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How Microsoft Earned Its Moat

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VanEck

Microsoft (MSFT US) has also earned Morningstar’s “wide moat rating.” Morningstar believes that Microsoft’s massive enterprise footprint creates a network effect around its productivity apps and operating systems. Morningstar also applauds management’s cloud-first, mobile-first vision, which is beginning to take hold. As many office workers can attest based on dominant desktop applications: “Microsoft’s effective monopolies revolve around its Windows operating system for both client devices and servers and the Office suite of productivity applications. Despite lengthening PC refresh cycles, declining PC shipments, and an influx of new device form factors, Microsoft has maintained upward of 90% PC operating system market share and consistent revenue contributions from both enterprise and consumer Windows desktop deployments.”

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Microsoft (MSFT) operates globally with successful products such as Windows, Office, and Azure. A strong brand, network effect, and economies of scale are Microsoft’s sources of moat (MOAT). However, like Salesforce, Microsoft operates in highly competitive markets that are changing very quickly, so its moat could be threatened.

As the graph above shows, while the company’s profitability remains robust, it’s been falling. Microsoft’s return on equity (or ROE) is currently 22.1%, compared to its five-year average of 24.0%. Meanwhile, its net margin stands at a decent 19.7%, lower than its five-year average of 21.5%. Competition has eroded the company’s profitability.

Microsoft Office has a very strong brand and profits from the network effect. However, the volatility in the company’s Productivity and Business Process segment’s market share suggests that its moat is narrow to an extent.

Microsoft’s Cloud segment is one of the main players in the cloud market. However, Amazon (AMZN) dominates the cloud space. Microsoft stands in a distant second place, followed by IBM (IBM) in third place. Microsoft’s cloud services could contribute to its overall economies of scale, but it’ll be tough to build a moat in this space.

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