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Microsoft Cloud Revenues, Margins: Closer Look

Amy Hood

Amy Hood

Microsoft’s cloud business continues to grow quickly, especially as partners begin to extend from Office 365 to Azure. However, some critics are starting to raise questions about Microsoft’s own cloud profit margins — especially compared to Amazon Web Services‘ recent quarterly results.

As Motley Fool asked in recent days: Are Microsoft’s Weakening Cloud Margins a Cause for Concern? “Though still profitable, the segment’s 16% decrease in profitability in just one year deserves further investigation.” The investor-driven website speculates that Microsoft is spending heavily to build out its cloud services.

Microsoft CFO and Cloud Margins

During Microsoft’s quarterly earnings call with Wall Street analysts last week, CEO Satya Nadella and CFO Amy E. Hood answered a range of questions around the cloud margin topic.

“Our commercial cloud gross margin was 45% this quarter, declining year over year,” Hood conceded. “This decrease was driven by a higher mix of Azure revenue, our ongoing investment in data center capacity and geographic expansion, and a small FX headwind. As I mentioned last quarter, even as we are focused on gross margin improvement within each of our key cloud services, our total commercial cloud gross margin will reflect the dynamics of changing revenue mix and targeted investments.”

Moreover, Microsoft remains on track for a $20 billion commercial cloud revenue run rate goal, she added, as the company grows revenue, drive consumption and focus on gross margin improvement in Office 365, Azure and Dynamics Online.

Microsoft CEO and Cloud Margins

Responding to an analyst question about cloud margins, Nadella said:

“So to your point about margins, I feel that we actually will have software licenses with hybrid rights. That’s a different margin structure. We will have IaaS services, and you talked about the existence, proof at least from Amazon about what margins at scale can be achieved there. We have PaaS services in infrastructure like EMS that have SaaS-like margins, and then of course we have SaaS services in Office 365. So I think the mix of our gross, or rather that mix will define our long-term gross margin and operating margin for our cloud services. But the mix will also shift each quarter, just because the mix is not a stable mix. We’ll see growth in different parts at different times.”

Bottom line: Even as more and more Microsoft revenues shift to cloud services, the company will likely have continued margin turbulence. Generating OpEx revenue vs. spending on CapEx data centers is a delicate balancing act. And it sounds like Azure hasn’t quite reached the economies of scale that AWS now enjoys — at least in terms of margin protection.

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