Will cloud computing economics add up for Microsoft?

Will cloud computing economics add up for Microsoft?

Summary: Microsoft at its financial analyst meeting made the case for being a cloud computing leader and argued that its economic prospects will improve as information technology shifts to an on-demand model.

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Microsoft at its financial analyst meeting made the case for being a cloud computing leader and argued that its economic prospects will improve as information technology shifts to an on-demand model.

The big question: Do you buy the argument that cloud computing will accelerate Microsoft's earnings and revenue growth? Let's face it: Every software vendor is talking cloud computing, but the economic theory is that it's better to cannibalize your own business than allow some rival to do it. Few established software vendors have argued that the cloud will gussy up their financial metrics.

Microsoft CFO Peter Klein, however, made the case that cloud computing is going to be big business, improve the company's gross margins, cut costs and bring in more customers. And, as noted by Altimeter partner Ray Wang, Klein did a decent job putting cloud computing in financial terms. It's too early to put any hard data around Microsoft's nascent Azure efforts, but Klein said that the software giant could grab a bigger piece of the enterprise IT pie. After all, the historical dividing lines between vendors---software, hardware, networking and storage---are melting away.

So how's Microsoft going to harness the cloud for financial gain? Klein had a few big themes to ponder: The cloud opens up a broader IT spending pie. In cloud computing, software, hardware and services blend together. You don't buy servers. You buy capacity. Klein said:

Obviously, the total global IT spend, which we're going to address more of now in the cloud world, is much bigger.  And so obviously at a high level is an incredible opportunity for the cloud to have us address a much larger piece of the IT market.

Microsoft can sell to more users. Klein talked a lot about how cloud computing can allow Microsoft to be more of a player for midmarket companies that don't have the resources to implement a SharePoint infrastructure. Klein said:

[The cloud] allows us to sell to more users. This could either be new customers that we don't serve today or new users within existing customers today. So, this is greenfield incremental opportunity selling to users that today don't have Microsoft products.

He continued:

And with business users, I want to start with the mid-market segment.  Historically, while the mid-market has been a very attractive market for us, it also poses some challenges.  Number one, it's highly fragmented, and number two, there's a little bit of a gap between the needs and desires in terms of IT capabilities that mid-market companies have and the resources and expertise they have to deliver those capabilities.  In some sense, you could say a mid-market company has the needs of enterprise IT but the capability of a much smaller business. The cloud really solves that problem by bringing cost-effective, easy-to-deploy technology solutions to mid-market customer in ways they can't today.

Delivering software via the cloud will improve gross margins by lowering costs for Microsoft and customers. The automation of deployments, configuration and ongoing maintenance will cut costs for all parties. There are also hardware savings. Klein said:

Interestingly, the one thing I want to point out on this, the 10 percent savings is net of what an organization would pay us for the Azure service.  So, it's the net of what they would pay more, in addition to the licenses and for the service, and on top of that there's 10 percent savings.  And again, given the one instance that you're running, given the automation, you reduce support costs.  It's actually a good thing for not only the customer but for Microsoft.  And you add all that up and that's a 30 percent savings, again, net of what Microsoft would make for the existing software license, plus gross margin on the service.

The cloud makes it easier for Microsoft to garner "competitive migrations"---essentially poaching customers from rivals. "All that revenue is brand new and incremental to our bottom line," said Klein.

Microsoft can make a "pretty smooth" transition to the cloud and lower costs of goods sold (COGS) and improve gross margins from the 80 percent mark today, said Klein. For comparison's sake, Salesforce.com's gross margins are roughly 82 percent and Oracle's is projected to have margins in the 75 percent range (down from 80 percent due to its Sun hardware business). The pace of this transition remains to be seen, but Microsoft is confident. He said:

We spent a lot of time thinking, both from a sales and revenue perspective, and a sort of build-out perspective, how do we smooth out the impact of that.  And I think we've got -- we've done some great work on the sales side for our customers in particular to provide a smooth transition from sort of our existing business models to the cloud model.

And from a margin perspective in terms of the COGS, I think, number one, we're able to sort of leverage all the investments we make across the company in datacenter technology, which provides good scale for us and ability to smooth.  And we've done a lot of work to plan out how we think about datacenter build-out, how we get really smooth about how we just get it right in front of sort of the demand.  So, we've done a much better job in forecasting demand and then making out build plans on datacenter.  So, both from the revenue side, I think we've got some good licensing plans to make that smoother, and then from the COGS side -- unless there's sort of just dramatic spikes, which of course I think will cause COGS to go up.  I think we can smooth that out pretty well.

There were a few missing elements. Klein wasn't specific about estimates for margin improvement and percentages on future growth, but it's too early for that level of detail. Add it up and Microsoft's case for cloud economics was a lot more fleshed out than details provided by other software companies.

More from Microsoft’s analyst meeting:

Topics: Cloud, Data Centers, Hardware, Microsoft, Servers, Software, Storage, Virtualization

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16 comments
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  • The cloud is a pipe dream in the US

    ANYONE that puts ANYTHING on the cloud in the US is a fool. The "Patriot Act" means ANYTHING stored on the cloud is wide own to ANY government agency that wants a peek.

    It's why MS and Google can't sell the idea in Canada, they aren't dumb enough to allow thier information to be looked at by the US government. Americans = Sheeple.
    NoAxToGrind
    • So why not an internal cloud?

      @austinm@... at my work, I've set up a VMWare farm that I can parcel out (according to need) server space, DB space, and bandwidth according to individual or departmental needs.

      We don't even have to think about going outside to do it.
      Random_Walk
      • RE: Will cloud computing economics add up for Microsoft?

        @Random_Walk It still is a problem with centralization. A failure of the cloud will cause a much wider company failure as well. Decentralization is more expensive, but also much more robust.
        hayneiii@...
      • RE: Will cloud computing economics add up for Microsoft?

        @hayneiii: Not necessarily. If you have multiple VM servers spread out in groups over a WAN (yes, it is very possible with the right sized pipes and VPN), and the really remote sites running on SRM (Site Recovery Management), then things are no longer centralized (at least insofar as you no longer have a single point, or even site, of failure).
        Random_Walk
    • RE: Will cloud computing economics add up for Microsoft?

      @austinm@... Actually I agree to that in every country. It put your data into the hands of others. It centralizes and make you more dependent. A bad move all around. Computers and the internet are robust because they are decentralized. Cloud computing takes that away. I can see it for games and not much else.
      hayneiii@...
    • RE: Will cloud computing economics add up for Microsoft?

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  • Sure, just as much as other cloud vendors.

    Basically "the cloud" is another platform and another model for computing. MS has just as much chance of cracking the acorn as any other company does. If they offer advanced security tools and integrated privacy tools, I would put them so far a head of the game, they could do to the cloud what they did to the desktop.

    In just my own experiences in business, the biggest hurdles of cloud adoption are security, privacy, and compliance. Solve those things and you are well on your way to being the golden child of cloud adoption. Add on an effective service plan for eventual downtimes and offer limited client to cloud syncing for offline work when network coverage is not available and you have almost found the holy grail of cloud computing.

    Micro Soft is well positioned for a cloud dominance if they played their cards right. They have browser tech which can serve as a front end to cloud services, they have a large hardware vendor partnership, they have shown they can develop cloud data centers, they have productivity software that can run on client machines and sync to a cloud service. They have a lot of cash to play with. Cloud adoption will probably break out in the corporate space before hitting the consumer space and MS has a great deal of experience in the corporate space.

    As I said above, if they solve the security, privacy, and compliance issues with the cloud, they could be well on their way to a brand new profitability.
    mr1972
  • Microsoft is behind in the cloud

    Its a continuing theme for Microsoft, they are behind in the curve in creating cloud offerings. Looking at the cloud computing landscape, http://cloudtaxonomy.com, few current vendors are using MS technologies for their platform. Looking through all the cloud software available, very few vendors are creating software for MS platforms. MS is also behind on big data software such as a Hadoop competitor.

    MS will be able to catch up in some areas. There's a large number of software vendors with products that can be converted to SaaS offerings. They will need to rearchitect. However, vendors building from scratch are using more productive languages such as Python, Ruby, and PHP which gives them a large advantage over .NET or Java development. They are the first generation of application vendors that are taking true advantage of cloud economics.
    bbuck153
    • RE: Will cloud computing economics add up for Microsoft?

      @bbuck153: You mean http://cloudtaxonomy.opencrowd.com/ ? :)
      Random_Walk
  • Microsoft is becoming "me-too peanut butter"

    No originality and spreading themselves thin. I just read that they're now going back to making tablets after watching Apple sell 3.3 million in the first 3 months.

    Didn't they learn the first time that no one wants a Windows tablet?
    jprothe
    • RE: Will cloud computing economics add up for Microsoft?

      @jprothe - Now where does Apple come into the picture of Cloud Computing?

      Some guys simply love to bash MS for any reason at all. Duh!
      Rahul Mulchandani
      • RE: Will cloud computing economics add up for Microsoft?

        @Rahul Mulchandani: MobileMe for starters (consumer, yeah, but still...)
        Random_Walk
  • RE: Will cloud computing economics add up for Microsoft?

    IMHO, MS has indeed been leading in cloud computing for 15 years. I offer as evidence their primary tool: Microsoft Updates. With the exception of a few hiccups, this service has been flawless. There are those that argue that if there weren't so many security holes, we wouldn't need updates. This is true. But the fact is Updates has been their back office backbone since Win95. And I personally trust it to work flawlessly every time. And so do millions of others.

    This concept of a public "cloud" is marketing gobbledygook. MS needs to get away from the Live concept of a landing page with pictures and contacts and chat and god knows what else they try to suck in for the general public. Facebook cornered social. Period. And they don't have all this special customization of the landing page. If people wanted that, they would have stayed with MySpace. Everyone knows that MS is primarily business focused. Ballmer needs to bite the bullet and stop trying to be everything for everybody. Develop different markets, sure, but stop trying to tie it all together. That's what the name does now: "Microsoft". The public already knows who you are. The cloud will always exist.
    Joey1058
    • RE: Will cloud computing economics add up for Microsoft?

      @Joey1058: Widnows/Microsoft Updates is actually run by Akamai, not Microsoft. ;)
      Random_Walk
  • Absolutely not.

    Microsoft is in a very difficult spot. In fact, they're in an impossible spot. Any one who's participated in both a legacy on-premise project and a true cloud implementation knows the truth. Customers absolutely get more for less. This is great news for customers and vendors with business models built around the web and a global cloud infrastructure (i.e. Google) this is horrible news for a software products company with 100+ six figure sales reps and sale engineers in every major city.

    Microsoft's 2010 product launch was overwhelmingly on-premise - Exchange, SharePoint, Office, etc. If this was going to be a nice orderly transition from on-premise to Cloud then Microsoft would have a chance. However, this isn't an on-premise technology upgrade cycle but disruptive technology.

    Microsoft is a company (a system) purpose built for the on-premise business model ... you can't maintain the structure even though the world for which it was built no longer exists. Microsoft has been in a position of dominance for decades, certainly no one thinks it will last forever. If you believe this paradigm shift (the most significant in the history of computing) won't have a huge negative impact on the firm, and the system for which it was built, then your position is essentially that nothing will.

    At the heart of cloud computing's value is not technology, it is economics. Microsoft executives can give as many presentations as they want but the economic realities will not change. Mr. Klein is correct in assuming the pie will grow as more functionality is put into the hands of more users across more devices. However, he seems to assume that he will also be allowed to keep the pie he already has, and continue to take his huge bites of customer cash, which is incorrect.
    @...