[eccr] From The Economist: Nokia vs Microsoft - The fight for digital dominance

Title: From The Economist: Nokia vs Microsoft - The fight for digital dominance

Nokia v Microsoft

The fight for digital dominance

Nov 21st 2002 
>>From The Economist print edition

The convergence of mobile phones and computers is bringing the giants of the two industries into direct conflict

IT MAY look like a mobile telephone, but the Orange SPV, launched last month, is much more than that. With its colour screen, garish icons and musical ringtones, it resembles other handsets on the market. But it has one far more significant feature: the software inside, indicated by a familiar-looking four-coloured logo on its screen. For the SPV is the first ³Windows-powered smartphone²‹in other words, it runs software from Microsoft. It is the software giant's attempt to stake its claim in the new market created by the convergence of mobile phones and computers. It is no less than a declaration of war.

By putting new technologies into consumers' hands in an easy-to-use form, the new handsets seem to be succeeding where the PC has failed

The market for smartphones is still small. But it is growing fast, as new features are added to handsets, making them ever smarter. Of the 400m mobile phones that will be sold this year, around 16m will have built-in cameras. Nokia, the world's largest handset maker, expects to sell 50m-100m colour-screen handsets next year. A new report from Analysys, an industry consultancy, predicts that by 2007 nearly 300m Europeans will be carrying handsets with colour screens, cameras, music players, support for downloadable games, and other features that are now available only in the most advanced models. Such features are already common in Japan and South Korea, and they are starting to appear in Europe and America. These advanced handsets are, in effect, pocket computers‹but they have emerged from the consumer-electronics industry rather than the world of computing.

By putting new technologies, such as digital photography and electronic messaging, into consumers' hands in an easy-to-use form, the new handsets seem to be succeeding where the PC has failed. Mobile phones have a far broader appeal than PCs (see chart 1). The lone exception is North America, where PC ownership exceeds mobile-phone ownership. But even there phones are catching up.

In Europe, more people now send and receive short-text messages on their phones than use the Internet, according to figures from Gartner, another consultancy. This year, users of mobile phones around the world passed the 1 billion mark. The number of mobile phones is now greater than the number of fixed-line ones.

The walkie-talkie PC

PC sales, meanwhile, have stagnated, and innovation has slowed: today's PCs are really just like those of a year ago, or two years ago, only faster. Sales of handheld computers, or personal digital assistants (PDAs), at around 10m a year, are dwarfed by sales of mobile phones. It looks increasingly as though the ³personal computer² was a misnomer. The truly personal digital device today is the phone. 

That does not mean that PCs will vanish. Just as mainframes continue to hum in companies' back offices 20 years after the emergence of the PC, so too PCs will continue to have an important role. But their appeal is far from universal; no matter how cheap they become, there are limits to the number of people who want to buy one. Microsoft's once-visionary mission statement‹³a computer on every desk and in every home²‹now seems dated. Instead, the company talks of ³empowering people through great software, any time, any place and on any device². This is an acknowledgment, concedes Ed Suwanjindar of Microsoft's mobility division, that the PC is no longer king, and that ³mobile devices are totally critical to the new extended vision for the company.²

It might seem an odd time to enter this market, given the uncertainty and technical difficulties surrounding the switch to ³third-generation² (3G) mobile networks. But the possibility that mobile phones might be taking over from PCs as the focus of the entire technology industry means that Microsoft has no choice. Hence the launch of the SPV.

The SPV is the first of a new range of devices intended to extend Microsoft's dominance into the new mobile realm

With its Windows-based software, the SPV is, in effect, a PC crammed into the casing of a mobile phone, complete with scaled-down versions of Microsoft's web browser, e-mail and media-playback software. It is the first of a new range of devices intended to extend Microsoft's dominance of the computer industry into the new mobile realm. Microsoft is hoping for a replay of what happened in the PC market, where hardware became a commodity and Microsoft established an enormously profitable monopoly with its Windows software. (Figures that emerged for the first time this week show that Microsoft's profit margins on its Windows software are 85%, whereas many of its other divisions are making losses.)

Yet even as Microsoft tries to get into this new market, the established mobile-phone makers, chief among them Nokia, are determined to stop it. They have seen how Microsoft's Windows monopoly turned PC makers into commoditised box-shifters, and they are determined not to suffer the same fate.

Symbianics

The first obstacle thrown into Microsoft's path by the handset makers was their refusal to license its software‹a complete reversal of what happened in the computer industry. There, PC makers queued up to license Windows. The largest mobile-phone makers, on the other hand, established a software consortium called Symbian to produce smartphone software of their own. Their aim was to achieve the benefits of Windows (a single, common software standard) without what they regard as its chief drawback: that the predatory Microsoft owns it. ³We want to fend off Microsoft‹we don't want to go the way of the PC business,² says a spokesman at one handset maker.

Several Symbian-powered handsets have already come to market. The latest is the Nokia 7650, with a built-in camera and colour screen. It was launched in the summer and sales are expected to exceed 2m by the end of the year. More Symbian handsets will appear over the next few months. Besides Nokia, Symbian's backers include Motorola, the world's second-largest handset maker, Siemens, the number two in Europe, SonyEricsson, Panasonic and Samsung. Between them, Symbian licensees account for almost 80% of all handsets sold (see chart 2).

Quite how the market will evolve, and what sorts of devices will prove popular, is not yet clear, says David Levin, Symbian's chief executive. But just as car makers can make several entirely different models on the same ³platform², or chassis, the Symbian software is flexible enough to allow handset makers to try out many different designs without having to start from scratch every time. Some phones will focus on photography and picture messaging; others on playing music or games; yet others on corporate e-mail access. When Henry Ford launched the Model T, notes Mr Levin, he had no idea that the sport-utility vehicle or the Winnebago would follow. The handset business, he suggests, will also evolve in unexpected ways.

An interesting twist on the Symbian model has already emerged. The Symbian software provides the underlying features that are essential to a smartphone operating system, such as support for telephony, graphics, security and Internet access. But Symbian licensees and software developers are able to examine and modify its innards, unlike handset makers who use Microsoft's software. Licensees may also change the software's on-screen menus and graphics, or ³user interface². Nokia, for instance, has developed a user interface called Series 60, and has licensed it to other phone makers, including Samsung, Siemens and Panasonic.

Series 60 could end up as the standard user interface for smartphones‹much as Windows has for PCs. Microsoft is sceptical, of course. ³Every one of Nokia's Series 60 licensees is a competitor in the hardware arena,² Mr Suwanjindar observes. ³If you're Siemens, does Nokia have your best interest at heart?² Yet the only large handset maker to have licensed Microsoft's competing smartphone software is Samsung. And Samsung is well-known for licensing everything: it has Symbian and Microsoft licences, and it has also launched phones that use the Palm operating system, the dominant software in the niche PDA market. So Samsung's support for Microsoft's software is not the ringing endorsement it might seem.

Worse, Microsoft suffered a setback this month when one of the few licensees of its smartphone software, a tiny British handset maker called Sendo, defected to the Symbian/Nokia camp, announcing that its forthcoming phones would use Series 60. Sendo cited its inability to gain access to the source-code of Microsoft's software as one reason for switching.

Microsoftly, softly

Having failed to sign up the large handset makers, Microsoft has decided instead to get round them by going directly to their customers: the mobile-network operators, which buy handsets in bulk and sell them to their subscribers. Microsoft is able to do this because a significant proportion of mobile phones (26% this year, according to figures from Strategy Analytics, a consultancy) are made by contract manufacturers, to which handset makers outsource some or all of their manufacturing. Some contract manufacturers, such as HTC of Taiwan, also design products and are known as ³original design manufacturers² (ODMs). The SPV phone is a joint venture between Microsoft, HTC and Orange, a European mobile-network operator. HTC designed and built the hardware, Microsoft provided the software, and Orange agreed to buy the phones. 

For operators such as Orange, the appeal of this approach is that they can customise the phone and brand it with their own logo, differentiating themselves from rival operators. For Microsoft, the appeal is that it can get phones into the marketplace without the support of the large handset makers. In the long run, it hopes that the industry will develop as the computer industry did: away from a vertically integrated model, in which the same companies make hardware and software, and towards a horizontally layered model in which software is supplied by Microsoft and hardware becomes a commodity made by firms such as HTC.

But there are a number of problems with this vision. The main one is that the economics are skewed in favour of the large handset makers, which produce far bigger volumes. Nokia, Motorola and Samsung produce handsets in quantities measured in millions. An operator placing an order with an ODM, in contrast, will order a few hundred thousand handsets at best. With fewer economies of scale, this makes the handsets more expensive.

Matti Alahuhta, president of Nokia's handset division, insists that his company has nothing to fear from contract manufacturers. About 20% of Nokia's production is outsourced, and this provides a reference, enabling Nokia to ensure that its own manufacturing facilities stay competitive. 

Vertical integration will continue to make sense in such a fast-moving industry, says Mr Alahuhta. He concedes that handsets are becoming a commodity‹but only at the very bottom of the market, and even there he claims that Nokia's superior logistics mean it has better margins than its smaller competitors. At the top end of the market, though, where Microsoft is trying to compete, Mr Alahuhta insists there is no sign of commoditisation.

It is too early to conclude that Microsoft's attempt to by-pass the handset makers will fail. But the omens from its previous joint venture with HTC, a hybrid PDA-phone running Microsoft's Pocket PC software, are not good. Sales of the device, known as the XDA in Britain, the MDA in Germany, and the ³T-Mobile Pocket PC Phone Edition² in America, have been slow. A British operator, O2, has sold only 12,000 XDAs since its launch this summer, despite a massive advertising campaign. This may reflect a lack of enthusiasm for PDA-like devices, but it also highlights another problem with the ODM approach: the lack of a strong brand.

Mobile phones are fashion items, and branding matters to their users. Once again the large handset makers, and Nokia in particular, have the upper hand. Surveys show that consumers rate Nokia above all other mobile-phone brands, whether or not their present phone is a Nokia. Its customers are also more loyal to Nokia than to their mobile operator, although operators such as Vodafone are now doing their best to promote their brands above those of the handset makers.

The powerful pull of monopoly

So far, then, Microsoft's plan to invade the mobile-phone market is not going well. ³Microsoft have their work cut out to have any major impact on this market as things stand,² says Ben Wood of Gartner. The company's best hope, he suggests, is to use its traditional weapon for attacking new markets: its Windows monopoly. By tightly integrating its smartphone software with its desktop and server software, Microsoft might be able to appeal to corporate users. For example, the SPV can, with the help of Microsoft's software, gain access to e-mail, calendars and databases on both PCs and servers.

But there could be legal problems with this strategy. Microsoft's competitors have already complained to the European Commission, which is investigating the company, that its next-generation e-mail server, codenamed Titanium, is being designed to favour those mobile devices that are running Windows.

It is far too early to count Microsoft out. It is nothing if not determined. Its lucrative Windows franchise will be able to fund its forays into loss-making new markets for years to come, and it is sitting on $40 billion in cash. The troubled switch to 3G technology means that the mobile-telecoms industry is in turmoil, and Microsoft may be able to capitalise on the confusion. If all other strategies fail, it could always resort to the drastic step of buying an operator or handset maker.

Mr Suwanjindar insists that it is still early days, and that Microsoft continues to negotiate with handset makers about using its software. As for Nokia, which he agrees is Microsoft's biggest competitor in this arena, Mr Suwanjindar admits that ³we have a tremendous amount of respect for them as a handset manufacturer²‹in other words, only as a hardware company. 

Smartphones, says Mr Suwanjindar, are an entirely new class of device. Although they resemble phones, that does not give Nokia and other handset makers a ³birthright² to the market. ³There is a contribution we can make to the mix,² he says.

In Nokia, however, Microsoft may have met its most Microsoft-like competitor to date. Comparisons between the two firms are difficult to avoid. Mobile-network operators grumble that Nokia has too much clout, much as PC makers grumble about Microsoft. They also worry that with Club Nokia, its loyalty programme, Nokia is encroaching on the operators' own turf, just as Microsoft was wont to do. Club Nokia offers Nokia-specific features, such as ringtones, games and logos, which customers can take with them from one network provider to another.

Moreover, Nokia's Series 60 software could yet emerge as the mobile equivalent of Windows. ³Nokia is the Microsoft of mobile phones, the gorilla of the industry,² says Gartner's Mr Wood. (It is also, he might have added, the equivalent of Dell, whose superior logistics have made it the number one PC maker.)

Yet, for all their similarities, Microsoft and Nokia differ in one crucial respect. Microsoft's dominance stems from its closely guarded ownership of Windows. But the mobile-phone industry, in which Nokia is top dog, is based on open standards. The use of common standards that are not owned by any particular vendor has benefits. For example, it enables handsets based on the GSM standard to be used in most parts of the world. But it also has drawbacks: Europe's proposed standard for 3G does not work yet. Nokia has achieved its dominance not through ownership of proprietary technology, but from its ability to innovate around open standards, from its strong brand, and from its impressive logistics. In other words, in several respects it is not like Microsoft at all.

Nokia's attitude to Microsoft is revealing. ³We are not in competition, but approach convergence from different sides,² says Mr Alahuhta, choosing his words carefully. He is right: Microsoft is so insignificant in the mobile-phone market that it is not a competitor‹at least, not yet. But as their industries collide, the firms are sure to become opponents in what promises to be a long and bitter fight. 

Copyright © 2002 The Economist Newspaper and The Economist Group. All rights reserved.