Microsoft's Strategy For Nokia Becomes Clearer

English: Stephen Elop meets the bloggers in 2008 Suomi: Stephen Elop vuonna 2008 (Photo credit: Wikipedia)

News from Microsoft in the last few days - 4Q14 earnings, an announcement of 18,000 layoffs, and the release of a memo from Microsoft's EVP of devices Stephen Elop about rightsizing - has brought about a clearer picture of Microsoft's plans for Nokia's phones, which it acquired in April for $7 billion.

Nokia was one of many cellphone manufacturers that struggled as Apple's iOS and Google's Android gained dominance of the smartphone market and displaced cellphones and other smartphones. Rumors of Microsoft's buyout interest, or lack thereof, in Nokia circulated for years before an alliance shifted to an acquisition. But when Microsoft announced the acquisition last year, the natural question was how the software company planned to generate profits from a cellphone maker that was bleeding money.

Nokia's still bleeding money, and cost Microsoft 8 cents from its earnings per share last quarter. But strength from Microsoft's cloud computing and the sense that CEO Satya Nadella, who replaced Steve Ballmer in February, is containing Nokia's losses has impressed analysts. Microsoft expects Nokia to break even by 2016, said Amy Hood, CFO of Microsoft, during the earnings call on Tuesday.

Daniel Ives, managing direct at FBR Capital Markets, said after a decade of missed opportunities, Nadella seems like he's taking an honest look at Microsoft and 'skating with the puck' in front of him. 'He's playing a long game,' said Ed Maguire, senior analyst at CLSA, leveraging the cloud and Nokia as a way to sell applications.

Despite being obtuse to the suffering of 12,500 former Nokia employees set to lose their jobs while he praised his business unit, Elop laid out a framework for cost cuts in a memo to employees on July 17. Devices would focus on high and low cost Windows smartphones, suggesting a phasing out of feature phones and Android smartphones. Two business units, smart devices and mobile phones, would become one, thereby cutting overlap and overhead. Microsoft would reduce engineering in Beijing and San Diego and unwind engineering in Oulu, Finland. It would exit manufacturing in Komarom, Hungary; shift to lower cost areas like Manaus, Brazil and Reynosa, Mexico; and reduce manufacturing in Beijing and Dongguan, China.

According to reports that same day, Microsoft would sunset Nokia X Android phones, Asha and Series 40 phones within 18 months.

Nadella gave hints about how Microsoft will make money on Nokia during Tuesday's conference call. Devices, he said, 'go beyond' hardware and are about productivity. 'I can take my Office Lens App, use the camera on the phone, take a picture of anything, and have it automatically OCR recognized and into OneNote in searchable fashion. There is a lot we can do with phones by broadly thinking about productivity.'

In other words, the sale of a smartphone is a means to other sales.

Over time, Microsoft may move away from all phones but premium smartphones, said Maguire. It may shutter or divest more manufacturing assets.

The next generation of Windows, Windows 9, promises to unify phones, tablets, PCs and gaming consoles with one operating system, and the unification may lead to efficiencies and new opportunities throughout Microsoft.