Microsoft’s successful transformation: From Microsoft to Microcloud

Microsoft CEO Satya Nadella on stage at Microsoft Ignite Sept. 26, 2016 in Atlanta, Georgia


Last week Microsoft announced its latest earnings, and there were some enlightening gems in the disclosure. A few years ago some questioned whether Microsoft could make the transition to the new tech world, especially after the complacency of the Ballmer regime, but it is now pretty clear Satya Nadella has a done an excellent job pivoting the company into a leadership position. Let’s have a look at what the latest earnings tell us about Microsoft’s health.

First, the world has changed to one where cloud is the critical platform going forward. Although the company still relies on sales of packaged applications (e.g., Office), it’s pivoting rapidly, especially at its enterprise customers. Microsoft’s commercial cloud revenues grew to almost 60 percent of revenues. This indicates that the company has effectively made the transition to a cloud company and the growth as a percentage of overall revenues will likely continue to increase.

In addition, Azure revenues increased 94 percent. That indicates Microsoft is doing a good job of holding off competitors (e.g., Google, AWS) from impacting its core business clients’ transition to cloud-based applications and puts Microsoft in a solid position of supplying its core base of business users. This is where the “big bucks” are going to be made in cloud, not in the cutthroat consumer “sell any web services you can for whatever price you can get” space. It’s a strong indication of the high comfort level companies have with staying on Microsoft products and using the Microsoft tools they know well and have used for years. It’s also an endorsement that companies feel Microsoft can offer the security and operations flexibility necessary to keep them on track, including with additional services like Dynamics, which also increased its revenues.

And finally Office 365, the cloud-based successor to the venerable Office suite, which drove much of Microsoft’s revenues in the past, grew 47 percent in commercial space and 22 percent in the consumer space, indicating an excellent growth rate (and transition) from device-installed Office apps to a recurring-revenues online service. Many had feared Office would be eclipsed by competitive cloud offerings like Google G Suite, but for the most part Microsoft seems to be keeping the majority of its base of Office users (some that had switched to Google have even switched back).

And, of course, Microsoft still sells a lot of operating systems that power PCs and servers. While not as quickly as planned, Windows 10 seems to be taking hold in enterprise as many more companies are migrating. As a result, Windows revenues were up more than expected. From talking with many companies, I expect 2017 to be the year of transition for many large commercial enterprises, and Windows 10 momentum should continue. But it’s likely that Windows revenues will be flat to only slightly higher going forward as enterprises reach some level of full migration and the fact that consumer PC sales are flat to lower.

On the downside, sales of Windows commercial server licenses are slow. But this is likely a result of many companies moving to cloud based apps rather than increasing their own server farms, hence Microsoft’s major increase in cloud revenues. This is likely to continue, as the shift to Office 365 and related commercial productivity products (e.g., Skype, Dynamics, etc.) continues over the next several years.

Microsoft has essentially given up on the mobile OS and hardware market, selling its last remaining vestiges of the disastrous Nokia handset acquisition (made by Ballmer and rightly rolled back by Nadella). But Windows on mobile was never a large revenue producer in itself, so this is not a major loss. However, Microsoft continues to expand its mobile-driven products and services (e.g., Office on iOS and Android), which is its real potential goldmine.

Microsoft’s future continues to expand around cloud. Its LinkedIn acquisition will eventually add upside potential to the core cloud services (although LinkedIn is not yet a profit center for Microsoft) and will complement its Office 365, Skype, and Dynamics offerings. Its flirtation with AR/VR (HoloLens) and 3D (Microsoft Windows 10 Creators) will pay dividends in the coming 2-3 years. And its continued success in driving the PC hardware space around Surface, Surface Pro, Surface Studio, and larger scale systems for collaboration (Surface Hub) will allow it to drive markets in needed directions and provide some leadership to its ecosystem.

All in all, I believe Microsoft has effectively made the transition necessary to become Microcloud – a company that continues to dominate many aspects of the commercial computing space in the new cloud era. Kudos to Nadella for being the visionary that Microsoft needed to pull this off. If there is an Oscar for best CEO, he should be high in the running. The ship has been righted, and it is sailing into the future, although no doubt it may hit a few choppy waves.

Jack Gold is the founder and principal analyst at J.Gold Associates, LLC., an information technology analyst firm based in Northborough, MA., covering the many aspects of business and consumer computing and emerging technologies. Follow him on Twitter @jckgld or LinkedIn at https://www.linkedin.com/in/jckgld.

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