Microsoft To Pay More Than Half A Billion Dollars To Jump-Start Windows Phone 7

Editor’s note: The following guest post is by Kim-Mai Cutler.

Nearly four years after Apple launched the iPhone and two years after Google open-sourced the code for its Android operating system, Microsoft is finally set to re-enter the mobile market this holiday season in a serious way with Windows Phone 7.

It is trying to catch up to those more modern smartphones the only way it can — with cold, hard cash.

The company could spend a half-billion dollars or more in marketing costs and payments to developers and handset manufacturers to subsidize the expense of building phones and apps, so that the Windows Phone 7 ecosystem is well-seeded at launch.

Jonathan Goldberg, a telecommunications analyst at Deutsche Bank, estimates that Microsoft will spend $400 million on marketing alone for the Windows Phone 7 launch. That doesn’t include the millions it has already committed to pay for “non-recurring engineering” costs that help offset development costs for handset manufacturers.

“This is make-or-break for them. They need to do whatever it takes to stay in the game,” says Goldberg. “It’s still wide open. They don’t have to take share from Android or Apple, so long as they can attract enough consumers switching from feature phones.”

On a visit earlier this month to the company’s headquarters in Redmond, Goldberg says company executives told him that Microsoft, along with its carrier and manufacturing partners, would likely spend “billions” of dollars in the first year for marketing and development. Another source familiar with Microsoft’s manufacturer and carrier agreements says the company will spend $1 billion on the launch, half on marketing and half on other development costs.

“We have a long-term view and Microsoft has been in this position before in other businesses where we’ve had to take a long-term view,” says Microsoft senior product manager Greg Sullivan, who would not comment on the estimates. “The mobile phone market is growing by leaps and bounds, but it’s still in the early stages.”

In some cases, potential manufacturing partners have accepted payments only to later back out.
Out of the original eight handset manufacturers that Microsoft announced Windows Phone 7 with in February, there’s serious traction left at just three—HTC, Samsung and LG, according to Goldberg. (The others were Dell, HP, Sony-Ericsson, Garmin-Asus, and Toshiba). Sullivan didn’t comment on the launch partners either. But HP, which was set to design and sell Windows Phone 7 handsets up until it acquired Palm in April, had a contract covering development costs over several years that could have been worth up to $20 million, according to a source familiar with the deal.

Sullivan declined to comment on the nature of its deals with handset makers. “We have a broad range of interactions with our partners and sometimes that involves our engineers working closely with their engineers,” he says.

Not only that, Microsoft has been offering financial support sometimes in the form of revenue guarantees to developers so that there will be enough apps in its store at launch, according to Microsoft senior product manager Anand Iyer. Apple and Google, in comparison, have accumulated enough natural momentum for their mobile platforms to attract developers for free.

Iyer counters that  already there has been 300,000 downloads of Microsoft’s development tools, suggesting strong interest. Indeed, Microsoft has hundreds of thousands of developers it can tap through the relationships it’s built over the years with the Xbox and Windows.

But the reality is that Microsoft has been outmaneuvered by a team a fraction of its size over the last five years at Google in a space it rightfully should have owned. It initially focused on enterprise consumers when RIM commanded the smartphone market with the Blackberry, but had to switch gears once Apple blew open the doors with the ultra, consumer-friendly iPhone. It also originally focused on phones with resistive touchscreen interfaces (the kind that work with a stylus) and only recently started supporting capacitive touch, years after Apple launched it.

Its most recent efforts in the mobile space have bombed. The company took the much-hyped Kin phone off the market after reportedly selling fewer than 10,000 units. Furthermore by spending hundreds of millions of dollars, it is effectively competing against its own business model. It licenses out its software for a fee of roughly $15 per OS shipped to manufacturers, unlike Android, which is free and lacks the same software restrictions. A big question for Microsoft is whether it will be able to keep its licensing model afloat   (Even at $10 per device, 100 million Windows 7 phones will have to ship before it recoups $1 billion in marketing and engineering subsidies, not counting revenues from search advertising or its cut of app sales).

That said, Microsoft has come from behind before. It entered the console market years
behind Sony and Nintendo; the Xbox is now the top-selling console in the U.S. this year and Xbox Live, its online gaming service, generated an estimated $1.2 billion in revenue last year.

Windows Phone 7 has also won positive reviews from tech blogs across the board with its
sleek interface. MobileCrunch’s Greg Kumparak praised the OS, calling it “the little girl who was kind of a punk to you in second grade somehow managed to grow up kind of cool — and to top it off, she’s actually sort of hot.” Many manufacturers also don’t necessarily want to be wholly dependent on Android and want to diversify by supporting Windows phones.

Sullivan says the company’s OS would marry the best of Apple’s tightly-controlled platform model, with a consistent user experience and elegant design from device to device, with the best of Android’s horizontal model, which lets consumers choose their handsets and carriers.

Plus, the marketing dollars do make a difference. The $100 million Goldberg estimates that Verizon, Motorola and Google collectively spent on marketing helped turn the Droid line of phones into a serious stable of competitors against the iPhone. (Compare that to Google’s fizzled Nexus One launch, where the search giant pinched pennies on marketing.)

So a half a billion could do even more. At this point, Microsoft doesn’t have any other choice.

Update: Dell PR has contacted TechCrunch to let us know, “Any reports, or speculation, that report Dell will not support Windows Phone 7 are false…Microsoft announced Dell as a supporting partner at this year’s Mobile World Congress and nothing’s changed.” However, we’ve heard that Dell might wait until after the Windows Phone 7 launch to bring out their phone (and thus don’t have as serious traction as HTC, Samsung, or LG). When we asked Dell if this is true, they wouldn’t comment on the timing of the launch.

Photo credit: Flickr/Michael David Pedersen.