Should Microsoft Buy Nokia or Make Its Own Smartphone?

Speculations have gripped the market in recent days that Microsoft Corp. (Nasdaq: MSFT) may begin making its own tablet PC and smartphone as it continues efforts to propagate the Windows operating system.

I wouldn't bet against either this or even the possibility the company may purchase Nokia Corp. (NYSE: NOK), its troubled partner in the wireless communications equipment market. In fact, if Microsoft wants to take the lead in being disruptive and making Windows OS competitive, I believe it should bring Nokia firmly under its wings.

Microsoft won't be new to the hardware business and is probably better prepared to extend its brand into newer areas than many of the companies that have ventured into tablet PCs and suffered significant setbacks, including Hewlett-Packard and Research in Motion.

Although primarily a software company and the dominant competitor in the PC operating system segment, Microsoft has also established itself as a major player in the gaming market with the Xbox, in addition to selling other hardware, including keyboard, mouse, and branded headphones. The extensive supply chain network the company has built for the Xbox can easily be leveraged to support other equipment the company may want to introduce in future. Click here for a list of Microsoft products.

I suspect for several reasons Microsoft may have no options but to dive headlong into the communications equipment market with its own products and rather than through surrogates as it has so far done. The profile of the traditional OEM is changing rapidly with former partners morphing into rivals and new alliances and support systems being constantly forged in the rapidly evolving market.

The expertise available at electronic manufacturing services (EMS) providers, coupled with off-the-shelf IP from companies like ARM Ltd. (Nasdaq: ARMHY; London: ARM) as well as offerings from fabless chipmakers, which in turn get support from semiconductor wafer foundries like TSMC, has made it easy for companies like Amazon.com, Barnes & Noble, and Walmart to stray well beyond their traditional markets to embrace hardware products. Even companies that could be described as regular OEMs are enlarging the pool of products they offer in response to changing customer needs.

Companies like Google (Nasdaq: GOOG), for instance, have changed the way we look at service providers. The acquisition of Motorola Mobility Inc. (NYSE: MMI) by Google, for example, is still reverberating in the wireless equipment market, while its introduction of the Android operating system has contributed to the displacement of Nokia as market leader in favor of Samsung Electronics Co. Ltd. (Korea: SEC). Google, while more popular for its search engine, is essentially today a hardware company via the acquisition of Motorola Mobility, but there are ongoing speculations the company itself may be getting ready to make and sell its own smartphones.

If this idea seems strange (since Google already owns a smartphone vendor), consider this: Even Facebook may get into the smartphone business, according to a report in the New York Times. Why should Facebook get into the hardware business? Because more people are accessing the company's services via mobile devices than on regular computers, making it difficult for the social media company to track users and sell advertising against their online behavior.

Even Apple Inc. (Nasdaq: AAPL), once a purely PC company, has changed the dynamics of several adjacent markets with the iPhone, the iPad, and the iPod. It's fair to say today that Apple is more of a consumer electronics company than a PC vendor. But even that description is in flux as Apple seeks to expand its influence into other end markets. On EBN, one of our more successful blogs -- in terms of page views -- is a report that speculated on new directions Apple might take that could supercharge any of a bunch of currently dull markets. (See: Apple's Next Big Thing Will Be Huge.)

The wireless handset and computing equipment market is obviously evolving too rapidly, and the changing profile of the players indicates enterprises in this area will continue to redefine whatever they consider their core operations.

For Microsoft, its days as a software-only company are over. It is today compelled to mix up hardware and software to remain competitive. The alliance with Nokia in the smartphone market gives it a good opportunity to light a fuse under Windows OS for mobile devices, but the market response has so far been lukewarm. A Microsoft-branded tablet PC or smartphone might be the game-changer the company needs to be more competitive against Apple OS and Android.

One option Microsoft has is to simply purchase Nokia. It has the funds ($60 billion in cash and short-term investments at the end of the March quarter) and the market value to support such a transaction. Plus, the target company is wounded and in survival mode. Its market capitalization has dropped to less than $10 billion versus $250 billion for Microsoft. Will Microsoft make such a move? I doubt it, but I wouldn't be surprised.