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Microsoft’s Shift to the Cloud Is Pressuring Its Margins

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Nov. 20 2020, Updated 5:24 p.m. ET

Microsoft’s shift to cloud impacted its margins

Earlier in this series, we discussed Microsoft’s (MSFT) improving stance in the cloud space, which resulted from its initiatives and well-received cloud offerings. However, Microsoft’s revenue mix transition toward cloud offerings has weighed on its gross margins. Cloud-based subscription revenues are recognized over an extended period. In contrast, software revenues boost the top line immediately. So, the reduction in the company’s upfront revenues puts pressure on its margins.

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Oracle (ORCL), SAP (SAP), IBM (IBM), and Adobe (ADBE) all are facing this pressure. Moreover, billion-dollar investments in cloud data centers add to this pressure. Last year, Amazon, Microsoft, and Google (GOOG) collectively spent $31.5 billion, the majority of which went to build data centers. However, all leading technology companies are taking initiatives to expand and improve their cloud offerings.

The answer lies in businesses’ willingness to pay more for expansive cloud offerings software suites over the long run than for on-premise suites. Moreover, cloud offerings like Azure, Office 365, and Microsoft 365 are broadening Microsoft’s addressable market. The chart above shows the major players’ positions in the cloud space.

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Microsoft’s turnaround

Microsoft, which had been heavily dependent on the struggling PC market, has made a successful transition to the cloud. Industry analysts are hopeful that Microsoft’s recently announced strategic restructuring would enhance its profit margins and operating cash flow. This would benefit the company as well as its investors and shareholders.

Amid the recent sell-offs in the technology space driven by valuation concerns, Microsoft stock fell from $73 per share to ~$68 per share.

Despite the recent sell-off, optimism in the tech sector is likely to continue in 2017. Morgan Stanley (MS) also has high expectations for the tech sector, describing it as having “only moderate uncertainty.” Microsoft, which is behind only Amazon in the cloud space, should benefit from this optimism.

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