Dial W For War

Recent headlines seem to indicate that Europe poses a threat to Microsoft's ravenous appetites. Pushing a fight abandoned in the United States, European Union trustbusters are reviewing Microsoft's move into the market for digital media, and are due to rule early next year. Meanwhile Linux, the free Finnish operating system, has been gaining customers at the expense of Microsoft's profit center, Windows. The most recent large customer to begin testing the free software: the British government.

None of this is good news in Redmond, Washington. But less noticed is the fact that the battle may be turning in Microsoft's favor on perhaps the most important technology front of all--the war for the future of the mobile phone. Dominated by Finnish giant Nokia, the mobile market is the one technology sector in which Europe has enjoyed a sizable lead over American and Asian competition. In recent weeks, however, Microsoft deals with the No. 2 and 3 mobile-phone makers, Motorola and Samsung, and a new partnership with the world's largest mobile operator, Vodafone, have some experts betting that Bill Gates will be able to dominate the mobile-phone arena as completely as he has the computer world.

The battle centers on smart phones, the wireless handsets that will soon (or so we're told) allow us to e-mail, play games or do business on the go. Smart phones will represent a $16 billion market by 2007, up from $3 billion today, predicts IDC, a technology-research firm. The key to unlocking the profit in this field is not in making the phones but in making the software inside. While the price of smart phones is expected to fall over time, the software that turns phones into multipurpose tools and toys is expected to be a gold mine. That's what happened when Microsoft came out with Windows: it turned the PC into an increasingly cheap shell for expensive software. "The danger is that Nokia may continue to be the world's leading handset maker, but Microsoft will end up taking most of the mobile industry's available profits," says Keith Woolcock, a director at London-based Westhall Capital.

The Windows operating system is in only about 10 percent of smart phones being shipped today, so Microsoft is playing catch-up. In 1998 Nokia teamed up with other phone manufacturers to create their own operating system, called Symbian. The Symbian operating system now runs in 70 percent of smart phones. And Microsoft's forays into mobile devices haven't been seamless, with some early PDA and smart-phone deals flopping or unraveling.

But now Microsoft is making headway in a two-pronged attack on the Nokia- Symbian position. The first prong is designed to win over big phone companies, which play a key role in selling smart phones (you've heard the pitch: buy our service for a year, get a phone cheap). Last month Vodafone agreed to work with Microsoft on developing standards for mobile-phone software. That doesn't mean Vodafone will choose Microsoft over Symbian in the end, but it does make the world's largest mobile-phone company (123 million customers) a more neutral party in the war.

Microsoft courted Vodafone by offering goodies Nokia has not. The Finnish giant's latest gadget, N-Gage, plays games that must be bought in stores rather than downloaded--effectively cutting off revenue to network operators like Vodafone. Microsoft, meanwhile, offered operators a new source of revenue. On Oct. 13, Gates and Vodafone strategic-relationship director Ian Maxwell introduced a device that would allow PC users to tap Vodafone services. "By giving the operator a slice of the PC business, Microsoft is being very cute on strategy," says Woolcock. "It's offering the operators medicine for their pain," caused by growing competition and falling prices for regular phone calls.

The other prong of the Microsoft offensive is designed to bust up the wagons circled against it. Symbian is essentially a Nokia-led attempt to rally fellow hardware makers against the threat of hollowing out at Microsoft's hands. But this year one of the original members of the partnership--the No. 2 handset maker, Motorola--sold its Symbian shares and began shipping Windows-enabled phones. The No. 3 maker, Samsung, bought into Symbian, but also began shipping Windows-enabled smart phones. The clear message: the majors are beginning to hedge their bets.

The endgame will be to get giants like Vodafone to choose as many Windows-enabled phones as possible. Microsoft has a leg up, in that most consumers are already familiar with Windows and most software developers work with the operating system. Though most of the latter are designing for the PC, Microsoft has recently created ways for them to translate their ideas to a mobile-phone operating system with relative ease. Those ideas will be the seeds of the games and other applications that European operators are already counting on to produce 77 billion euro in revenue over the next few years. "In three to five years, we want to be the company that made all these mobile applications work," says Microsoft mobile-devices corporate VP Juha Christensen.

To do that, Microsoft has decided it will have to make an end run when it comes to mobile standards. The Open Mobile Alliance, an effort to create common programming standards supported by big industry players like Nokia, Vodafone and even Microsoft, has been slowed by turf wars. Some analysts say the Microsoft-Vodafone partnership has a good shot at establishing the industry standard. "The problem with OMA is that it's a system of standardization by consensus," says Nomura analyst Richard Windsor. "That takes forever and ends up with a system that's optimized for nobody."

Of course, Nokia isn't taking the onslaught lying down. It is pushing into the market for sales to business, a traditional Microsoft stronghold, and putting a lot of effort into licensing its own software. But experts say they need to get even more aggressive. A few weeks ago at a big technology conference in Los Angeles, Microsoft was busy pushing developers to create mobile Windows applications. September quarterly results show that revenues for the company's mobile unit, while still relatively small, have doubled year on year. If Nokia wants to guarantee its share of future mobile-data traffic, "it will need to take the fight to the streets like Microsoft does," says Andy Buss, a senior analyst with market-research firm Canalys. Otherwise, Europe's best-known technology company may find itself outmaneuvered by outsiders.