoft, if it really did try to sell its own smartphone, would be even more reliant on the carriers—the Redmond company only has a handful of its own permanent retail sites and they’re veritable ghost towns compared to your average Apple showroom.

So the carriers still control the point of sale for most customers. And the carriers don’t like how Apple’s seemingly overnight dominance of the cell phone market took power out of their hands. Consumers were no longer coming to buy whatever their carrier had kicking around when the contract was up—they came to the store wanting someone else’s product, one that carriers had to beg to get their hands on and subsidize with big up-front payments to Apple.

That’s one of the big reasons the Android platform has exploded, dwarfing the number of iPhones sold. Since Android was opened up to virtually any manufacturer, carriers could order up their own phones without giving in to Apple’s demands or prices. It was a return to the good old days.

And it’s not just Apple. Kindel, who negotiated with carrier executives when he worked on building the Windows Phone 7 platform for Microsoft, found that carriers had a lot of distrust for operating system companies.

“In my meetings with Verizon back in 2009, when we were working on Windows Phone, those were extremely hostile meetings,” Kindel says “There’s just a huge distrust of Microsoft—although at the time, to be fair, Microsoft had no leg to stand on … the Kin burned Verizon massively.”

So why would carriers embrace a theoretical Microsoft handset, built, owned, and controlled by one company in the style of Apple? Sure, Microsoft would probably offer much better terms than Apple, since it would have room to make up. It might even throw some cash at the carriers to pay for marketing, which would be hugely needed.

But even then, the carriers would be put in the position of flogging a phone that nobody really wants yet, with the benefit flowing to one company that controls the whole pie. Microsoft simply can’t sell a large number of smartphones without the carriers, and there’s no sign the carriers are interested.

THE HANDSET MAKERS

The handset manufacturers also have Android to lean back on. As Peter Bright wrote last week in Ars Technica, making a serious push into building and selling its own smartphone would seriously jeopardize Microsoft’s relationships with existing manufacturers who could build devices based on its operating system.

It’s even worse when you’re talking about Nokia. The Finnish company has tied its entire existence to the Windows Phone platform, bringing on a former Microsoft executive to run the show and ditching its old operating systems in favor of growing with Redmond’s new version.

Dumping its own smartphone on the market with an intention of grabbing a lot of sales could severely harm Nokia at its most fragile.

Nokia absolutely needs to sell a good number of Windows Phone 8 smartphones this holiday season if it has any hopes of surviving. That will take a ton of marketing spending, from both Nokia and from Microsoft, in order to get the carriers to push the Lumia line of phones. Rolling out another option from Microsoft itself—which would probably be welcomed as the better of the two by the press, given the Microsoft vs. Apple showdown it would imply—could cripple the Lumia.

On top of all that, it appears that Microsoft has, for at least the near future, signed away its own access to the best of its own operating system. Nokia CEO Stephen Elop told GigaOm that Nokia’s commitment to the Windows Phone platform—when no other manufacturer really cared—landed his company access to unnamed, but special features that even Microsoft itself wouldn’t be able to touch.

“We have rights beyond any of the other manufacturers to do unique things and to enforce certain exclusivities for our products. We don’t disclose what those are, or the extent of those. But we have the ability to differentiate,” he said. “We still preserve the same rights under the contract, regardless of who is making those phones. There are certain things we have rights to.”

MICROSOFT ISN’T A HARDWARE COMPANY

Setting aside all of the other facets of the smartphone market for a second, let’s just take this at its simplest: the Xbox is the only piece of consumer electronics produced by Microsoft that anybody purchased in a notable quantity. The rest of the pack includes the Zune music player, the aborted Kin mobile phone, and various stabs at tablet computers.

Organizations of Microsoft’s scale can’t simply swap out their DNA and build an entirely new business because Apple is having great success with that model. It’s why Hewlett-Packard almost evaporated while trying to switch from a hardware maker to an IBM-like software and services business. It’s why Web 1.0 giants like Yahoo and AOL have been swimming in circles for years, trying to figure out what kind of companies they really are.

Microsoft makes all of its money from selling Office and Windows. Everything else is peanuts, or worse.

The surprise unveiling earlier this year of the Surface tablet has led many observers, however, to assert that things have changed. In this view of the world, the Surface tablet is indisputable evidence that Microsoft is challenging Apple’s iPad head-on. Microsoft is pissing off the other manufacturers, even though it needs them to keep building machines that run on Windows.

Except that’s not really true. It’s painfully clear that Surface is a “north star” product, as Kindel has repeatedly said, meant to set a high-end standard for others to follow rather than selling a large number of units.

At its big unveiling in L.A., nobody outside of Microsoft was permitted to touch or handle the thing for more than a few minutes. So nobody knows how many of the claims that Microsoft is making about its capabilities really hold up.

Microsoft only intends to sell the Surface on its websites and in its own retail stores. Even with temporary “pop-up” locations set up just for the holidays, that only amounts to just over 50 storefronts in North America. Apple, on the other hand, has hundreds of stores—and in a reversal of the smartphone business, those Apple stores are the single largest source of iPad sales.

Microsoft is reported to be readying more than 3 million Surface tablets for sale. VentureBeat actually reported that this meant Microsoft was “going big” in its commitment to selling the devices.

Sure, it’s a big number, but put it in perspective: Amazon’s Kindle Fire HD is projected to ship 5 million units by the end of 2012. The iPad hasn’t sold fewer than 3.7 million units in a single quarter since the first three months of 2011—which was right after its first Christmas on the market.

Still not sure? Take it away, Steve Ballmer: “Surface is just a design point … It will have a distinct place in what’s a broad Windows ecosystem. And the importance of the thousands of partners that we have that design and produce Windows computers will not diminish.”

So where does that leave a possible Microsoft smartphone? I’d say it’s one of two things.

On one hand, it could be similar to the Surface—a reference device that shows manufacturers how Microsoft sees its vision being carried to its fullest, along with a niche product that could move a decent number of units for higher-end gadget buyers.

It could also be a last-resort measure in case the phones from Nokia (and HTC or others) don’t take off in the marketplace. I’m not entirely sure how Microsoft’s end-to-end production would make a huge difference if experienced phone makers fail—especially given the fact that Microsoft does not have the years of experience that Apple does building an integrated device and software company.

Former Microsoftie Hal Berenson goes one step further: He thinks that if Microsoft can’t make a dent with the current carrier-manufacturer-OS setup, it might be forced to set up its own integrated wireless service plan. This would involve buying big chunks of access to wireless networks and reselling it under the company’s own brand, a kind of entity called a mobile virtual network operator.

“By going the MVNO route Microsoft would be freed from carrier decisions about which phones to carry, how to price them, how to promote them, how quickly to update them (!), who shares in what parts of the subsidy pie, lock-in terms, etc. It would own its own destiny. On the flip side, it would lose the carriers’ large retail footprint and healthy marketing budgets. And carriers have developed new techniques, such as family plans, that make switching very unattractive for the consumer. But if WP8 fails using the traditional carrier model, this is a tradeoff that Microsoft would be forced to make.”

Now that would shake up the tech world. Would Microsoft be that bold? I don’t think there’s any evidence that it has to act so drastically in order to win in the new computing landscape. There are other routes, particularly offering cross-platform software like Office, that could play more easily into Microsoft’s strengths.

For all of Ballmer’s insistence that Microsoft is a “devices and services” company, it seems like the former is something between a marketing ploy. The services are what Microsoft has always done best.

Curt Woodward is a senior editor for Xconomy based in Boston. Email: cwoodward@xconomy.com Follow @curtwoodward

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