Microsoft: Leveraging software expertise for industry dominance (MSFT)

Lisa Tide Williams

Microsoft (NASDAQ:NASDAQ: MSFT) made a habit of entering industries relatively late and dominating them thereafter. The rapid expansion of the company’s presence as a second cloud computing player is a perfect example. Despite the fact that Microsoft’s Azure has become commercially available about 4 years after that of Amazon (AMZN) AWS, Azure is now on the tail of AWS in terms of market share.

Although Microsoft still derives a significant portion of its revenue from its traditional business, from its Windows operating system to its software tools, the company has significantly expanded its reach in recent years. Microsoft’s smart cloud business, for example, generated $20.9 billion in the fourth quarter and shows no signs of slowing down. Microsoft’s ability to continually adapt to a rapidly changing technology landscape should not be underestimated.

Leverage software expertise

Microsoft’s ability to quickly gain market share in highly competitive industries is closely tied to its industry-leading software capabilities. Microsoft’s growth in the cloud is a perfect example of how the company leverages its software expertise for outsized success. This feat was particularly impressive considering the tech heavyweights involved in the cloud space, including Amazon’s AWS.

Ultimately, success in the cloud space comes down to a company’s ability to manufacture/purchase hardware at a relatively low cost and deliver high quality cloud services. Since most large tech companies have the capability and resources to meet the first requirement, the real differentiator among these companies is the ability to offer excellent cloud services. Microsoft stands out on this front because of its software expertise and established software ecosystem.

There are countless cloud services for a wide range of use cases i.e. compute, storage, database, serverless, etc. The hundreds of popular cloud services such as Lambda, Active Directory, EC2, CosmosDB, DynamoDB, Memorystore, etc., are all competing for business on both the small business and large enterprise fronts.

Microsoft’s background in building software and its established Windows ecosystem have allowed the company to leapfrog many well-established cloud providers in many respects. Even cloud heavyweight AWS is struggling to keep up with Microsoft when it comes to the enterprise cloud segment. While AWS services are easier to use and understand, Azure is geared more towards the enterprise market.

Microsoft’s pre-existing Windows ecosystem also gives the company an edge in the industry. Many organizations already know Microsoft products, from its operating system to its suite of productivity tools, Microsoft 365. This makes the transition to the Azure cloud platform a no-brainer for these organizations. For organizations that only sell Windows, of which there are many, choosing Azure as your cloud provider is a no-brainer.

Microsoft continues to take market share in the highly competitive cloud market.

Cloud market share

Synergy Research Group

Underrated gaming ecosystem

Much of the attention Microsoft has focused on its software offerings and cloud business. While these businesses still account for the majority of Microsoft’s revenue, the company’s burgeoning games division holds the most long-term growth potential. Microsoft has had a strong presence in gaming for decades with Xbox. However, the company is starting to pay much more attention to its games division.

Microsoft recently acquired gaming giant Activision Blizzard for $68.7 billion. In what is by far the biggest acquisition in the industry, Microsoft now owns some of the most iconic gaming franchises of all time. Titles like Call of Duty, World of Warcraft, and Overwatch are now all under Microsoft. Adding Activision Blizzard properties to Microsoft’s already vast library of games positions the company as the dominant force in gaming for the foreseeable future.

Microsoft’s vision of being the Netflix (NFLX) of the growing video game industry seems to be coming to fruition. The company’s XBox Game Pass and Cloud Gaming services have already made waves in the gaming industry. With the addition of gaming giants like Activision Blizzard, Microsoft looks set to dominate the gaming landscape for the long term. No other company is about to catch up with Microsoft in terms of building a gaming ecosystem.

According to Statista, the video game industry was worth $180.1 billion in 2021. In fact, gaming has replaced every other major form of entertainment in terms of global revenue, beating out both music and movies combined. Microsoft’s current strategy of creating an unprecedented gaming ecosystem is a wise move considering the direction the industry is taking.

The video game industry continues to grow at an incredibly fast pace despite its sheer size.

Video game revenue

Statistical

Microsoft reported ~$15.367 billion in gaming revenue in 2021, which is a big increase from the company’s $11.57 billion in 2020. As more consumers get their hands on the latest consoles in the coming years and also strongly anticipated titles, Microsoft is expected to see this figure increase significantly.

Microsoft games revenue

Microsoft games revenue

Statistical

Upcoming challenges

Microsoft risks spreading itself too thin with its expanding business ventures and numerous acquisitions. In addition, competition is intensifying considerably in the main business segments of the company. While Microsoft still has a solid grip on the personal computing and productivity software markets, the same can’t be said for most of the company’s other businesses.

Given Microsoft’s surprising success in the cloud, it’s easy to forget that the cloud industry is still dominated by AWS. On top of that, other tech giants like Alphabet (GOOGL) and IBM (IBM) are starting to invest a lot more in the cloud space, which is not surprising considering how profitable it is for Amazon and Microsoft.

The gaming industry presents its own unique set of challenges to Microsoft. For one thing, the video game service model may not be a long-term winner like the video streaming service has been for Netflix (NFLX). Since consumers spend far more time on single game titles than single movie/TV titles, Microsoft’s Game Pass subscription model may not have the same pull as a Netflix or Disney+.

It may ultimately make more sense to buy games individually, given general consumer habits. Unlike a movie or TV show that most consumers watch once or twice, games have a much higher repeatability factor. As such, Microsoft is taking a significant risk by focusing so much on a Netflix-like video game service model.

Conclusion

Microsoft reported fourth-quarter revenue of $16.6 billion, $20.9 billion, and $14.4 billion for its Business Productivity/Process, Intelligent Cloud, and Personal Computing segments, respectively. These three segments experienced moderate growth despite relatively difficult market conditions. Despite Microsoft returning to pre-Covid levels, the company saw its valuation drop around 30% to $1.8T. Given Microsoft’s growth opportunities and its recent downturn, the company seems relatively cheap given its current market capitalization.

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