Surface Phone And Xiaomi Partnership Could Save Windows Ecosystem

  • Microsoft aims to challenge Android/iOS eco-systems but lacks a significant smartphone device.
  • Microsoft will solve that with a Xiaomi Mi 4 device and a Surface phone.
  • In 2016, Microsoft will add the final bricks to its ecosystem with the Surface phone and Hololens.

In recent years, Microsoft (NASDAQ:MSFT) observed massive changes in the consumer electronics market and saw Apple (NASDAQ:AAPL) and Alphabet Inc-C (NASDAQ:GOOG) develop two mammoth ecosystems that cover a wide range of devices from smartwatches, smartphones, tablets, smart TVs, cars, and more. To remain relevant and try to regain its leadership position, Microsoft made some bold moves, like acquiring Nokia (NYSE:NOK), launching the Surface product line, changing the Windows/MS Office pricing model, and attempting to lead the evolving augmented reality market. In the heart of these changes lays Microsoft's attempt to develop its comprehensive eco-system to challenge iOS and Android.

More than a year ago, Microsoft announced its new Windows 10 strategy that is aimed to mimic Android and iOS dominance and include a Windows dedicated version to every device in every segment. The Surface devices are the flagship devices, similar to Google’s Nexus models. Looking at Android and iOS, we can see that a significant smartphone market share is an eminent step towards a successful ecosystem. However, Microsoft’s strongest asset is its market share and leadership position in the PC market while Android and iOS lead the smartphones market. As PC leadership is less relevant nowadays to the building of a successful ecosystem, Microsoft focuses on strengthening its smartphone offerings beyond the Nokia product line.

At the beginning of the year, Microsoft started a somewhat revolutionary action to replace Android on some of the Xiaomi Mi 4 devices. Xiaomi’s VP Hugo Barra explained that Microsoft’s announcement was only an experimental program. However, the Chinese giant is cooperating with Microsoft and providing access to the required information. As per IDC, Xiaomi was the fifth largest smartphone company in Q3 2015, with 5.2% of the market and more than 18 million units sold. Xiaomi is currently not threatening Apple or $SSNF worldwide, but it’s the second largest smartphone vendor in China and has only recently fallen from the top position. Xiaomi is not only a leading player in China, but it is also rapidly expanding into other emerging markets like Brazil, India, Indonesia, Malaysia, and other Asian markets.

Microsoft's move to introduce a Xiaomi Mi4 with Windows 10 is a key action to gain market share in the growing Chinese smartphone market. Just as a reminder, in its recent earnings call Apple announced that its iPhone sales growth is driven by stronger demand in China that increased 120% year-over-year. By partnering with the Chinese giant Xiaomi, Microsoft targets China as a growth driver for the Windows 10 ecosystem. The official release of the Xiaomi Mi 4 with Windows 10 is rumored to take place before Thanksgiving.

The Xiaomi partnership is a great move, but it provides only a partial solution to Microsoft’s eco-system problems. Alongside the emerging market solution, Microsoft launches a Surface phone to support Nokia’s offering in the smartphone market. Microsoft expanded its Surface brand from tablets to laptops, and rumors about Microsoft’s intent to introduce a Surface phone in 2016 to lead the company’s attempts in the smartphone market have recently intensified. While rumors about a Microsoft-branded phone existed for many years, it now seems that the Surface branded phone will be the final brick in the Windows 10 ecosystem together with the Hololens headset.

Once Microsoft completes these two actions of penetrating China via Xiaomi and launching a Surface branded phone, the Windows 10 ecosystem will be ready to take off and gain more than the 2.6% market share it currently has. As Microsoft plans to launch both the Hololens and the Surface phone in 2016, I would have considered allocating a small percentage of the tech portfolio to Microsoft stock in order to capture a potential upside.

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