Microsoft posted its Q3 FY 2018 earnings on April 26th, reporting $26.8B in revenue, a 16% increase with better than expected performance across all segments. Microsoft’s exceptional growth is driven by its over-arching cloud strategy which clearly will continue to be a primary focus as they transition into a cloud provider.
- Commercial cloud revenue was $6 billion, up 58%
- Commercial cloud gross margin up 6 points, now at 57%,
- Office 365 commercial revenue up 42%
- Office 365 commercial seats grew 28%
- Office commercial products revenue down 15%
- Dynamics 365 revenue up 65%
- LinkedIn revenue growth of 37%
- Azure revenue up 93%
This kind of astounding growth is typically more common among newer companies or new lines of business with low baselines to grow from so given Microsoft’s longstanding position in the market and as an incumbent vendor, this growth is especially impressive.
Clear Demand for Cloud
This impressive growth is largely driven by Microsoft’s on-premise customer base migrating to cloud solutions, specifically Microsoft Office 365, Azure, and Dynamics 365. However, they are also selling more to their customer base (i.e., increasing cloud adoption within) while also increasing the very important ARPU (“Average Revenue Per User”) through price uplifts at renewal and pushing adoption of more robust and expensive cloud bundles.
Digital transformation is top of mind for many CEOs and CIOs. Enterprises who have not already migrated to the cloud, plan to eventually and most plan to immediately. Microsoft CEO, Satya Nadella, pointed out that Microsoft is the provider with the means, tools, and solutions that will enable organizations to achieve the business outcomes they are striving for through digital transformation programs, including employee empowerment, productivity, and collaboration. The current overwhelming interest in cloud presents a tremendous opportunity for Microsoft to maintain momentum.
Customers who haven’t migrated to cloud yet will continue to feel pressure from all angles to do so, especially if they remain an on-premise Office customer. Current Office 365 customers will likely be pressured to adopt more, add an additional cloud offering like Azure or Dynamics 365, or move to a more robust plan like E5. Ultimately, Microsoft wants customers to go all-in and adopt Microsoft 365 E5 which is the most robust cloud bundle they offer as it includes Office 365 E5, Windows 10 Enterprise and Enterprise Mobility + Security. Bundles like Microsoft 365 are ideal for cloud vendors because once a customer subscribes to the bundle, they will not be able to remove specific pieces (i.e., Enterprise Mobility + Security) until renewal time and there will absolutely be a significant price increase tied to the pieces that remain. Essentially, customers will be left with no choice but to move forward with a solution that doesn’t fully meet their requirements and needs at the time while Microsoft gets to communicate to the market high renewal rates, utilization, and seat growth.
Cloud Models Provide More Predictable Revenue Streams
As highlighted above, revenue tied to on-premise solutions has gone down, which is an expected outcome of Microsoft’s cloud transition. Cloud revenue is far more appealing to large IT vendors like Microsoft since it provides reoccurring revenue that is steadier and more predictable than those tied to more traditional on-premise models. Customers don’t own their cloud subscriptions as they did with traditional on-premise software licenses, so they have no choice but to renew if they want to maintain access. Microsoft knows this and will regularly capitalize on this increased dependency by implementing significant price fee increases upon renewal.
It is critical that Microsoft customers do not fall for one-time, upfront, “special” discounts to motivate adoption of a particular cloud solution like Office 365 and they also must ensure they have proper downstream price protections as well as flexibility in place.