Lumia sales slump sabotages Microsoft's strategy before it starts

Nokia's disclosure today of weak Lumia sales last quarter has put Microsoft's devices strategy in the hole even before it finalizes the acquisition of the Finnish firm, analysts said today.

For the quarter ending Dec. 31, 2013, Nokia reported sales of 2.6 billion ($3.6 billion) in its devices and services division, the one it will hand over to Microsoft. That represented a 29% drop from the same period the year before, and a 5% fall from the previous quarter.

According to Nokia, it sold 8.2 million Lumia phones -- its flagship, armed with Microsoft's Windows Phone operating system -- which was also a downturn from the prior quarter when it sold 8.8 million.

Wall Street had expected earlier momentum to boost sales to 10 million Lumias, but Nokia's actual sales were 18% lower than that, either a major misjudgment by analysts -- it wouldn't be the first time the Street called it wrong -- or a failure of Nokia to push the devices.

The drop in sales and revenue were troublesome signs for Microsoft, which will wrap up the $7.4 billion acquisition of Nokia's handset business this quarter. When the purchase was announced in September, Terry Myerson, who now heads the operating systems group at Microsoft, pointed out the string of Nokia's Windows Phone successes.

"The Nokia Windows Phone momentum has made Windows Phone the fastest growing mobile platform, with 78% year-over-year growth," Myerson said last year. "Every quarter for the past eight quarters more customers have activated Windows Phones than in the prior quarter."

Nokia is the only handset maker to fully commit to Windows Phone, and its sales have accounted for more than 80% of all devices powered by Microsoft's OS, the primary reason Microsoft moved defensively to snap up the Finnish firm's unit.

Nokia's poor showing for the quarter probably has several explanations, analysts said today. But they rejected one that circulated earlier Thursday when some quickly concluded sales had slumped because of anti-Microsoft sentiment -- that, in effect, Microsoft's brand had suddenly poisoned Nokia's in consumers' minds.

"There's no correlation in terms of a tainted brand," scoffed Patrick Moorhead, principal analyst at Moor Insights & Strategy, pointing out that Nokia has been linked to Microsoft, and the latter's Windows Phone OS, for years.

"There may have been some backlash in buying Lumia, but for the most part consumers don't care about these things," said Carolina Milanesi of Kantar Worldwide Panel.

Instead, the experts pinned the blame on Nokia first and foremost, and secondly on the all-too-natural distraction caused by the Microsoft acquisition.

"It's like they said, 'It's not our problem anymore,'" Milanesi said, adding that she interpreted the numbers as evidence that with the acquisition looming, Nokia essentially washed its hands of the business, and probably reduced its promotional efforts and lowered carrier incentives.

Moorhead agreed. "I really do think that there's a possibility that Nokia took their eyes off the ball," he said. "They spent more time in transition meetings than making sure the sell-in and sell-through for the holidays was ramped up."

Tuong Nguyen, principal analyst at Gartner, echoed others when he pointed to likely uncertainty on the part of mobile carriers, who sell the bulk of phones at retail. "The wariness would come more from the vendor partnership side rather than consumers," he said, reflecting on the speculation that Microsoft's acquisition had turned off buyers.

If they're right, Microsoft's chances of improving Nokia sales may not have taken much of a hit, if any. But that doesn't mean the Redmond, Wash. company doesn't face some huge challenges making the deal pay off.

"The challenge is two parts," said Nguyen. "First, the feature phone business is scaling down as they ramp up the Lumia line, but that's not ramping up as fast as the feature phone is ramping down. And as the industry as a whole has seen less true innovation, the fourth quarter isn't a blow-out quarter like it once was. The market's hitting the point, in developed countries anyway, where it's a replacement market now."

Milanesi said that while Microsoft clearly lost some of the momentum it had thought would be there, it could still make good if it hustled, something Microsoft has had trouble doing even in the recent past.

"It is critical that when [Microsoft] lands the deal, they go out and show something and say something," Milanesi said. "Microsoft cannot take six months to do that. It would kill them."

Moorhead was on the faster-not-slower bandwagon, too.

"Microsoft does have a distribution problem. When only two out of 100 phones are Windows Phone, it's very hard to drive meaningful share, it's hard to get developers excited, and creates a vicious circle," said Moorhead. "The top of everyone's mind in the channel and among developers is, 'What's next, Microsoft? How are you going to drive volume?' It needs a very early disclosure of what it wants to be in mobile, and must move as quickly as possible to do that."

While both Milanesi and Moorhead expect Microsoft to use its Build developers conference, slated to run April 2-4 in San Francisco, to clarify its handset strategy, Moorhead believes that might be too late.

"I don't think Build is early enough, but I do think that's where they'll give some disclosure," said Moorhead. "Microsoft will want to take advantage of the friendly environment at Build, where developers who are arguably pro-Microsoft may be able to influence those who are on the fence."

Whatever Microsoft does, and no matter what Nokia's final 2013 numbers were, all agreed that the former has a very hard row to hoe this year.

"The numbers hurt to some extent," said Jack Gold of J. Gold Associates "So how do you bring this back in the short term? That's the question."

"There's still an opportunity for Microsoft, but it needs to work with the carriers and look for those users who have low-end Android phones, who have not invested in the ecosystem," said Milanesi. "Those are the people Microsoft-Nokia should be going after. But they need to get devices on the market."

Gregg Keizer covers Microsoft, security issues, Apple, Web browsers and general technology breaking news for Computerworld. Follow Gregg on Twitter at @gkeizer, on Google+ or subscribe to Gregg's RSS feed. His email address is gkeizer@computerworld.com.

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