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See you around, Larry: AWS is our new Oracle, says Microsoft's Nadella

As cloud era sweeps in, Redmond faces up to fresh competition

Analysis Amazon's cloud service AWS has replaced Oracle and VMware as Microsoft's chief rivals, the Windows giant's CEO Satya Nadella has said.

In a conference call with analysts to discuss its Q2 2017 financials, Microsoft executives said their margins were fat enough to fend off AWS and other cloud competitors.

Nadella said: "Even in the client-server era, we had tough competition. We had Oracle. We had VMware, and we had many other players we competed with and I grew up competing with.

"And we now have AWS, I think who is going to be a credible competitor. So I feel that, as I said, we have a cloud strategy that is not just about infrastructure. It is about, really, SaaS and infrastructure. And we're going to uniquely think about what are the things that we can do to differentiate and add value to our customers' digital estate in the cloud in that context. And that's where, if you will, our fair share will come from by competing hard where we have to but also mostly thinking about differentiation."

Among Microsoft's moves to differentiate is its commitment to getting customers to shack up with channel partners.

Nadella described this as Microsoft "putting a lot more technical depth in the front-line sellers," because this is where its largest accounts used to be, based on PCs. Now its biggest customers are ranked by "consumption of cloud capacity."

The so-called "intelligent cloud" segment accounted for $6.9bn in sales, about 28 per cent of the $24.1bn total revenues in Q2 2017. In a statement accompanying the results, Microsoft hailed the uptick in cloud business, with Azure revenues up 93 per cent on the same quarter last year and Office 365 revenues up 47 per cent.

Microsoft's on-premises Server & Tools business grew five per cent, driven by the releases of Windows Server 2016 and SQL Server 2016. In the earnings call, Amy Hood, Microsoft's chief financial officer, said the company was "encouraged by the customer reaction, even our transactional customers, to the security and management value prop as well as the hybrid nature of our SQL and Windows Server 2016 releases that have taken place this year."

Transactional revenue – sales from one-off purchases rather than contracted payments – is expected to drop in the coming quarter, however, with announced price increases driving quick purchases in Q2, although Hood claimed that "the biggest driver of the transactional performance this quarter was really the value prop people saw."

Commercial cloud services are expected to continue to drive growth, according to Hood. The company anticipates commercial unearned revenue of $20.2bn to $20.4bn, in line with "historic seasonality. We continue to expect some volatility in our transactional business due to macroeconomic conditions and the ongoing shift to the cloud," she said.

Margin call

"When I think about the material gross margin improvement we saw in Azure, it continues to the path we've actually been on where we've been discussing, as you continue to see customers ask for us and our help in managing their digital estate, consistently, securely through one interface, you'll actually see growth across all components of that cloud," said Hood.

"It benefits margin, not just in Azure but across actually the entirety of the cloud" according to Hood, who noted a two-point year-over-year increase in the gross margins in its commercial cloud revenues: "Even with the massive growth in Azure over the course of the year, [this margin increase] certainly implies the improvement that we expected."

Hood acknowledged that times are a-changing, with Microsoft's enterprise services revenue continuing to decline due to reduced volume of Windows Server 2003 service agreements. But this was offset due to "material improvement in Azure gross margin," and this is where the business would differentiate itself from competitors.

"We really do think about and talk about our cloud as containing all of the components," she said, "from the IaaS layer to the platform layer to the SaaS layer. You'll hear us talk about Dynamics 365, Office 365, as well as our Azure core and premium services." ®

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