Microsoft has a long and illustrious history of operating system sales. The model has served the company well on the PC, but if it wants to make money in the phone market, it needs to start thinking like a consumer electronics company and start making its own phones.
Microsoft is a firm believer in the model of commoditized hardware with a third party, hardware agnostic operating system (just as long as the operating system is bought from Microsoft, of course), and it's true that the model has worked very well for the company over the years; 175 million Windows 7 licenses is nothing to be sniffed at.
But this model hasn't always worked out so well for Redmond's other post-PC efforts. Microsoft wanted to sell its own scheme for DRM-protected audio, PlaysForSure, to a range of hardware vendors and online stores. It didn't work out very well.
The Xbox 360, for all its hardware problems, makes a similar case. The red ring of death flaws certainly detract from the Xbox 360 as a piece of design. But ultimately, it's a well-liked, well-designed appliance, and it shows off the benefits of vertical integration. As with the Zune HD, the Xbox 360 shows that Microsoft can build a tightly integrated combination of hardware, software, and online services. Though it may not ever make much money, for various reasons, it nonetheless serves to demonstrate that Redmond can do the consumer electronics thing properly.
Windows Phone 7 is Microsoft's first step away from the model of old. With its new phone operating system, the company is taking control of the user interface, the online store, and the PC-side software. However, the company is still leaving the hardware to third parties. And then there's the most important reason of all to go with vertical integration: money. There just isn't a whole lot of money in licensing a phone operating system like this. We don't know, because the information isn't public, just how much a Windows Phone 7 license will cost an OEM, but it's generally assumed to be a few tens of dollars.
But if the company wants to achieve any relevance in this market, it needs to stop acting like a software company, and start acting like a consumer electronics company. It learned that lesson with Zune. It knew it was the only option with Xbox. It needs to do the same for phones.
ARS Technica: http://arstechnica.com/microsoft/news/2010/07/microsoft-should-cut-out-the-middle-men-and-build-its-own-phones.ars