Microsoft's Frantic Race for Third Place in Smartphones - Businessweek

Apple's (AAPL) not in the mobile phone business, it's in the perpetual-motion business. If past performance is any indication, the announcement on Sept. 12 of the iPhone 5 will lead to a rush of customers when the first units go on sale. Apple releases product, people buy product. Rinse, repeat.

There's another company that would like to be in the perpetual-motion business, too: Microsoft (MSFT). The computing giant has some experience with this, having turned Windows into an indispensable part of the PC world for much of the 1980s and '90s.The action has moved on to mobile now, and Microsoft has two wishes as it comes to that market with its line of Windows Phone 8 devices in the coming weeks: that there's room for three companies in the battle and that it'll be one of them.

Looking at the state of the mobile market, neither of those is a given. According to market-research firm ComScore (SCOR), Google's (GOOG) Android operating system commanded 52 percent of the U.S. smartphone market in the second quarter of this year. Apple's iOS took up 32 percent; Microsoft's Windows Phone had 4 percent.

So how does Microsoft make a dent here? One way, after years of letting hardware companies make lackluster devices under the Windows Mobile banner, is to take a page out of Apple's playbook and closely ally software with hardware. Microsoft began to take this tack in 2010, starting the Windows Phone brand and imposing strict hardware requirements on its device partners.

Microsoft has entered into a close relationship with Nokia (NOK), which in February 2011 abandoned its own operating system, Symbian. (Other handset makers are also building Windows Phone 8 devices, but Microsoft and Nokia are closely linked, sharing technologies and courting developers together.)

Nokia's chief executive officer, Stephen Elop, is a former Microsoft employee, and introduced the company's latest smartphones, the Lumia 820 and 920, one week before Apple's announcement. The phones have been praised for their design and their advanced navigation features. But Elop's inability to give an exact date for when the phones would go on sale—and the discovery that the company's demonstration videos exaggerated the Lumias' image-stabilization technology—damped enthusiasm. Nokia shares tumbled by 16 percent on the day of the Lumia unveiling.

Nokia is in a position similar to Microsoft—big in other areas of tech (such as basic-feature phones), but way behind on smartphones, where its 8.2 percent market share trails far behind Apple's and Samsung's. The Finnish company is by far the largest Windows Phone maker; it's responsible for 59 percent of all devices sold with that operating system. Given Windows Phone's 4 percent market share, that makes Nokia the tallest dwarf.

Windows Phone 8 has some things going for it: It's generally admired by the tech press for its originality and creativity. The user interface, like that of Windows Phone 7, dispenses with the traditional grid of icons and instead uses "Live Tiles" to display up-to-date information on the home screen. The operating system's unique look and feel also means it has escaped the costly patent litigation that's ensnared Android manufacturers and Apple. Indeed, during the U.S. Apple-Samsung trial, an Apple lawyer held up a Windows Phone 7 device to make the argument that you could create a smartphone different from Apple's.

But one man's original is another man's eww. "The real obstacle is that consumers see it as something unfamiliar, maybe even weird," says Horace Dediu, an independent mobile analyst and former Nokia executive.

Microsoft thinks it can get consumers over this hurdle by introducing them to another product: Windows 8, its desktop operating system, which comes out at the end of October. The new operating system has an interface similar to that of Windows Phone 8, making the smartphone look more like a natural extension of the desktop experience. "It's going to feel familiar," says Greg Sullivan, the senior product manager for Windows Phone. "Windows 8 helps get the word out there."

There's little doubt Microsoft will be funding a massive marketing effort behind Windows 8 and Windows Phone 8. What's less certain is whether such a push will work and whether the company has enough time to turn things around. Given how long it took people to adopt Windows 7, Microsoft is facing a tough road, says Charles Golvin, an analyst at Forrester Research (FORR). "We may be talking about exposing people to Windows 8 for three or four years before they want it on their phone. That kind of timing doesn't work to their advantage."

That's because the opportunity to gain customers is shrinking. Consider the U.S. market: Approximately half of all Americans have a smartphone, with the number growing by almost 2 percent every month. Microsoft and its partners have a limited amount of time to reach consumers who don't already have a smartphone—a group decidedly easier to win over than existing smartphone users. According to a 2011 survey from UBS (UBS), 89 percent of iPhone users intend to buy another iPhone when it comes time to replace their handset.

The people coming late to the smartphone game are, by definition, not early adopters. They're likely to have less technological sophistication than people who bought smartphones earlier, making an unfamiliar interface even harder to sell. "They have to communicate very quickly to an audience that may not be interested in their value," says Michael Gartenberg of Gartner Research (IT).

Microsoft is known for its tenacity when it enters new markets. "Our road map for Windows Phone is measured in years, not months," says Sullivan, the Windows Phone product manager. History supports this: In 2001, Microsoft released the Xbox, a gaming console that most people said had little chance against Sony's (SNE) established PlayStation and, later, Nintendo's more family-friendly Wii. Eleven years later, the Xbox has a 47 percent market share and is widely considered to be the dominant gaming platform. Microsoft may be patient. It'd better hope consumers are, too.

The bottom line: Microsoft has quality mobile products to offer but faces an uphill battle to expand its 4 percent share of the smartphone market.