Why Microsoft really, really, hates the cloud

Guest post Louis Naugès has been a proponent of cloud computing and office automation for almost two decades and is co-founder of Revevol, the first authorized Google Apps reseller and one of the most successful. Based in Paris, he blogs for ZDNet France and has translated an abridged version of this recent post for publication as a guest post here. Read on for a controversial and eclectically illustrated perspective of why, for Microsoft, it may be more a case of 'all over' than 'all-in' when it comes to the cloud.

Why this title? Have we not heard from top-level Microsoft officials the praises of Cloud Computing, around their Azure solutions?

This text is anything but an anti-Microsoft pamphlet. It's an analysis — cold, objective and financial — of the potential impacts of the Cloud Computing Tsunami on the finances of Microsoft.

The Cloud decade has began in 2010; though it will take some time before we are able to visualize all its impacts, we can already see some first results:

• The 'Sale' sign, put by Microsoft on Office 2010, a product not yet available.
• Microsoft has also released the prices for Office 2010 in England, with a 30% price reduction over the 2007 version.
• And this is just the beginning ...

Almost at the same time, Steve Ballmer gave a one hour long conference at University of Washington, explaining that "Microsoft has over 70% of its developers working on cloud solutions". In an internal email to Microsoft employees, he said that: "As a part of this, I request that you do the following:

• Watch the speech on demand here
• Learn more about our cloud offerings and how they relate to our overarching software plus services strategy here (unavailable outside Microsoft network)
• Review your commitments to ensure you are landing our vision with customers and partners."

So, now, you have two opposite views:

• Steve Ballmer's, which explains why Microsoft "loves" the Cloud.
• Mine, which explains why Microsoft really hates the Cloud.

More: Microsoft's revenues threatened by the cloud ...

Microsoft sources of earnings in 2009

For over 10 years, Microsoft has tried everything to diversify: Xbox, BING search engine ... Xbox Image. Despite all these efforts, and tens of billions of dollars invested in R&D, the results have not been obvious.

The arrival of Ray Ozzie as the number two of the company remains one of the keys to the possible success of Microsoft on the Cloud. A long article in InfoWorld presents in a positive way efforts made by Ray, while remaining skeptical about his ability to counter Google.

This graph shows the distribution of Microsoft's earnings by product lines, over the past three years. These numbers don't lie! At the end of 2009, all Microsoft earnings came from historical products: Office, Windows desktop and Windows Server solutions. All other divisions around the Internet or gaming platforms are losing money or just balancing their accounts.

The US stock market has taken into account this situation; Microsoft is no longer regarded as a growth company, but as a cash machine. With quarterly earnings between $5 and $8 billion, Microsoft is still one of America's most profitable companies.

The performance of Microsoft's share price has not really been outstanding over the last 10 years! Today, at the beginning of 2010, it has lost value compared to January 2000.

This is even more striking when you compare it to Google and Apple; over the same period their share prices have respectively increased by 400% and 700%.

So why worry? In early 2010, the situation is anything but a disaster, as evidenced by the good numbers published by Microsoft at the end of December 2009:

• Quarterly profits remain high, exceeding $8 billion.
• Windows has more than 90% market share in PCs and Windows 7 is better accepted by the market than Vista.
• Office is still dominant on desktops of every organization.
• Windows Server has gained good credibility in the computing centers.

Yes, but ... the Cloud Computing Tsunami is announced! -- >

Impacts of Cloud Computing on the earnings of Microsoft

If you think Cloud Computing is a fad, a ripple of change, the remainder of this text will seem totally unrealistic. Otherwise, you should agree with most of my findings.

As shown by the previous chart, Microsoft still derives, in early 2010, the bulk of its earnings from the three lines of historical products. The migration of business organisations to Cloud Computing will very quickly drain these three historical sources of profits for Microsoft. This major "climate change" will reach its peak within a decade, but by 2015 we will be able measure its first impacts.

So, let's do a fast forward, to 2015, and evaluate the level of reduction of these three sources of earnings for Microsoft.

2015: Servers and Tools

All industrial players of Cloud Computing — Amazon, Facebook, Google, IBM, Yahoo! — use almost exclusively open source solutions to run their huge data centers: Linux, Hadoop, MapReduce, Traffic Server, HipHop, Cassandra ...

With Azure, Microsoft is the only major player in the Cloud that will continue to use proprietary solutions: Windows Server, SQLServer, .Net ...

In 2010, Microsoft has one of the largest group of developers trained in its solutions. In many organizations and software houses, they have successfully defended their skills, their 'certifications' and managed to slow down the Open Source movement. In 2015, a majority of 'legacy' applications such as large ERP and in-house developed applications will not have migrated to public Clouds. They will still run in private clouds, on the same technical solutions used in 2010 (let's not forget that Cobol still has a huge presence in 2010). In 2015, this 'tribe' of developers using Microsoft solutions will still be very strong; however, they will begin to suffer from aging as we have seen happen today for the 'tribe' of IBM mainframe experts.

The Server division of Microsoft will be the one whose earnings will be the least impacted by the move to Cloud Computing, as a majority of organizations will still be running Private Clouds on Windows Server and development tools from Microsoft. But the migration to public clouds of 50% of existing applications running under Windows Server and the virtualization of all remaining servers — combined with strong pressure on prices — will reduce by 60% the earnings from this division.

Earnings of the servers and tools division in 2015 will be 40% of its earnings in 2010.

2015: Windows Desktop

2010 has started well for the Windows Desktop division, with the successful launch of Windows 7, after the fiasco of Vista. Windows 8, the next version, could appear as early as 2012. Unfortunately for Microsoft, the launch of this 'last scion' of the Windows family will be a resounding flop, as demand for a fat OS will become minimal.

In 2015, to access the Cloud, 80% of "access tools" will be mobile devices: smartphones, tablets, netbooks ...

The lightweight OS that will equip these mobile tools are JoliCloud, ChromeOS, Android, MeeMo. They are all open source and free for manufacturers.

As we have already seen with the arrival of Netbooks in 2008, Microsoft was forced to discount Windows XP at a price lower than $3 to counter the Linux offensive. Faced with excellent and free Open Source solutions, Windows 8 and Windows Mobile 7 will no longer be competitive at their current prices.  To protect its market share, Microsoft will be forced to drastically reduce the selling price of these two OS to all manufacturers, even the most faithful such as Dell or HP.

Yes, in 2015 you will still have many PC running Windows. Yes, but ... they will be running mostly 'old' versions like Windows 7 and the new versions will be sold with much smaller margins than in 2010. So... the operational revenues of the Windows Desktop division will be reduced by 70% in 2015.

Earnings of the Windows desktop division in 2015 will be 30% of its earnings in 2010.

Yes but ... how much will Office drag down Microsoft? -- >

2015: Office

In 2010, about one billion people are using Microsoft Office, all versions included. In 2015, 200 million users still believe, sometimes rightly, that they need a very powerful desktop solution for their spreadsheet or presentations. They have kept their favorite version of Office, 2003, 2007 or 2010 and have not bought the new 2014 version, even at its discounted price of $37.

The other 800 million users continue to write, to make presentations, to use spreadsheets ... but they now use native Web based collaborative solutions, sold by Cisco, Google, IBM and Microsoft. The 2010 reference cost, $4 per person per month, pioneered by Google Apps, has been maintained while the level of functionality has made tremendous progress. For personal usage, only free Web solutions are used, and there is not one single person left on earth that's going to pay for social computing tools for messaging, calendar, word processing, spreadsheet, presentation, wikis, blogs and microblogs, sharing photos and videos ...

The Office division of Microsoft is the one that will suffer the most from the Cloud Computing Tsunami. Microsoft will be one of the main vendors with a $4/month solution. However, these Web solutions require substantial resources in infrastructure (all vendors provide 50 GB as a minimum) and will have a huge impact on the earnings of this division, which will be reduced by 80%.

Earnings of the Office division in 2015 will be 20% of its earnings in 2010.

Market value of Microsoft in 2015?

In early 2010, the market value of Microsoft is around $250 billion. Over the last four years, the operating incomes of each division were the following:

• Servers: $1 billion
• Windows: $9 billion
• Office: $10 billion
• Total: $20 billion

What is important are the orders of magnitude. For example, the average 'operating income' during the period 2006-2009 was $19.36 billion, but taking into account the losses of other divisions, I rounded up this number to $20 billion for all three divisions.

If the predictions I have made about these three divisions are reasonable, I can compute the following numbers for the operating incomes of Microsoft in 2015:

• Servers: $1 billion x 40% = $0.4 billion
• Windows: $9 billion x 30% = $2.7 billion
• Office: $10 billion x 20% = $2.0 billion
• Total: $5.1 billion

In summary, the annual earnings of Microsoft will drop from $20 billion to about $5 billion. A respectable number, but one that represents a decrease of 75%. As noted above, for ten years the stock market has looked at Microsoft as a cash machine, whose price is closely linked to its earnings. On these assumptions, I forecast that the market value of Microsoft should also be divided by four, namely:

Microsoft market value in 2015: 60 billion dollars.

Worst Case Scenario?

I know I will be attacked from all sides for writing an anti-Microsoft pamphlet, a 'finance fiction' story, for working on unrealistic assumptions ... and I am prepared!

Let's summarize the main lines of this scenario:

• Cloud Computing will be the great wave of change for the decade 2010 to 2020.
• Cloud Computing will undermine the existing main sources of earnings for Microsoft.
• Microsoft will not be able to find sufficient sources of growth in this new Cloud Computing environment to halt a steep fall of its margins and earnings.

In my view, the first two points cannot be disputed. On the third one, I would be very happy to be proven wrong, but unfortunately what happened between 2000 and 2010 does not make me very optimistic about the ability for Microsoft to create lines of products and services capable of generating billions of dollars in new earnings in order to fill the huge losses of the three historical divisions.

Under these conditions, how can we expect a company like Microsoft to welcome with open arms a Tsunami named Cloud Computing which will sweep away three quarters of its earnings and market valuation?

It's hard not to excuse Microsoft for doing everything it can to postpone the arrival of Cloud Computing! There are no IT suppliers, whatever power they may have today, which can stop this powerful Tsunami named Cloud Computing.

Only the suppliers that will be able to anticipate, to adjust to this revolution will still be playing a key role in IT in 2020.

Not all vendors will have the ability to survive ...