London - Nokia and Microsoft teamed up on Friday to build an iPhone killer in a desperate attempt to take on Google and Apple in the fast-growing smartphone market.
Shares in the world's largest cellphone maker fell sharply on uncertainty about the financial impact of Nokia's new chief executive Stephen Elop's strategic u-turn which will use Microsoft's Windows Phone software in its smartphones.
"It is now a three-horse race," said Elop, who was drafted in from Microsoft last September to turn Nokia around.
The deal marks a major breakthrough for Microsoft which after years of struggling to establish itself in wireless will get its software into upwards of 30 million smartphones sold by Nokia every quarter.
"To have the largest phone manufacturer in the world... it's fantastic, it's truly fantastic," Andy Lees, head of Microsoft's mobile business told Reuters in an interview.
Nokia plans to use Microsoft's Bing search engine across its cellphones, opening up a huge market for Microsoft as it seeks to challenge Google as the world's leading search engine.
The partnership will mean thousands of job cuts at Nokia around the world, with a dramatic reduction in research and development spending.
Investors were unconvinced by Elop's new strategy and Nokia shares tumbled 10% after it said 2011 and 2012 would be "transition years", fuelling fears of a margin hit.
Nokia said its operating margin in the phone business would be "10% or more" after the transition period. Analysts had expected margins to rise to 11.4% in 2012.
"They have woken up...changes have to be made. I hope it's not too late," said Alan Lancz, president of Alan B. Lancz & Associates Inc, which holds Nokia stock.
Nokia has rapidly lost share in higher-margin smartphones as Apple's iPhone, and products based on Google's Android platform, have revolutionised the market.
Analysts said the Finnish company, which invested billions of dollars in building up mobile internet services under its previous CEO, had effectively admitted defeat in its services strategy by joining forces with Microsoft.
Analysts said the partnership meant there was no longer any need for long-rumoured takeover of Nokia by Microsoft since the U.S. firm had achieved its goal without the costs of a bid.
An outright acquisition by Microsoft was "never really discussed as an option," Elop said.
Although Microsoft's Windows Phone platform, which had a 2% market share in the last quarter, is widely recognised by industry experts as a promising technology, it has not yet caught the imagination of consumers.
The decision to throw its lot in with Nokia could put others such as LG, Samsung and HTC off using its software, but analysts said that on balance it was Microsoft that would gain most.
Nokia, which has struggled to create a rival to Apple's iPhone phenomenon, is now watching smaller competitors like HTC Corp and Motorola hook up their smartphones to Google's Android software and lure customers around the globe.
"This is a partnership born out of both parties' fear of marginalisation at the hands of Apple and Google but there is no silver bullet," said analyst Geoff Blaber from CCS Insight.
Nokia's share of the smartphone market fell to 31% in the fourth quarter of 2010 from 38% the previous quarter.
"This is a very frank admission that Nokia's platform strategy has failed and underlines the seriousness of Nokia's position. Such a move would have been unthinkable just 12 months ago," Blaber added.
In a bid to stem Nokia's losses, chairman Jorma Ollila poached Elop from Microsoft last year. The 47-year-old Canadian is the first non-Finn to head Nokia, which has been criticised for an inability to develop new products quickly. Elop said the deal with Microsoft would address this.
Nokia said in a statement it would stick with its current management team, with only one senior executive set to leave and a reshaping of its North American team promised. There had been speculation of a wider cull at the company.