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Microsoft’s first quarter proving its ability to become a dominant force in cloud computing with superior cloud offerings

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Following the results of the previous quarter described as Microsoft is ready to become a dominant force in cloud computing with superior cloud offerings, a Windows ecosystem under complete renewal, first signs of Surface-Lumia-Xbox successes on the market, and strong interest in technology partnerships by other industry leaders [this same blog, Oct 24, 2014] now we have the following (as touted by Microsoft):

Jan 26, 2015: From Microsoft Earnings Release FY15 Q2

Microsoft Cloud and Devices Momentum Highlights Second Quarter Results 
Commercial cloud revenue grows triple-digits for the sixth consecutive quarter, reaching an annualized revenue run rate of $5.5 billion

  • Commercial cloud revenue grew 114% driven by Office 365, Azure [Enterprise Mobility Suite see in the earnings call below] and Dynamic CRM Online, and is now on an annualized revenue run rate of $5.5 billion
  • Surface revenue of $1.1 billion, up 24%, driven by Surface Pro 3 and accessories
  • Office 365 Home and Personal subscribers increased to over 9.2 million, up 30% sequentially over prior quarter
  • Search advertising revenue grew 23%, with Bing U.S. market share at 19.7%, up 150 basis points over prior year
  • Xbox console sales totaled 6.6 million units, with strong holiday season performance
  • Phone Hardware revenue of $2.3 billion, with 10.5 million Lumia units sold driven by growth in affordable smartphones

Jan 26, 2015: From Microsoft’s (MSFT) CEO Satya Nadella on Q2 2015 Results – Earnings Call Transcript regarding the above “Cloud and Devices Momentum” emphasized as the positive sign about Microsoft futures

I’m encouraged by the progress we’re making in our transformation to become the productivity and platform company for the mobile-first and cloud-first world.

Azure services continue to grow in appeal to enterprise IT and developers with rapid improvements across hybrid services, premium cloud storage and VM offerings, enhanced data and data analytics offerings. Microsoft Enterprise Mobility Suite is one key of product innovation that I would like to highlight given the growth and uniqueness of our offering. Microsoft offers a comprehensive solution that brings together mobile device management, mobile application management, hybrid identity management and data protection into a unified offering via EMS.

Office 365 now includes new app experiences on all phones and tablets for mobile productivity.  Further, we have released completely new scenarios. This includes Office Sway for visualizing and sharing ideas; Delve, to help search and discover content; Office 365 Groups to make it easier to collaborate; and Office 365 Video for secure media streaming for businesses. Finally, we continue to invest in enterprise value by integrating MDM and the Enterprise Mobility Suite into Office 365; new encryption technologies and compliance certifications; and new eDiscovery capabilities in Exchange.

[Amy Hood:] Office 365 continues to be a priority for CIOs, as both existing and new customers move to the cloud.  This transition accelerated, with 45 percent of our renewal seats in Office moving to the cloud this quarter.

Q: What’s driving the increase in cloud margins within the commercial other segment?

A: [Amy Hood:] We’ve seen a mix shift as we have moved Office 365 and Azure to our premium service and to premium SKUs within our cloud environment, that is one of the drivers that helps improve margin growth. In addition, we’ve done a lot of hard engineering work I believe over the past six quarters to be able to take advantage of more utilization and capacity over time.

A: Overall, the shift to the higher layer services is the real driver here, which is obviously Office 365 and its various levels is one factor. The other one is what I talked about in the Enterprise Mobility Suite, that’s really got fantastic momentum in the marketplace because the solution has really come together and is fairly unique, as well as Dynamic CRM. So these are all got a different profile in terms of margin and they are all now pretty high growth businesses for us. So when you think about our cloud, you got to think about the low-level infrastructure. Even there we now have premium offerings and then we have higher level services. So that aggregate portfolio is what helps us move up the margin curve.

In Dynamics CRM Online, we added 53 markets this quarter, bringing us to 130 markets around the world.  And we are bringing together CRM with Cortana, Yammer, Power BI and Skype to add unique value for customers.

Q: Over the last several quarters you’ve opened up a number of the products to different platforms, Office in Android and with Minecraft and Skype, you’ve got a number of really multiplatform products and services. Could you quantify so far to what extent you’ve seen benefit and as this plays into the free upgrade for Windows 10 at least for a limited period, how you expect this to play out benefitting the business case of your products across the portfolio? 

AOverall at the highest level, our strategy here is to make sure that the Microsoft Services i.e. cloud services be it Azure, Office 365, CRM Online or Enterprise Mobility suite are covering all the devices out there in the marketplace. So that, that way we maximize the opportunity we have for each of these subscription and capacity based services. So that’s the core rational for why we are doing cross platform.

Now the next question is what’s the uniqueness of Windows? And the uniqueness of Windows comes because we don’t think of these services and their application end points as apps, but fundamentally core to the Windows experience. So we are building them natively into windows. So for example, when you log into Windows, you are logging in with Microsoft account or Azure ID. When you have files, they are synching with OneDrive. Outlook is the email client for Windows. So that’s how Windows will differentiate and not to mention, our Gaming and Xbox Live experiences.

So overall, we will build a differentiated Windows because our application experiences for our cloud end points will be native in windows and at the same time, we will make sure that our services are available on all end points driving more usage, more subscription growth. So the best way to measure our progress is Office 365 subscription growth, Azure growth and EMS growth.

We are expanding our capabilities in the cloud through five new acquisitions.  Last week we announced an agreement to purchase Revolution Analytics, the leading provider of statistical computing and predictive analytics, which will enable our customers to unlock big data insights.  We bought HockeyApp, a leading mobile app testing and development service to enhance Azure services for mobile developers.  Our acquisition of Aorato accelerates our ability to give customers unique security capabilities by tapping into behavioral intelligence around Identity and access spanning on-premises and the cloud.  We’re bringing on new capabilities in machine learning as applied to eDiscovery and other enterprise compliance processes with the acquisition of Equivio; and we also welcomed Accompli, a provider of innovative mobile email applications for iOS and Android.

The common theme across all these acquisitions is advanced data analytics and machine learning driven capabilities that improve with more customer adoption and usage.

We are also making progress in our CONSUMER cloud services.

Office 365 Home and Personal revenue grew nearly 150 percent year over year as we added 2.1 million net new subscribers since last quarter.  Bing U.S. search share continues to grow as does search revenue with 23 percent growth this quarter.

However, it’s how our strategies are coming together with Windows 10 that give me the greatest optimism.  The vibrant social gaming community on Xbox Live will span Xbox, Windows PCs, tablets and phones.  With Windows 10, gamers on a PC, tablet or Xbox console can play together and games on Xbox One can easily stream to a Windows 10 PC or tablet.  It’s also getting clearer how the games people love today will evolve to mind-blowing experiences in the future when designed for the mixed reality that Windows 10 and HoloLens create – just imagine what is possible with Minecraft.  Gaming truly is a valuable part of millions of people’s lives and Microsoft will excel and increase our lead.

[Amy Hood:] Revenue in our Devices & Consumer Other segment grew 30 percent.  As noted earlier, Xbox Live transactions and first party games performed well, and contributed to this growth.  Additionally, Search revenue growth was strong, with improvements in both rate and volume.  Within display, revenue declined on our MSN portal, though we saw revenue growth across other Microsoft properties.  We are also pleased by our gross margin expansion in this segment.

[Amy Hood on Q3 guidance:] In Devices and Consumer Other, we expect revenue to be about $2 billion reflecting continued progress in key areas like Office 365 Home and Personal, Xbox Live and Search.

Q: How should we think about monetization Satya for the Windows devices sub 9 inch?

A: One of the comments I had made in my remarks was some momentum we’re seeing in our consumer cloud services. So for example, the store monetization, Bing monetization, Xbox Live monetization as Xbox Live monetization as Xbox Live now in fact is going to span devices are all things that drive monetization for below 9 inches. So I think of device gross margin in some cases because we are building devices like the phones as well as this post sale monetization using our consumer cloud services as the two additional levers that we have in order to be able to monetize Windows devices.

We are making progress with our own devices – both those in market driving positive results and those we have recently announced.

This quarter we surpassed the one billion revenue mark with Surface for the first time.  The value proposition of being the most productive tablet is resonating.

[Amy Hood on Q3 guidance:] In Computing and Gaming, we expect revenue to be $1.5 to $1.7 billion.  This range reflects normal seasonality coming out of the holidays for our Xbox and Surface businesses.

Q: Have you done any assessment in terms of the set you’re seeing in Surface Pro 3 definitely is a real productivity device. To what extent is that cannibalistic from what would have been Windows PC sales and to what extent do you think you’re expanding the market opportunity with that device?

A: I think it’s definitely expanding the market opportunity. One of the things that I feel very good about is the risk we took to introduce the two-in-one category and I feel now that we see that in fact inspire even a lot of activity in our own OEM ecosystem and we see many good designs coming because it’s viewed as a category that drives growth. And so from that perspective I feel good about leading because that’s one of our strategic goals, which is we want to create new categories, foster more demand for the entire ecosystem.

Further, sales for Lumia phones topped 10 million units, growing 30% year over year this quarter with strength in devices such as Lumia 500 and 600 series – our affordable smartphones.  In this segment of the market the combination of our brand and value standout and we plan to continue to build a beachhead here.

[Amy Hood:] We articulated our plan for the Phone business back in July, and we are executing to plan.  With our Lumia portfolio of phones, we are driving volumes in the low price device category.  We sold 10.5 million Lumia phones this quarter, an all-time high.  We also sold over 39 million non-Lumia phones, even while we make changes to the product portfolio and manage this business for profitability. We are looking forward to bringing new products to market that will showcase the features that we presented at our Windows 10 event last week.

[Amy Hood:] Our integration and restructuring efforts have been focused on optimizing resources across the company which includes reducing the expense base in our Phone business.  To date, we have integrated the manufacturing and supply chain teams across Microsoft, while also rationalizing our phone manufacturing capacity.  In operating expense, we committed to reducing $1 billion from the Phone cost base, which we have done.  We continue to look for opportunities to drive further efficiencies.

[Amy Hood Q3 guidance:] In Phone Hardware, we expect revenue to be $1.4 to $1.5 billion.  This range anticipates accelerating year-over-year growth in Lumia units driven by our affordable smart phone devices. We also expect both volumes and ASPs of Non-Lumia devices to continue to decline in Q3.  With this lower aggregate revenue base, we expect gross margins, which include non-cash amortization, to be lower for the next couple of quarters.

We are also creating new device types that open up new markets and opportunities for Microsoft.  In October, we launched our first wearable – the Microsoft Band.  And just last week we revealed to the world Microsoft Surface Hub and Microsoft HoloLens – two new device categories made possible with Windows 10.  Surface Hub will revolutionize group collaboration and meetings.  HoloLens and Windows Holographic computing will make mixed reality applications part of everyday life across work and home.


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