Assignment Reference ME/Jan11/1 Razman Tengku Othman, 8024686

Nokia- Microsoft Alliance Nokia Nokia is the biggest mobile phone maker in the world with a record of shipment of 400 million phones, meaning more than one million every day. Mobile communication evolves rapidly in early 2000, where the trend of mobile device adding new features on the single device from phone call to music, picture, pocket computer, games which is often refer to as digital convergence. Nokia market share and growth has shifted down in July 2009 till today after Apple, RIM, Android make a big shift in the smartphone ecosystem.

Nokia specialises in making mobile hardware device and mobile internet services. Nokia had many 1st mover advantages in the mobile industry from Mobile Handset to Mobile Network. Telecommunication is a very vertically integrated industry controlling design, production, marketing and mobile communication infrastructure.

In 1992, Nokia focused its industry from making multiple ranges of products to only mobile technology and spread the mobile device into 9 segments in 2002. The specialisation of Nokia in mobile phone market has created insight of market segmentation. Nokia owns all the R&D design, production and marketing in various centre around the world, manufacturing plants in many of the emerging countries and sales offices virtually all around the world. Nokia uses contractors to produce phones when the demand becomes higher than what their production can handle. Nokias brand is the 8th most valuable globally and has the 19th most efficient supply chain in the world.

The mobile phone giant also builds their core competency in-house and has vertically integrated most of its supply chain. Nokia Mobile has the economy of scale to produce global demand for mobile phones and also the economic of scope producing the network

infrastructure through Nokia Network Division to make the mobile phone usable seamlessly in any country.

Nokia suffers what economist calls Penrose Effect from 1991 to 2009, after 18 years of sustaining super profit. In 1998 with 6100 series model, Nokia operation profit jumped 75%, stock price increased by 220% and market capitalization of $70.39 Billion. In 1999-2000, with the mobile Internet related technology being introduced on mobile phones , Nokia market capitalization leaped to $211.05 Billion.

In the 1st of the 9 years which Nokia grew, clearly using the Baumol model, where price and cost is the key driver to increase market share. In telecommunication Average Selling Price (ASP) and Average Revenue Per User (ARPU) are well known revenue yields from asset. In Mid 2005, Nokia is the only company that did not rely on subcontractors in their design reference and solution. Nokia had the competency in house across all the product segments from high end to low end device. In term of TCE, Nokias expertise in mobile device R&D, production and sale enjoyed economic of scale by delivering one million phones everyday.

In 2006 on average, it cost Nokia 69 euros ($87.63) to make a phone, and on average it sells phones (ASP) for 102 euros ($129.54), creating a gross margin of nearly 33%, better than its rivals . In 2010, Nokia Mobile phone ASP is 64 euros($91.41 ). That is a drop of 37% from 5 years ago. In 2009 Nokia stopped using subcontractor like Foxxcon, China BYD American Jabil and Eloteq, after the market demand for Nokia phone reduced and had excess capacity in the market.

Figure .1 ASP Cost breakdown of mobile phone

Source: Infoma 2010

Figure. 2 ASP Evolutions across market segments

When ex-CEO Jorma Ollila stepped down in mid 2006 and was replaced by 25 year veteran Olli-Pekka Kallasvuo, Nokia strategy changed to service oriented industry. With the fast growing internet industry and complex ecosystem mobile industry, Nokia faced Bounded Rationality, three of them being ; limited and unreliable information regarding possible alternatives and consequences, limited capacity to evaluate and process the information and limited amount of time to make decision. There is evidence when Nokia came in late in the clam shell design, slim and touch screen. In summary, Nokia was too focused on the current User Interface using keypad and its icon software - Symbian. Nokia also ignored the social factor of the consumer hunger for innovation products and services. Nokia often made decisions based on satisfying the complex situation. In 2010 Nokia spent $4Billion in R&D to reduce phones sizes and increase performance with opposite effect on its market share of smartphone.

Microsoft

Microsoft is the biggest software company in the personal computer industry with 92% market share in Window Operating System. Recently, Microsoft Kinetic, broke the Guinness World Records for being the fastest-selling consumer electronics device ever released, selling an average of 133,333 units per day in 60 days between 4th November 2010 and 4th January 2011. Last year in Feb 2010, Microsoft launched Window Phone 7 to gain the mobile market ecosystem. This is the latest mobile OS that Microsoft launched after 10 years of developing Pocket PC in 2000.

A lot of feedback from analysts, quoted the Window Mobile being wrong market segment and has become irrelevant. Microsoft is known for specializing in making software for personal computer and not mobile phone. When Microsoft noticed that the market has been introduced a new technology which the company does not have within, Microsoft uses a common strategy to gain entry - strategy embrace, extend and exterminate. When Microsoft reached the vertical boundaries in technology, for example, Browser with Netscape, Java with SUN, Networking with Kerberos, Instant Messaging with AOL, MS Office with Adobe System , Google with Bing and recently Wii with Kenitec.

The Evolution

The beginning of 2007 brought significant changes in mobility, computing, consumer electronics and service industries shifted from device oriented towards platform oriented strategy. Smartphone specialists like RIM, Apple, HTC(Android) took the spot light from the mass production of middle and low cost devices such as Nokia, Samsung, LG, Motorola. That changed the vertical chain of most companies that has been in the industry for more than 10 years whom focused on production of the hardware devices to Service and Application. Smartphones today embrace microprocessor, memory, operating system, application and

function from PC and internet. The Specialization of each of these components has made the mobile phone industry break the value chain and vertical integration to every layer of the hardware and software leading expertise. One of the major components is Operating system that Nokia uses in all are phone model call Symbian.

In 2008, purchased 100% share of Symbian off the market and make the OS its open source. This move transformed Symbian OS to become royalty free and encouraged developers to create application on Symbian Foundation to compete against iOS from Apple and Android from Google. The royalty Symbian charged a phone OEM was average $4.10 and on the extreme Window Mobile Microsoft OS charged $8 to $15 per device. Nokia invested $1.4 Billion on Symbian R&D vs. Apple only invested $744 Million to produce iPhone 4. Market share of Symbian device fell dramatically despite the huge investment into the technology. Android has become the number one spot of next smartphone device in term of next device to buy and current market leader.

Figure.3 U.S. Smartphone Market Share Jan 2011

Issue Tree Question

Are there existing suppliers that can attain economic of scale that in-house unit could not attain?

Nokia: Yes vertical integrated from R&D, Manufacturing and Sales. It have production HW and OS in multiple country China, India, Brazil, Hungry. However the demand and market share reduce. Nokia spend 4B euro in R&D double than Apple 1.7B. and 1.3B euro to Symbian and Meego Microsoft: No production only OS

Do they posses execution capability that an in-house would not? Nokia : Yes. However the VP resign execution leader gone Microsoft: No There demand for smart have shifted to Android due to multiple HW manufacture using the OS

Would intermediate arrangements (alliance, close-knit supply arrangements) suffice? Nokia: Had alliance with Microsoft in 2009 for Eseries with Microsoft Office Mobile Microsoft: Had start communication sector alliance with operator and Hardware vendor in communication industry

Strategic Alliance

Feb 11 , 2011 CEO Nokia Steven Elop and CEO Microsoft Steve Balmer, made a Strategic Alliance for the new third ecosystem for smart phones. Nokia will use WP7 OS with Nokia Devices. In this strategic alliance, Nokia Microsoft will form vertical strategic alliance and

fall in arms length market transactions. Both company will remain mutual independent and involve a lot of cooperation, coordination and information sharing. However these requirements produce uncertainty in behaviour and create opportunism.

Kenichi Ohmae mention strategic alliance is like a marriage, There may be no formal contract.There are a few, if any, right binding provisions, It is loose, evolving kind of relationship. All it need is a lot of trust and reciprocity compare to long complex contract and negotiation to resolve issue.

Nokia-Microsoft Alliance is the natural candidate which: 1) The third ecosystem will cover multiple technology and activity; it will have an obstacle of complex and long contract. This is because of the future activity is uncertain and each other bounded rationality. 2) The third ecosystem transaction is going to be in term service and application will create relation-specific asset by both company and each company could hold up each other. 3) The third ecosystem will create new way of doing for both company, standard commercial and contract law does not foreseen the gaps it will created thus create incomplete contract. 4) The third ecosystem will share the cost of developing the R&D together by using the both experience curve by Nokia in mobile hardware and Microsoft in OS software. 5) The third ecosystem market is unknown and uncertain it will continue for a long time, this enable both company to remain independent and run business as usually. 6) The third ecosystem will use US as their market opportunity, which is the Microsoft have home advantage and also Nokia biggest shareholders.

Picture 1. Third Ecosystem

The hybrid or immediate structure is the key topic of Nokia Microsoft Alliance. The new CEO of Nokia, Steven Elop was from Microsoft and he knows Microsoft in terms of culture and has relationship with Steve Balmer who is the Microsoft CEO. The technology contribution from both leaders in mobile industry, Nokia and software operating system development, Microsoft will create a new way in which smartphone functions and performs. The time to launch the product will be crucial to offset the negative momentum of Symbian and maintain the smartphone sales volume. Speed is the paramount key competitive advantage that Nokia has in mobile phone value chain.

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Strategic Alliance usually comes with the issue of instability, suboptimal performance and also break-up, all these issues comes with high failure rate. There will be an issue with cooperation between the two companies. Of course the incentive to take opportunism or cheat will be advantageous to maximize the gain each company will create the cost of the agency. This incentive to cheat will bring us back to the prisoner's dilemma situation. In order for both to win and gain its highest return, both companies have to voluntarily cooperate. For the cooperation to be successful, a non-zero sum game theory must continue for Nokia and Microsoft to create the third ecosystem focusing on transactional cost of economic. The frequency of interaction and behavioural transparency in sharing information, need to be enhanced and promoted throughout the strategic alliance. The response time needed for Nokia Microsoft to deliver the third ecosystem, though mentioned two years, must be faster to show the power of signal to the market.

Microsoft agreed to pay $ 1 Billion to Nokia for supporting the new Window Phone 7 OS , showed a non-recoverable investment of Microsoft towards the commitment of this alliance. This also shows Microsoft is serious in the partnership, as Microsoft wish to dismiss its reputation of embrace, extend and exterminated. This also promotes goal of congruence between companies. The new Nokia-Microsoft Alliances needs to evolve into soft cooperation, informal relationship and trust-dominated process which will guard against opportunism, reducing transaction cost and improving efficiency.

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