Microsoft morphs into a hardware giant with Nokia deal completion

Microsoft is no longer just a software giant, it’s now a hardware giant.

Nearly eight months after its original announcement, Microsoft has completed its deal to purchase Nokia's devices and services unit today. Microsoft will pay €3.79 billion for Nokia's phone making business, plus another €1.65 billion to license its portfolio of patents. That's a total of around €5.44 billion (around $7.2 billion), a lot less than the $8.5 billion Microsoft paid for Skype back in 2011. Nokia expects the total transaction price will be "slightly higher," and the company plans to provide full details next week during its financial results. The deal sees Microsoft take control of more than 90 percent of all Windows Phones with Nokia's Lumia lineup, and the company will also acquire the low-end Asha brand, Android-based Nokia X handsets, and feature phones. The Redmond-based software maker will now morph into a hardware maker responsible for shipping more than 200 million handsets a year with an additional 32,000 employees moving across from Nokia.

Welcome to Microsoft Mobile

Microsoft is planning to use the "Microsoft Mobile" moniker for the Nokia phone business, running it as a separate subsidiary where the vast majority of employees making the switch won't be making the physical move to Redmond. It's a significant acquisition for Microsoft and it's clear the company wants to keep the incoming Nokia business slightly separate before it can tackle the complex task of fully integrating its new phone making skills into the firm. To highlight that complexity, Microsoft CFO Amy Hood admitted on the company's Q3 earnings call yesterday that deal closure "is about four months later than the deal economics that we outlined in September." Microsoft was clearly aiming for January, and even publicly committed to completing by March, but regulatory approvals and other issues pushed the deal back. As a result, the original deal had Microsoft acquiring Nokia’s Korean manufacturing facility and an Indian handset plant, but neither will be fully acquired. An ongoing tax dispute means Nokia will continue to operate its Indian manufacturing plant on a contract to Microsoft.

The manufacturing alterations are just a piece of a giant puzzle that Microsoft will now have to piece together. Microsoft is taking control of the Nokia.com domain and social media accounts for up to a year to ease the transition, alongside the huge phone making business. Nokia will still exist, but it now plans to focus on three core technologies: NSN (its network infrastructure) HERE (its maps and location-based services); and Advanced Technologies (a licensing and development arm). Microsoft will pay Nokia for a four-year license of the HERE services, but overall Nokia will be a much smaller company. The "Asha" and "Lumia" trademarks will transfer to Microsoft, but the "Nokia" mark will remain property of the Finnish company, and may only be used on feature phones under a 10-year license agreement. Nokia, as it exists today, is now barred from using the Nokia brand on any mobile devices at all until December 31st, 2015. Any future Windows Phones built by Microsoft will now be Microsoft-branded.

What does Microsoft do with millions of phones not running Windows?

Nokia sold nearly 251 million handsets last year, a mixture of feature phones and smartphones. While the Lumia lineup of Windows Phones only accounted for 30 million of that 251 million, Microsoft now has to plan and manage how it handles the millions of other devices that Nokia produces that do not run Windows Phone. That's a mixture of Asha handsets, feature phones, and Nokia's new Android-based X range. It's a big worldwide business that places Nokia in second place behind Samsung in the top mobile phone manufacturers. Microsoft is now the world's second largest phone manufacturer by sales.

A tricky balance between making Windows Phone software and hardware

Nokia's Android handsets are the most intriguing part of the deal, as they shed some light on how Microsoft might approach the messy and complex nature of shipping devices that don't run the company's Windows software. The Nokia X introduces a new "forked" version of Android that’s akin to what Amazon does with its Kindle Fire line, but it also includes a Windows Phone-like UI and an Android store that's separate to Google Play. Microsoft has the chance to control another app store, but also a solid opportunity to push its own cloud-based services. OneDrive, Outlook, and Skype are all preinstalled on Nokia X handsets, and Bing is the default search engine. Microsoft CEO Satya Nadella is taking a "cloud first, mobile first" approach, and the Nokia X or Office on iPad are good examples of how Microsoft can leverage platforms outside of Windows to push and sell services. "The feature phone product family coming to Microsoft will start to have more of the Microsoft services shipped on those phones right out of the gate." admits Microsoft's Tom Gibbons, the corporate vice president who is responsible for the Nokia integration.

Perhaps the biggest challenge Microsoft faces with its Nokia deal is the risk to Windows Phone. Microsoft is now in a rather unique position dominating Windows Phone hardware, while also producing the software that runs on rival devices from phone manufacturers like Samsung and HTC. Microsoft is desperately trying to convince other phone makers to use Windows Phone, and the company recently made the software license free to encourage adoption. Windows Phone 8.1, the latest software update, includes some changes designed to allow phone makers to easily reuse Android designs with on-screen software buttons and better chipset support.

The big risk in all of this is that Microsoft will have to balance out the priorities of shipping its own hardware to compete with its own licensees, while still creating a successful platform. Microsoft could be the rare exception that manages this well, but Apple failed with the original Mac and the Newton, Palm failed with Palm OS, and Nokia itself struggled with Symbian. Google's experiment with making its own Android phones resulted in the search giant selling Motorola to Lenovo for $2.91 billion, less than two years after paying $12.5 billion to acquire it.

Surface or Lumia? Microsoft has to decide

Regardless of how Microsoft handles the tricky balance of making the phones and licensing the software, there's a number of questions that still remain largely unanswered. Former Microsoft CEO Steve Ballmer outlined a "devices and services" plan for the company which included the big Surface bet. While Microsoft has experimented with hardware for years, it has never competed directly with PC makers until it unveiled its Surface tablets. Former Nokia CEO Stephen Elop returns to Microsoft and will take control of all hardware projects, including Lumia, Surface, and Xbox. Nokia has released one Lumia tablet running Windows RT, so Microsoft is also tasked with figuring out its tablet strategy once again. Does the company opt for Nokia's Lumia tablet design or Surface? It's a question Microsoft has not yet answered. Likewise, it's not clear what exact branding will be used on the company's Windows Phones going forwards.

Nokia and Microsoft have confirmed the close, but Microsoft has not yet provided any details on the full plan for how it's going to handle the integration of Nokia yet. Stephen Elop plans to answer questions on Monday, but for now he says Nokia's phone business has to "not only evolve to fit into Microsoft in general, but into an evolving Microsoft." Skype's integration into Microsoft was, and still is, a rather a slow process that has kept it largely separate from the software maker. Hopefully the collaboration means improved Windows Phone software and hardware in the future, something that Nokia and Microsoft had been working on together as separate companies until now. Whatever the deal brings, a big part of Microsoft's "mobile first" strategy is focused on Nokia's assets. Microsoft can't afford to be slow with its latest acquisition and risk Windows Phone's growth and sales numbers. Nokia might be over as a phone manufacturer, but Microsoft Mobile lives on and Windows Phone's future relies on it.