Distilling market noise into market sense

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Microsoft + Nokia: the marriage of two broken business models

Microsoft’s acquisition of Nokia’s Devices division is the new beginning for both Microsoft and Nokia. But how does it make sense when both Nokia’s legacy OEM and Microsoft’s mobile software licensing business models are broken? VisionMobile Strategy Director Michael Vakulenko takes a long-term perspective of the acquisition through a business model lens.

Nokia and Microsoft

Most of the analysis on the Microsoft acquisition of Nokia comments on the reasons for the acquisition, whether it’s a good or a bad strategy or attempts to predict how Microsoft products will evolve. The key question however is what is the likely future for the new Microsoft?

Looking at the business models in each case helped us accurately predict as early as 2009 the duopoly of Apple and Google, the demise of Palm, the outcome of HP’s foray into mobile with WebOS, BlackBerry’s meltdown and the failure of Nokia’s gamble on Windows Phone – years before the story unraveled.

In the analysis from 2 years ago I argued that the paramount challenge for Microsoft and Nokia is the broken business model, not the product features, user interface or integration of software and hardware. This analysis is 100% relevant today and the acquisition of Nokia does not change the fact that the business models of the two companies are broken.
A business model describes how a company creates, delivers and captures value. People tend to focus on the “capture” part, but in reality “create” and “deliver” aspects are much more important.

For the purpose of this post I will use business model framework proposed by Mark W. Johnson, Clayton M. Christensen, and Henning Kagermann in 2008. We have extended this framework for the purposes of our research, but I’ll keep the extensions out for the sake of simplicity.

At the very basic level, a business model consists of four interlocking elements that, taken together, create, deliver and capture value:

  1. Customer value proposition – Value is created by helping customers get an important job done.
  2. Profit formula – The blueprint that defines how the company creates value for itself, while providing value to the customer.
  3. Key resources – Assets such as people, technology, products, facilities, equipment, channels, and brand required to deliver the value proposition to the targeted customer.
  4. Key processes – Operational and managerial processes that allow them to deliver value in a way they can successfully repeat and increase in scale.

The key point to understand about the framework is that the power of a business model lies in the complex interdependencies of its parts, where the four elements reinforce each other.

Major changes to any of these four elements affect the others and the whole.
Steve Ballmer, however, prefers to take the rather limiting, product-centric view on Microsoft’s business model:

“I think the right way to think about this is – or the way we think about it is kind of an integrated business model. There’s the device, the operating system, the back-end consumer services, and the extensibility of those – of that offering into enterprise services. And across that entire range, from hardware to, quote, operating system, because in the PC world we participate through our operating system royalty as opposed to through the direct hardware economics like we participate with Xbox. You know, when we bought Skype we were quite clear that a lot of the economic value from Skype would be from Skype and Lync connection and the ability to move people between the consumer and enterprise world and monetize in the enterprise.”

There is not a hint at the customer value proposition, just blind hope that somehow recombining different pieces of technology will do the magic.
It’s crystal clear that all four elements of Microsoft’s business model are challenged by the transition to mobile computing.

Let’s take a look at the four elements of Microsoft’s business model
Customer value proposition of Windows, Office and Server product lines is becoming less and less relevant in helping customers get an important new jobs done. No need to expand – A lot was written in the last year about how mobile ecosystem disrupted PC. Even the very definition of the customer is changing for Microsoft. Microsoft business model emerged in the era when computing was driven by enterprise and the company is still making most of its money by selling Windows licenses to PC OEM and Office and Server software licenses to enterprises. Contrary to personal computing, mobile computing market is driven by consumers and the value is created in a very different way, more on consumerisation shift by Marc Andreessen here.

While today’s leaders are focused on the customer, slide 22 of Microsoft’s Nokia presentation is worth a thousand words in exposing the company’s idea of “value creation”.

Long Term value creation

Compare that with Apple’s Jony Ive idea of how to create value:

“We are really pleased with our revenues but our goal isn’t to make money. It sounds a little flippant, but it’s the truth. Our goal and what makes us excited is to make great products. If we are successful people will like them and if we are operationally competent, we will make money.”

The profit formula for software companies has changed dramatically in the last decade. Instead of the software licensing model that brought Microsoft to prominence, today software is increasingly monetised indirectly. Such indirect monetisation takes multiple forms: Devices, ads, content, services, e-commerce, virtual goods and data. Microsoft tried many of these avenues, but failed to create a profitable businesses out of such attempts as Bing, Azure, Live, Xbox and Zune.

Resources like technology, products, channels and brand, which are all the cornerstones of Microsoft’s dominant position in the personal computing market, did not help the company take the leading position in mobile computing. It’s too late for Microsoft to hope for a meaningful position in mobile computing. It’s over. Android and iOS have won. Network effects inherent to the ecosystems business models of the leaders are making direct competition impossible.

Processes that form much of the company DNA are shaped by and are optimised to scale Microsoft key business – Selling software licenses to PC OEM and enterprises. Besides, Microsoft infamous “stack ranking” system created internal culture of that motivated brown-nosing and sabotage over collaboration (more here). While it worked for milking the existing market, it for sure won’t help the company reinvent itself.

The acquisition of Nokia Devices by Microsoft can bring the company some new resources and processes, but it brings nothing in terms of a value proposition or a profit formula.
Nokia’s Devices business model is as broken as Microsoft’s. In other words, Nokia won’t help Microsoft to get out of its business model dire straits.
There are two scenarios for Microsoft: A slow, Dell-style demise or an IBM-style business model reinvention.

The first scenario is the likely scenario as long as Microsoft focuses on direct competition with leading ecosystems. To be successful Microsoft would need to find a new business model that will challenge and render obsolete ecosystem business models of Apple, Google, Amazon and the likes. A very risky undertaking to say the least (more on ecosystem business models in our Mobile Innovation Economics workshops).

The second scenario of IBM-style reinvention would require milking the legacy businesses while reinvesting the profits in the discovery of new business models. The recent, massive reorganisation may prove to be a fatal mistake preventing that from happening. Previous divisional structures made much more sense. New businesses need separate organisational space from the legacy operation in order to be able to develop new processes and priorities for their emerging business models.

Mobile computing will continue to evolve in the coming years with the emergence of new business models where hardware is not the source of profits but a distribution channel (more in our recent blog post here). Chances are that the new Microsoft together with what’s left of Nokia devices will not be part of this future.

– Michael V (@mvakulenko)

  • Shocked they assume 15% market share in smartphones!

  • Yes but … so many companies use Microsoft software in the enterprise and, specifically, Active Directory for network authentication. Microsoft are splitting authentication into consumer (which will use Live.com for authentication) and enterprise (Active Directory). If they can figure out how to authenticate using Active Directory with Windows Phone 8 – so IT managers can control access & security on phones and tie in cloud services through Active Directory with single login for phones as well as desktops/laptops – then Nokia might just become the smartphone of choice for enterprises. They also need to ensure they assist enterprise vendors to create the apps that the enterprise users will need (SalesForce, SAP, QlikTech, etc.) Lumias are great phones and Windows Phone is great software. Yes they lack the app ecosystem of iOS and Android. But their advantage is in the enterprise and they should succeed here, most likely at the expense of BlackBerry. I wouldn't write Microsoft / Nokia off yet!


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