According to Google, Microsoft’s cloud business actually loses money

The company has been playing catch-up in the cloud infrastructure market for years, and is seen as a distant third behind Amazon and Microsoft in the U.S.

Investors face a challenge because the three companies don’t provide comparable metrics for cloud infrastructure.

Google employees, however, believe it is closer to second place than analysts think, based on a leaked Microsoft document and some extrapolation of other market statistics.

Based on the value of cloud infrastructure services used by clients, Google estimates Microsoft generated less than $29 billion in Azure consumption revenue in the latest fiscal year, which ended June 30. Wall Street analysts had forecasted Azure to earn $37.5 billion in fiscal 2022, but Bank of America was the most bullish, predicting revenue of $33.9 billion and UBS $32.3 billion.

Azure is projected to end its fiscal year 2022 with an operating loss of $3 billion, down from more than $5 billion in the prior fiscal year. According to the report, Azure’s sales and marketing costs exceeded $10 billion, accounting for 34% of consumption revenue. Over the same period, Microsoft said sales and marketing costs accounted for 11% of revenue.

Google’s bottom-line numbers were dismissed by one analyst.

A Cowen analyst with a buy rating on Microsoft stock, Derrick Wood, says Azure boasts an operating margin above 30%, while Google estimates a -10% margin for the service.

Cloud computing represents one of the most high-stakes battles in technology, with the largest and most well-capitalized U.S. tech companies trying to win lucrative deals from large enterprises and government agencies, which are increasingly pushing critical computing and storage out of their own data centers in order to save money.

The e-commerce company pioneered the market in 2006, and Google and Microsoft have been investing heavily to prevent it from dominating. But they aren’t being completely transparent about their efforts.

Microsoft provides year-over-year growth for Azure and other cloud services, but does not provide a dollar figure, nor does it specify how much of that growth comes from Azure alone. In addition to Azure and other cloud services, enterprise mobility and security tools are also included.

Alphabet, on the other hand, does not disclose how much revenue or operating income Google Cloud Platform generates. Those figures are only for what it calls Google Cloud, which includes subscriptions to Google Workspace collaboration software, as well as GCP, which competes directly with Azure.

Among the three companies, Amazon reports both revenue and operating income for AWS, providing investors with the clearest picture of its cloud business.

Satya Nadella, Microsoft’s CEO, said in 2019 that customers’ adoption of “higher-level services” beyond raw computing and storage resources can result in “good margins over time.”

Gartner estimates that AWS will hold 39% of the global cloud infrastructure market in 2021, followed by Microsoft at 21%, Alibaba at 9.5%, and Google at 7.1%.

Google and Microsoft declined to comment.

Estimates derived by Google

According to Google’s document, the analysis follows an Insider article, which cited a leaked Microsoft presentation that included Azure consumption revenue, or ACR, for its U.S. enterprise business in the past few years. In its document, Google stated that the leaked presentation enabled the company to model its business more accurately, and it concluded that ACR is Azure’s main source of revenue.

Using the leaked ACR information, Google made some assumptions. Based on Microsoft’s statement that 51% of total revenue in fiscal 2022 will come from customers in the United States, they calculated a possible number for ACR abroad. According to market data from Gartner and other sources, Google then added revenue from other customer segments, such as public and regulated industries.

According to an Insider report, Microsoft’s Cloud and Artificial Intelligence organization has over 60,000 employees and Google assumed 65,000 were dedicated to Azure.

For a realistic analysis of Azure’s profitability, analysts must remove revenue allocations from EMS and Power BI, which are highly profitable SaaS businesses with gross margins in excess of 80%.

Microsoft’s ACR growth slowed from 61% in the 2020 fiscal year to about 50% in the 2022 fiscal year, according to Google. That’s faster than Microsoft’s expansion of Azure and other cloud services, which went from 56% to 45%.

In fiscal 2022, Google expects Azure’s gross profit to grow from 29% to almost 63% after accounting for the cost of goods sold. Azure’s gross margin has increased as a result of hardware and software efficiencies, according to Microsoft’s CFO Amy Hood.

The cloud would be less profitable at those levels than Microsoft’s Windows and Office software franchises. Microsoft’s total gross margin in the 2022 fiscal year was 68%.

For their cloud groups, none of the three U.S. market leaders announce gross margins.

According to Cowen, Microsoft’s Azure and other cloud services group will account for 27% of its revenue in the current fiscal year 2023.

“A more specific disclosure would be helpful,” Wood said.

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