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Microsoft takes another hit on phones, but don't count it out yet

A fresh round of layoffs stings, but the company still plans to sell smartphones -- just not as many, or as widely as it used to.

Microsoft CEO Satya Nadella at the Build 2014 developer conference. James Martin/CNET

Microsoft is hoping to get a bigger bang from a smaller smartphone business.

The world's largest software company on Wednesday said it would cut 7,800 jobs, largely in the phone business, and record a charge of $7.6 billion to write-off assets related to its acquisition of Nokia's devices and services business. It essentially values the assets, which originally fetched for $7.2 billion, worthless.

The layoffs mark a significant shift in the company's strategy of selling mobile devices, which has floundered beneath the dominance of Apple's iPhones and smartphones running on Google's Android software. Having spent years struggling to push its Windows mobile operating system as a viable alternative to the Big Two, Microsoft had little progress to show for its efforts. In the last quarter, Windows represented just 2.5 percent of the market, compared with the 79 percent share captured by Android.

"It is clear that Microsoft is not willing to lose money indefinitely building phones that have little chance of succeeding," said Avi Greengart, an analyst for Current Analysis.

While Microsoft is in retreat, the company is not exiting the smartphone business. The company plans to focus on three key segments: business, value and flagship,Microsoft CEO Satya Nadella said in an e-mail to employees.

It will, however, significantly reduce the number of Lumia-branded devices it produces each year, and leave markets where its products are not selling well, according to a person familiar with the company's thinking.

"We are moving from a strategy to grow a standalone phone business to a strategy to grow and create a vibrant Windows ecosystem including our first-party device family," Nadella said.

Microsoft likely won't follow the Apple playbook of offering just one or two devices at a single event each year or Google's model of releasing a single Nexus smartphone each year. But the company will cut back on the models it releases. In 2014, Microsoft and Nokia released roughly nine devices, with different variants depending on region and carrier.

While the sheer amount of layoffs that have occurred -- 18,000 jobs were cut last year -- suggest a crippling of its resources, the company believes it has the manpower and research and development chops to maintain its phone business.

"They can't get out of phones -- it's too important," said Ken Dulaney, an analyst at Gartner.

It wasn't working

Microsoft telegraphed a shake-up in the smartphone business last month after the company jettisoned Stephen Elop, the head of the devices group, as well as his lieutenant, Jo Harlow. The devices group was brought under Terry Myerson, who also runs the Windows group.

The devices group, formed when Microsoft closed its acquisition of the Nokia assets in April 2014, had kept a low profile for the past year, releasing only a number of budget-friendly smartphones.

The Lumia 530 was a hit with budget-conscious customers, but didn't help drive the public perception of Windows Phone. CNET

When asked about a high-end, or flagship, smartphone, executives would only offer a tease. Microsoft still plans to offer a flagship smartphone by the end of the year, the person said.

The low-profile strategy didn't help raise the profile of Windows Phone for consumers. While customers in emerging markets and extremely budget-conscious folks in more developed market sought out Lumia phones for their value, the operating system never went mainstream like iOS or Android.

"The lack of a high end device in market today means they are not competing with iPhone 6 and Android devices like Samsung's Galaxy S6 - so the hardware approach is lagging," said Chris Hazelton, an analyst at 451 Research.

Even if a Lumia flagship doesn't rack up the same sales as an iPhone, it's important that Microsoft be in the game with the kind of broad campaign and carrier push that a Lumia 1020 received at AT&T.

The low profile was a primary reason Microsoft's vendor partners, which have eagerly lined up to build Windows 10 PCs and laptops, have been reluctant to commit to a Windows-powered smartphone. While partners like Samsung and HTC have produced Windows mobile devices, there is little enthusiasm behind them.

Preparing for what's next

Microsoft originally purchased the Nokia assets to build out its own smartphone business. But the decision to pare down its own product portfolio suggests it may attempt to rebuild its bridges with the other vendors, said Carolina Milanesi, an analyst at Kantar WorldPanel. It's what made Windows such a popular platform for PCs.

"Microsoft can go back to the original formula," she said.

The Surface business may serve as a model for the phone business. Sarah Tew/CNET

It's unclear, however, whether the vendors are eager to jump back on board. The company is banking on the fact that Windows 10, which can run on multiple devices and multiple sizes, will eventually drive interest in a Windows-powered mobile device. It's a pitch the company has used before with little success, but it believes it has more a legitimate argument with Windows 10.

Another shift in its strategy is getting away from the idea that its core services are only available on Windows devices. Instead, the company made its various apps and services -- Outlook, Office and Skype -- available across all platforms.

Beyond smartphones, Microsoft wants to be ready for the next category of devices that emerge from the mobile world. As such, the company believes it's still important to be in the hardware business and thinking about mobility, the person said.

"In the longer term, Microsoft devices will spark innovation, create new categories and generate opportunity for the Windows ecosystem more broadly," Nadella said.

So even if it missed out on this generation of mobile devices, Microsoft may have a shot at that elusive next big thing.