How Apple And Google Crushed Windows Phone

 

Summary

• Apple has set the standard for smartphones with its 64 bit processors and true 64 bit mobile operating system.
• This dashed any hope Microsoft had of positioning Lumia as a premium brand and forced it to compete with Android as a commodity smartphone.
• The result has been declining shipments and market share for Windows Phone.
• The purchase of Nokia was the wrong move that leaves Microsoft with almost no chance to be competitive or establish a viable smartphone ecosystem.

Yesterday Microsoft (NASDAQ:MSFT) unveiled some new Lumia devices, most prominently the Lumia 830, dubbed the "affordable flagship." Affordable it may be, but flagship is a bit of a stretch. For more than a year, the flagship category has been put out of reach by Apple's (NASDAQ:AAPL) superior 64 bit mobile processors, dashing Microsoft's hopes of having a premium smart phone brand. This left Microsoft with no choice but to slug it out with Google's (NASDAQ:GOOG) (NASDAQ:GOOGL) Android in the commodity smartphone market, a battle that has left Windows Phone bruised, bleeding and all but dead.

SmartPhone OS Market Share

IDC's recently published data on smartphone market share underscores the severity of the fall of Windows Phone. For more than a year, Nokia, Microsoft's principal Windows Phone partner, has been absent from IDC's list of top five smartphone manufacturers, so it was difficult to gauge how far Windows Phone had fallen, but IDC's August 14 announcement broke down the market by operating system:

Operating System	2Q14 Shipment Volume	2Q14 Market Share	2Q13 Shipment Volume	2Q13 Market Share	2Q14/2Q13 Growth
Android	255.3	84.7%	191.5	79.6%	33.3%
iOS	35.2	11.7%	31.2	13.0%	12.7%
Windows Phone	7.4	2.5%	8.2	3.4%	-9.4%
BlackBerry	1.5	0.5%	6.7	2.8%	-78.0%
Others	1.9	0.6%	2.9	1.2%	-32.2%
Total	301.3	100%	240.5	100%	25.3%

Windows Phone didn't merely suffer a market share decline in Q2, but a real decline in unit shipments year over year. This data has been confirmed by Microsoft's quarterly earnings report, which showed that only 5.8 million Nokia Lumia phones were shipped in the quarter.
I often hear Microsoft supporters affirm that Windows phone has achieved 3rd place among smartphone operating systems, which had been Microsoft's stated objective. But MS got third place by default as BlackBerry (NASDAQ:BBRY) sales collapsed, as the numbers above demonstrate.
Throughout 2013, Windows Phone gained market share, even passing Blackberry to take third place by Q2, according to Gartner data. The new standard set by iPhone 5s at the high end of the market and increasingly "premium" Android phones at the lower end of the market halted Microsoft's momentum by Q2 of this year.

Paradigm Failure

The failure of Windows Phone to achieve sustainable growth and profitability is fundamentally a failure of the commodity PC paradigm that Microsoft attempted to apply to the mobile device category. When Windows Phone 7 was introduced at the end of 2012, it's clear that Microsoft still assumed that the PC paradigm would work for smartphones: Microsoft would be the creator/owner of the operating system that it would license for a fee to an ecosystem of hardware vendors. These vendors would flood the market with Windows Phones at various price points, and like the commodity PC juggernaut, crush everything in their path.
From the start, this model started to fall apart. As the price for its participation in Windows Phone, Nokia had received a subsidy from Microsoft that canceled the license fees that Microsoft would have received for its phone OS. This was necessitated by the need to compete with Google's free Android operating system, which conferred a cost advantage to Android device makers. If Microsoft hadn't been willing to subsidize the OS for Nokia, Nokia would have gone with Android.
So the dynamics of the market had already been skewed away from the commodity licensing model that Microsoft had hoped to impose. But there was another fundamental dynamic that was changing. In the PC licensing model, hardware technology leadership rested with the chip maker, specifically Intel. The integrated mobile device makers such as Apple and Samsung (OTC:SSNLF) had seized this leadership in a paradigm shift away from the commodity chip makers, a shift that is still underway.
When Apple introduced its first custom designed SOC's (for the first iPad), numerous industry pundits predicted that this was merely an aberration, and that the commodity chip makers would eventually reassert their dominance. This just hasn't happened. Mobile device makers such as Samsung and Apple simply have become too powerful and too well funded.
Apple's introduction of its custom designed 64 bit A7, and its subsequent effect on iPhone sales and the smartphone market, demonstrate the strength of the new paradigm: integrated device makers designing their own ICs, which are then fabricated by third party foundries. Almost a year later, the fact that the only other 64 bit mobile processor in production is by Samsung shows the power of the new paradigm.
Commodity chip makers such as Intel (NASDAQ:INTC) and Qualcomm (NASDAQ:QCOM) are still scrambling to catch up. Qualcomm is expected to roll out its first 64 bit processors in 2015, and Intel? Here's what I believe happened to Intel. At the beginning of the year, Intel was expected to roll out the phone version of Bay Trail, Merrifield, which would have been Intel's 64 bit smart phone processor based on its 22 nm process. Merrifield has been a no show, and Intel execs didn't even want to talk about it at the Q2 conference call. I believe Intel backed off of the Merrifield roll out because they realized that it would also require contra-revenue subsidies to achieve any significant market penetration. This might have added another $1 or $2 billion in loss to their mobile devices division, and Intel management decided they simply couldn't afford it.
The lack of any effective response to the A7 from the commodity chip makers meant that Microsoft couldn't really play in the premium smart phone space. Instead, Lumia phones feature Qualcomm SOCs, which are nice, but they're last year's tech.

Forms of Integration

Microsoft's attempt to become an integrated device maker through its purchase of Nokia demonstrates a realization that the PC commodity paradigm had failed it. Unfortunately for Microsoft, it embraced the wrong form of integration. Apple has already demonstrated what works: designing your own custom SOCs. This provides the most leverage to device makers in order to create discriminators for their products. Being able to assemble your own devices is not actually an important discriminator and probably confers no competitive advantage. It's best left to contract manufacturers such as Hon Hai (Foxconn).
If Microsoft embraced the wrong form of integration with the purchase of Nokia, what chance does Microsoft have of making Windows Phone competitive? Almost none at this point. Apple will continue to set the standard at the high end of the smartphone market, while Google's forthcoming 64 bit Android L will dominate everywhere else.