Nokia and Microsoft Corp will team up to build an iPhone rival, the Finnish phonemaker's last-ditch attempt to catch up with Google and Apple and arrest its decline in the global smartphone arena.

Shares of the world's largest cellphone maker plunged 14 percent on fears the decision by new chief executive Stephen Elop to throw in the towel and use Microsoft's Windows Phone software will hammer margins and weaken its position during a tumultuous transition.

The deal marks a potential breakthrough for Microsoft, which has flailed in mobile for years but should now get its software into upward of 30 million smartphones sold by Nokia every quarter. But its shares slid 1.5 percent as investors weighed the merits of teaming up with a weakened player.

The decision by Elop, a Microsoft veteran drafted in September to turn around the flagging Finnish phonemaker, sparked a lively Twitter exchange.

Two turkeys do not make an Eagle, Google's vice president of engineering, Vic Gundotra, tweeted this week.

Elop struck back on Friday, invoking the Wright Brothers: Two bicycle makers, from Dayton Ohio, one day decided to fly.

Nokia has bled share in higher-margin smartphones as Apple's iPhone, and products based on Google Inc's Android platform, have revolutionized the market.

It is now a three-horse race, said Elop.

The Finnish company, which invested billions of dollars in building up mobile Internet services under its previous CEO, has effectively admitted defeat in its services strategy by joining forces with Microsoft.

On Wednesday, Elop sent a candid memo to employees in which he likened Nokia's position to standing on the edge of a burning platform.

Their partnership means thousands of job cuts at Nokia around the world, with a dramatic reduction in research spending. In protest, hundreds of Nokia employees walked out on Friday in Tampere, central Finland.


Microsoft's 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 plans to use Microsoft's Bing search engine across its cellphones, a huge boost for Microsoft as it seeks to challenge Google as the world's leading search engine.

This is all going to be about execution, said Michael Gartenberg at research firm Gartner. Can they get U.S. carriers excited about a Windows device that's built by Nokia? They made the leap, but that just buys you a few seconds. Now you have to decide what happens when you hit the water.

But investors were initially unconvinced by Elop's new strategy and Nokia shares tumbled after it said 2011 and 2012 would be transition years, fueling fears of a margin hit.

Nokia said its operating margin in the phone business would be 10 percent or more after the transition period. Analysts had expected margins to rise to 11.4 percent 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.

The tie-up deals a blow to Intel Corp, which like Microsoft has struggled to make inroads into wireless and had been counting on its software alliance with Nokia on MeeGo smartphones to jump-start its efforts.

While we are disappointed with Nokia's decision, Intel remains committed and welcomes Nokia's continued contribution to MeeGo open source, Intel spokeswoman Suzy Ramirez said.

Our strategy has always been to provide choice when it comes to operating systems, a strategy that includes Windows, Android, and MeeGo. This is not changing.


Analysts said the partnership meant there was no longer any need for a long-run takeover of Nokia by Microsoft since the U.S. company 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 percent market share in the last quarter, is widely recognized by industry experts as a promising technology, it has not yet caught the imagination of consumers.

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.

Its share of the smartphone market fell to 31 percent in 2010's fourth quarter from 38 percent the previous quarter.

This is a partnership born out of both parties' fear of marginalization at the hands of Apple and Google but there is no silver bullet, said analyst Geoff Blaber from CCS Insight.

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.

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 criticized 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.

Nokia's shares were down 14.2 percent in Finland while Microsoft shares were down 41 cents or 1.5 percent at $27.09 on the Nasdaq.

(Additional reporting by Georgina Prodhan in London; Writing by Alexander Smith and Edwin Chan; Editing by Jane Merriman, Dave Zimmerman and Matthew Lewis)