Lenovo and Microsoft recently announced a collaborative deal that sees Lenovo preinstalling a number of Microsoft's applications onto its Android-powered devices. In addition to installing a number of Microsoft's applications at the factory, which will include Microsoft Office, Skype and OneDrive, Lenovo and Microsoft have also signed a cross licensing patent deal. Whilst the terms of this have not been disclosed, it is likely that Microsoft is able to dip into Lenovo's patent collection and vice-versa. This cross licensing patent deal is not the first deal that the American technology company has made with smartphone manufacturers and it almost certainly won't be the last.
Both companies made something of their arrangement by explaining how consumers would benefit from Microsoft's productivity applications right out of the box. This is true and Microsoft are likely to see an uptick in the number of mobile customers using their applications. Having Microsoft's applications pre-loaded onto the device could also encourage customers to buy Lenovo devices, either in a personal or professional capacity. Whilst it is fairly easy to download the applications from the Google Play Store, there are many smartphone customers who may not consider to try the Office apps on their device.
However, there is much more to this arrangement than bringing in a few more users to Microsoft's applications and services. First, let's take a look at why Microsoft is arranging these licensing deals and what it stands to benefit. The crux of the matter is that there are several Microsoft patented technologies embedded into Android, which means that manufacturers should pay Microsoft a royalty in order to ship devices with Google's operating system. Many have dutifully signed checks to Redmond since 2011. The exact sum per device is not known but is believed to be between $7 to $15. In 2014, Microsoft sued Samsung for not paying this license fee and the two companies eventually agreed to share their patents between the two businesses. We've also seen Microsoft applications appearing on Samsung flagship devices, such as the Galaxy S6 and Galaxy S7 families. Back in 2014, Microsoft's annual earnings from patents were believed to be around $2 billion. For a company as large and profitable as Microsoft, this is a relatively small sum, but it contributes to the business nevertheless and most of it goes straight into the bottom line.
Android is the market leader in the world today, so surely Microsoft's patent office must be popping Champagne corks? Not so fast. Microsoft does not have licensing deals with all manufacturers. Far from it, actually, and since 2011 there has been massive changes in the smartphone market. We've seen a number of Chinese companies, such as Huawei, sell more and more Android devices whereas the established names back in 2011 are selling far, far fewer such as HTC. Many of those newer manufacturers to the Android party do not have a Microsoft licensing deal and are taking market share from those that do. This in turn is reducing the income Microsoft derives from patent license deals. Indeed, at the last quarterly results briefing Microsoft announced a 27% year on year drop and blamed a fall in license revenue per unit and licensed units. Microsoft's cross patent licensing deals will combat this drop in revenue.
Until comparatively recently, Microsoft was pushing its own mobile operating system: Windows Phone. As a platform, Windows Phone still exists and is being sold to those businesses reliant on Microsoft Windows and Server platforms where Windows Phone does have certain advantages. For the longest time, Windows Phone offered the best in class experience for using Microsoft's applications and services on the go but this was not a commercial success. Microsoft changed their approach, investing time and effort into improving their productivity applications. To use the example of Microsoft Office, this is a good productivity package on all available platforms, which include Android, iOS, Mac OS, Windows and even Linux and Chrome OS via Office Online. If a number of Lenovo's customers try Microsoft Office on the Android platform and enjoy it, they may be tempted to subscribe to Microsoft Office 365. In the short term, this will boost Microsoft's revenue but in the bigger picture, these customers are buying into Microsoft's infrastructure. From this point, it doesn't matter if they switch from Android to iOS, or from Windows to Mac OS or Chrome OS, they can still access their Microsoft applications.
Microsoft no longer wants to control the customer experience from start to finish, but instead is happy for the customer to access their applications and services by whatever route he or she wants. They are in effect treating the device as a dumb means of connecting to the customer. In this arrangement, it matters much less what manufacturer or platform is the current market leader, only that customers can access Microsoft's products and services. However, to press on this advantage, Microsoft does need to sign into more cross licensing or similar patent deals with manufacturers. Given Microsoft's patent portfolio and how useful this will be to those manufacturers wishing to break into the North American market, such as Xiaomi, we may be seeing more of these arrangements in the coming months. The alternative might be Microsoft suing any manufacturer that tries to sell devices into a patent-friendly market.