Microsoft’s Future Remains Cloudy—And That’s A Very Good Thing

Author

David Hamilton

October 24, 2014

Increasingly, Microsoft is looking like a successful cloud-services company that also happens to sell software, a game console and some other devices.

Of course, that’s not apparent at first glance. In Microsoft’s latest earnings report, covering the July–September quarter, it pulled in overall revenue of $23.2 billion in revenue and earned a net profit of $4.5 billion. Its “commercial cloud” revenue, which includes cloud-related revenue from its Office productivity software as well as its Azure public-cloud server business, amounted to just $1.2 billion—a mere 5% of the software giant’s overall sales.

See also: Azure Is Helping Microsoft Catch Up In The Cloud

But take a closer look. Microsoft’s commercial cloud revenue grew 11 times faster than that of the company as a whole, more than doubling in the quarter compared to the year-earlier period. Overall company revenues rose just 11% over the same timeframe. (That’s excluding $2.6 billion in July–September phone sales resulting from Microsoft’s acquisition of Nokia’s phone unit earlier this year.)

What’s more, the gross profit associated with Microsoft’s cloud and “enterprise service” operations almost tripled in the quarter. That profit jumped 194% to $805 million in the quarter. Overall, Microsoft’s gross profit barely rose at all, edging up only 8% (again excluding the Nokia handset business).

Head In The Cloud

All of which is to say that the long-held view of Microsoft as an old-school software business dependent on Windows and Office is due for an upgrade. 

Windows and Office are going to remain key to Microsoft’s operations for years to come; they’re still enormous, after all.

See also: What Microsoft’s Fiercest Critics Forget: Azure

They’re just not growing. Microsoft’s “devices and consumer licensing” revenue—i.e., Windows for consumer PCs and other gadgets—actually dropped 8.7% in the quarter, primarily reflecting the ongoing consumer shift toward tablets and phones away from PCs. Its “commercial licensing” business—read: Windows for business—bumped up only 2.7% in the quarter.

Both segments remain hugely profitable, with gross margin in the range of 92% to 93%. But profits in the two segments combined rose only 1.5% in the quarter. 

True, together they accounted for almost $14 billion in revenue and $12.9 billion in gross profit—that’s basically the definition of “cash cow.” But these cows don’t seem likely to get much fatter; in fact, the opposite is much likelier over time.

And while straight-line extrapolations are usually wrong, consider this for perspective. Should Microsoft’s cloud business keep growing at this rate (which it almost certainly won’t), it could eclipse the company’s entire Windows business in just four years.

Microsoft, of course, continues to do a variety of other interesting things, although they’re likely to remain sidelights in business terms. Revenue from sales of its Surface tablet more than doubled to almost $1 billion in the quarter. Total Xbox unit sales also doubled, although Microsoft still doesn’t distinguish between the older Xbox 360 and its newer Xbox One, suggesting that the latter isn’t yet something it wants to brag about.

But the cloud remains its real future.

Lead image by Robert Scoble

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