Microsoft’s Margin Compression

Microsoft’s Margin Compression:

The Economist, looking ahead to the future on Microsoft’s 40th birthday:

The biggest question is about Microsoft’s finances. As people and businesses buy ever fewer, and cheaper, PCs, the revenues from Windows are falling. In the quarter to December 31st they were down by 13% on a year earlier. Sales in the commercial cloud business, including Office 365, more than doubled year-on-year, to reach an annual run-rate of $5.5 billion. But this is only a small fraction of total revenues, and the division is still thought to be losing money. Furthermore, says Rick Sherlund of Nomura, an investment bank, it is unclear how newer applications, such as Cortana, will make a living. “The business models have yet to be invented.”

They are unlikely to be as much of a cash cow as Windows and Office, which still generate 44% of revenues and 58% of . The gross margin of classic Office is 90%; that of Office 365 is currently only 53%. In other cloud businesses profits will be elusive, given the intense competition from Amazon, Google and increasingly IBM. Citigroup, another bank, recently estimated that Amazon’s margin in the cloud was between -2% and -3%. In other businesses Amazon has shown a high tolerance for losses as it strives for growth.

The question isn’t whether Microsoft can continue to be a good business going forward, it’s if it can be a truly great business, as it once was, when the margins are being cut in half, or worse. It’s hard to live in the shadow of your former self.