Abhishek K. Mishra 2013PGP002
Dipak Senapati 2013PGP018
Gaurav Kala 2013PGP019
ABOUT MICROSOFT AND ITS BUSINESS DESCRIP TION
Microsoft Corporation is engaged in the development and marketing of software, services, and hardware devices. Apart from developing and licensing a range of software products and services, the company also designs hardware devices and delivers online advertising services. In addition, Microsoft provides consulting, product and solution support services, and also trains and certifies computer system integrators and developers.
Microsoft's operations span across five business divisions: Microsoft business division, server and tools,
Windows division, entertainment and devices division, and online services division. In July 2013, Microsoft realigned its organizational structure as part of its transformation to a devices and services company. Under the new structure, the company operates through five segments: devices and consumer (D&C) licensing;
D&C hardware; D&C other; commercial licensing; and commercial other.
ABOUT NOKIA AND ITS BUSINESS DESCRIPTION
Nokia Corporation is a provider of telecommunications network infrastructure, location-based technologies and advanced technologies. The company has operations across North America, Europe and Asia. It is headquartered in Espoo, Finland. Nokia Corporation provides network infrastructure to the telecommunication industry. The company also offers location intelligence solutions and advanced technology development and licensing. Nokia has global presence with operations, and research and development (R&D) facilities in Europe, North America and Asia, and sales in approximately 130 countries.
The company operates through three businesses: networks, HERE and technologies. Networks segment
(formerly Nokia Solutions and Networks) offers telecommunications infrastructure that focuses on the mobile broadband market. The networks business is further organized as two business units: global services and mobile broadband. Nokia’s network planning and optimization business offers network assessment and capacity and configuration planning. The company offers these services through two global delivery centres and five global service delivery hubs around the world. Nokia’s HERE business is engaged in location intelligence business that delivers maps, a location platform, and location experiences across multiple screens and operating systems. The company’s technologies business is engaged in technology development and licensing. It manages a portfolio of approximately 10,000 patent families comprising of around 30,000 individual patents and patent applications
INTRODUCTION OF THE MICROSOFT-NOKIA MERGER
Microsoft recently acquired Nokia to leverage its position in the smartphone market. On April 25, 2014,
Microsoft’s essential acquisition of Nokia’s handset business was finalized after a seven-month-long process. The former smart phone company Nokia will now be incorporated as a subsidiary of Microsoft and renamed Microsoft Mobile, according to the report. Taking cue from this deal, current leaders in smartphone market Apple and Samsung will have a new competitor to look out for in the future.
Microsoft initially announced the merger in September of 2013, and after going through some legal hurdles in Nokia’s Asian markets, the deal was finalized. Microsoft purchased Nokia’s smartphone business for
3.79 billion euros ($5 billion) as well as the company’s existing patents for an additional 1.65 billion euros
($2.18 billion) for a grand total of about $7.2 billion.
Earlier CEO of Microsoft Steve Ballmer described this merger as “bold step into the future” and a win-win situation for shareholders, employees and customers of both companies. This deal can be described as the merger of best of Microsoft’s software engineering with the best of Nokia’s hardware engineering.
This move by both the companies is not much of a surprise as both the companies had already established business relationship with each other. They have worked closely to produce Nokia Lumia smartphones
(They run windows OS).
In this report deal has been analyzed in a step wise manner. Initially SWOT analysis of both the companies is discussed. Then this report has tried to figure out, how these capabilities and weakness have been used for the merger. It also discusses management analysis to see the rationale of the management behind the acquisition and critically evaluates the judgment of the management. Financial analysis of the deal was carried out to see the monetary benefits of the deal for both the companies (Microsoft specifically).
Report has tried to figure out the future of this acquisition by carrying out in-depth analysis of the market, investors and customer sentiments after the merger. This report also analyzed the technological and R&D issues that merger may face in future. Future marketing and branding initiative that may evolve in future have also been discussed. Please refer the below diagram for the step wise approach for the analysis of the merger.
Process Flow for analysis of Microsoft-Nokia Merger
Microsoft and Nokia
Analysis and strategic rationale for acquisiton
Financial analysis of the deal as well as understanding market and investor sentiments
Future Issues as a result of Merger (Marketing and Branding,
Technology and R&D)
SWOT ANALYSIS OF MICROSOFT
Robust presence across the software and hardware landscape
Strong Distribution Channel
Strong R&D capabilities driving organic growth
Strong financial performance
Brand Loyalty and Brand reputation
Poor acquisitions and investments:
Dependence on hardware manufacturers:
Criticism over security flaws
Mature PC markets
Slow to innovate
Cloud based services
Growing application servers market
Growing Mobile devices Industry
Intense competition in software products
Changing consumer needs and habits
Open source projects
Note: The SWOT analysis has been done without taking into the account of the Acquisition
As we see that one of the Microsoft’s weaknesses lie in over dependence on hardware manufacturers or
OEMs, it would naturally point to the direction of building hardware capabilities and vertically integrating through organic methods or through acquisitions. Also with the pace of technological advancement and market growth of mobile devices, the time seems appropriate to enter into mobile devices with an established and trustworthy brand. The threats in Microsoft’s traditional software business seem to be manifold including the maturity of the market as well as availability of opens source software and platforms.
Hence, Microsoft’s diversification and increasing focus on hardware to promote its software and increase the installed base seems to be strategically right.
SWOT ANALYSIS OF NOKIA
Well established networks business
Robust patent portfolio to drive future growth
Diversified geographic presence
Strong brand awareness across the globe
High reputation of industrial hardware design, build quality and voice quality
High Levels of Brand Loyalty
Declining Top-Line Performance
Inward-looking and short-sighted vision
Failure to establish effective communications between teams
Long product development cycles and long time-to-market
Symbian cannot fulfil customer needs any more, but Nokia still heavily relies on it
Failed to commercialise R&D outcomes
Rising demand for high-bandwidth mobile communications
Strong outlook for connected and smart vehicles market
Nokia’s expanded partnership with
Intense competition in the telecommunications market infrastructure
Operating in highly regulated markets could impact growth
Foreign exchange risk
Nokia had declining top line performance over the last few years. It failed to respond to the market needs and trends and struck to its platform till it was too late to jump the bandwagon. It had long product development cycle and time to market for new smartphones with emerging platforms. The opportunity was quickly grabbed by likes of Samsung which used the android platform to build a series of smartphones and gain the early mover advantage. There are a number of other brands in smartphones who saw opportunity
6 and utilized the open source platform to build a range of phones in different price buckets. Apart from the competition, Nokia faced other risks like fluctuations in foreign exchange due to global presence with its financials already in strain. Adding up all these scenarios, the growth opportunity for Nokia was limited with a few segments like high-bandwidth mobile communication and smart vehicle market. The opportunities could be harnessed well with an umbrella cover of a financially strong brand with high reputation. This seemed strategically right to be acquired by such a brand as Microsoft and Nokia could gain from the deal.
BCG MATRIX FOR MICROSOFT
ATTEMPT TO CONVERT Q UESTION MARK INTO ST AR
Windows 8 mobile platform has great potential and serves as question mark for Microsoft in BCG matrix.
Microsoft is not able to gain market share in windows mobile as mobile computing demand has traditionally been OEM centric and based on perception. So every new player faces difficulty to build market share in the competitive environment. Nevertheless Microsoft can gain on its OS and platform knowledge and use windows for mobile devices to slowly increase market share. What it already has, is the OS and platform and only needed a brand in OEM that would vertically integrate its system and complete the value chain to market the whole bundle of hardware with OS. Acquisition of Nokia is a step in this direction as Nokia was
7 going through a financial trouble and was a target for acquisition and it had vast experience of hardware design with a number of patents and intellectual property.
Nokia relies on a strong corporate culture and the company’s value. It has been ingrained into the organisation. Customer satisfaction, respect for the individual, achievement and pedagogical value based leadership has been integral element of the Nokia’s culture. Nokia has relied on strong research and development and entrepreneurial spirit of its employees. It had a flat organisational structure which allowed it to be flexible and fast in decision making. This seems to be in fit with the philosophy and culture of
Microsoft. Although it is a matter of contention whether the corporate culture of Microsoft will have any adverse effect on Nokia in future with the possible changes in structure and leadership.
There has also been a shift in the focus towards more tech savvy management at Microsoft and the business at Microsoft has been changing. After the acquisition of Nokia’s handset division, Microsoft has been making management and leadership changes. Satya Nadella was made the CEO of Microsoft and then
Nokia’s former head Stephen Elop was given full control over the devices division of Microsoft to strategically integrate the processes in the two companies. The CEO named a chief strategy officer and disclosed the exits of several top executives. Nadella, who was promoted to replace Steve Ballmer, is lining up his leadership team as he seeks growth in devices and cloud services. Nadella is also replacing executives who’ve left after Ballmer’s management overhaul. The changes in management may have a positive effect on the integration of Nokia’s organisation structure with Microsoft in future. The acquired organisation has to have a similar structure in the long run to help successful integration to reap maximum benefits out of this deal.
Microsoft paid around 3.79 billion Euros to purchase Nokia’s device and services business and 1.65 billion euros to license Nokia’s patents. Microsoft also offered Nokia a credit of 1.5 billion Euros. From the financial perspective, Deal has helped Microsoft in following ways:
Deal has helped Microsoft in acquiring a high gross margin business of Smart device and services
( >$40 per unit) which is significantly higher than past partnership through which Microsoft used
8 to earn royalty on Windows phone( $10 per unit) This will help Microsoft in pushing its
Entertainment and Devices division at high profitability levels for the first time.
Microsoft expect to generate annual cost synergies of $600 million within 18 months after deal closure. Microsoft predicted that the purchase will reduce the FY-14 Earnings per share by $0.12, will again reduce by $ 6 in FY-15 and will improve earnings per share by $0.04 in fiscal 2016
(GAAP EPS). This is based on an assumption that Microsoft will integrate the new units very well and future product launches will be received well by the public.( ReferFig 1 )
Microsoft's has a US Cash surplus including liquid cash and short-term investment. Microsoft pays its dividends using this cash. This deal uses offshore cash pile and this does not impact the ability of Microsoft to return capital to US shareholders.
As per Nokia’s Income statement, sales of Q1, Q2 and Q3 totaled around 17.2 billion euro out of which 8.51 billion euro came from Devices and services division (49.5%). So Microsoft has been benefited by this deal by purchasing assets that account for 50% of sales.
This deal will improve unit gross economics as described above by the increase in gross margin and provide long term value creation fueled by growth in smartphone business.
At assumed operating margin of 5% Microsoft estimated the net present value of deal to be $15 billion and at
10%, the value is doubled to $30 billion. Refer Table-1 and Table-2 for more details.
Table-1: Smartphone Revenue Opportunity
Smartphone Revenue Opportunity
2018 Worldwide Smartphone demand 1.7 billion
Assumed market share
Table 2: Long Term Value because of Merger
Long term Value Creation: NPV
Assumed Operating margin 5%
Annual Operating Income $2.3 billion
NPV $15 billion
Three levers of the Microsoft –Nokia Deal for better unit economics driven profitability
Increasing further unit growth and market share
Fuel investment in
R&D and marketing
Improved per unit
Economics by increasing gross margins dollars and overall synergies
MARKET AND INVESTORS SENTIMENTS
Initially Microsoft investors showed unhappiness after the announcement of deal resulting in stock prices going down by 4.6% to $31.88, which led to elimination of $13 billion of market value. However Nokia investors welcomed the deal resulting in stock prices of Nokia surging by more than 40%. (ReferFig 2 and
Fig 3 ) Investors believed that ownership of Microsoft would not change the sales of windows phone, but
10 would decrease them as it prompts other Original equipment manufacturers to give up on it entirely. We believe that this deal was in favor of the US investors at Microsoft as the US cash pile was not used for the deal and hence did not hamper the ability of Microsoft to provide return in form of dividends to shareholders. Also as described by Microsoft in their “rationale for acquisition”, this deal creates long term value to investors of around $30 billion, assuming 10% operating margins.
RATIONALE BEHIND THE ACQUISITION
Microsoft has suffered similar problems to Nokia; it once held monopolist control over the PC market, and its operating systems are still ubiquitous. Despite strong revenues from its Windows OS, Office suite of business software and Xbox game console, the company’s mobile phone unit and tablets have not been successful. The trends show that the technology evolution has made the computers ubiquitous and soon will transform computing to purely mobile from the traditional. If Microsoft had to align with the current trends, it needed strong devices knowledge as well as market share. Microsoft saw a chance of that in Nokia and strategically decided to consider a buyout. Nokia has traditionally been good at mobile handset designs and technology till it lost the battle of OS to android which changed the mobile market scenario.
MICROSOFT’S UNSUCCESSFUL STINT IN MOBILE DEVICES
Microsoft has enjoyed a considerable success in the desktop and business software industry, and has consistently grown its revenues. However, the desktop market is declining, which has made the company think seriously about its long-term future. The explosive growth of the tablet and smartphone market is something the company attempted to capitalize on, but unfortunately it has not been able to quite compete with the likes of Apple and Samsung in the mobile devices design. (ReferFig 4 for Technology-S curve)
Table 3: Worldwide Device Shipments by Segment (Thousands of Units)
Device Type 2013 2014
261,657 Traditional PCs (Desk-Based and
Ultra mobiles, Premium 21,517 32,251 55,032
PC Market Total
Other Ultra mobiles (Hybrid and
Source: Gartner (June 2014)
LEVERAGING THE BRAND IN MOBILE DEVICES KE EPING OUT OEMS
Compared to its competitors, Microsoft systems are usually adopted by original equipment manufacturers
(OEM), preinstalling it on their devices. In new classes of devices, it is hard to get leverage simply through the OEM model (in particular phones and tablets) due to the lack of brand appeal and fragmented nature of producers. By acquiring Nokia, Windows hoped to create its own products and compete directly with Apple and Samsung. In other areas, Apple also possesses an advantage in distribution, by fronting its own retail presences across the world. A good retail presence of Nokia and its customer service focus will help
Microsoft to compete against Apple.
VERTICAL INTEGRATION WILL IMPROVE PROFIT MARGINS
Microsoft’s stint in mobile phones has been mostly unsuccessful and with the newly acquired Nokia’s
32,000 staff, the company hopes be able to focus the resources on tablet and phone production. The company thinks that the elimination of Nokia’s development and marketing costs would bump the average profit per unit up from less than $10 to $40. It will also have complete control over the product, allowing it to shape it as it wishes. By integrating a manufacturer into the fold, Windows will have a similar offering to Apple in both hardware and software designed together. Nokia will assist tablet manufacturing too.
Nokia’s experience will not only come into play with the smartphones, but also tablets. The Nokia Lumia
2520 is a tablet, and will help to compete over different price ranges compared to the expensive Surface.
There is also space to exploit “phablets”, a product somewhere between a phone and a tablet. There is also an advantage for corporate owners, adopting BlackBerry style abilities to administer a fleet of Windows
Phones easily. Blackberry’s current difficulties represent an opportunity for Microsoft to exploit the market for corporate phones, a potentially lucrative business area. Vertically integrating and providing complete solution with presence in the whole value chain will help Microsoft reduce cost as well as capture the high segment which requires security as well as service and trust which an android platform may not be able to deliver.
FUTURE MARKETING & B RANDING ISSUES
Now that Microsoft has acquired the mobile devices division of Nokia, along with a license to use the
NOKIA brand name for some feature phones for next ten years, there are huge speculations about the future branding of these devices.
Although Microsoft is entitled to use the NOKIA brand name, it cannot do so for long because even now
NOKIA as a company and brand does exist (in the networking business) and thus Microsoft cannot risk trading its mobile devices under NOKIA brand for much longer.
Secondly, Microsoft Mobile, a possible brand name for Microsoft’s line of mobile devices is not a wise choice either. Reason being, Microsoft has always been synonymous to PCs and laptops and a mobile brand in its name may not be well received by the consumers. Thus, looking forward, Microsoft will have to come up with a brand name for its new line of mobile devices which captures the essence of Microsoft and windows platform as well as leverages the huge brand recall for NOKIA products. The main contention that lies here is Consistency i.e. the new brand must also be consistent with Microsoft’s organizational theme.
A common speculation that is on the rage in market is that Microsoft’s mobile phones would be badged as
Lumia, Surface or Xbox.
Apart from coming up with a strong and relevant brand name, other concern that lies ahead of Microsoft is to use the blend of NOKIA’s product along with Windows OS to compete with Google’s android platform, especially the Samsung-Android combo. Also the mobile devices product line can help Microsoft push its
Skype video chat and VoIP platform and maintain its supremacy despite a reasonable threat from Google
FUTURE TECHNOLOGY AN D R&D ISSUES
Through NOKIA’s acquisition, Microsoft suddenly got access to a huge pool of patent and a strong R&D team in the mobile & smartphone technology. But the main point of concern here lies in the fact that will
Microsoft be able to leverage upon this vast knowledge and if so, how? The key points related to technology and R&D are as follows:
Microsoft got around 8,500 design patents and rights to the Asha and Lumia brands, as well as a
10-year license to use the Nokia brand on feature phones. Nokia retained ownership of some of the most valuable utility patents in the wireless industry. Microsoft didn’t buy those patents, but it licensed them for 10 years, giving Microsoft free arena that other rival phone makers would not have.
Through this deal, Microsoft has gained a deeper store of research knowledge through Nokia’s huge spent on R&D. All R&D Staff related to mobile products and smartphones is going to be
13 transferred to Microsoft. This will help Microsoft in leveraging the R&D for the manufacturing of innovative products in mobile segment.
Microsoft has to compete with low cost manufactures (Chinese mobiles) but it can use Nokia’s international manufacturing and distribution for its advantage in future.
Microsoft acquired the Morph Concept of Nokia which is a research and development for flexible device bodies and nanotechnology. Nokia’s innovation can help Microsoft in making Windows
Phone OS more developed and innovative.
LIST OF FIGURES
Expected EPS Impact by Deal
Fig 1: Expected impact on EPS after merger
Fig 2: Stock Price of Nokia after Deal Announcement
Fig 3: Stock Price of Microsoft after Deal Announcement
Fig 4: Technology S-Curve