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Cloud may squeeze margins, says Microsoft exec

May 19, 2008

Microsoft expects corporate customers to accelerate their shift to the cloud computing model over the next five years, bringing changes in the company's financial model, says Chris Capossela, the senior vice president who manages Microsoft's Office business. In one of the most forthright statements of Microsoft's view of the shift from in-house to utility-run software, Capossela said, as summarized by Reuters, that "the company will see more and more companies abandon their own in-house computer systems and shift to 'cloud computing,' a less expensive alternative."

The shift to the cloud will be felt most immediately in Microsoft's big Exchange business for running corporate email and messaging systems:

"In five years, 50 percent of our Exchange mailboxes will be Exchange Online," said Capossela, who expects a portion of Exchange Online customers to come from customers switching from International Business Machines' Lotus Domino system. According to research firm Radicati, Exchange will run about 210 million corporate e-mail accounts in 2008, growing to 319 million mailboxes in 2012.

The shift from software licenses to software subscriptions is likely to squeeze Microsoft's profit margins in its business division, says Capossela, though he expects it will also bring higher and more consistent sales:

The shift to cloud computing will introduce some changes, according to Capossela, in the earnings model at Microsoft's business division, which generated revenue of $16.4 billion and operating profit of $10.8 billion in fiscal 2007.

Currently, customers pay Microsoft a licensing fee for the software, then buy their own computer and hire their own technology staff to manage those systems. In a services business, the customer will pay Microsoft a larger fee, since Microsoft also runs and maintains all the hardware. But Microsoft's profit margins may not be "as high," Capossela said, even though revenue may be more consistent.

Capossela's assumption that Microsoft will be able to charge companies more under the cloud model seems optimistic, given the different economics of providing software as a web service and the aggressive pricing strategies of cloud pioneers like Google, Zoho, and Amazon.

Capossela told Reuters that the key to competing successfully in the cloud will lie in the company's ability "to run its computers systems as efficiently as possible to reduce hardware costs." He says that Microsoft is now adding 10,000 servers a month to its cloud-computing data centers - "a staggering amount of computing power" equivalent to the total hardware currently powering Facebook.

Comments

“Capossela's assumption that Microsoft will be able to charge companies more under the cloud model seems optimistic,”

You took the words out of my mouth Nick, but there has to be some spin as they struggle to figure out the way forward/downward.

Alan

Posted by: alan [TypeKey Profile Page] at May 19, 2008 03:01 PM

Microsoft has always depended on its dominance in the PC desktop to make embrace, extend and extinguish work. The cloud is not a "market" that it can leverage that dominance. Even if they manage to build more servers that anyone else, unless they adopt open source and open standards they will always be unable to compete.

Case in point: Linux Mobile. LiMo is being adopted by phone vendors because they don't want to have a single vendor dominate in the mobile phone OS market. M$ business model is still inheritably built on the PC desktop market. As the desktop become less important, unless they retool their business model they are doomed to be a minor player.

Posted by: Linuxguru1968 [TypeKey Profile Page] at May 19, 2008 06:55 PM

I can't wait for the day when a Microsoft salesperson phones and asks if I want to move into the cloud. I'd be willing to pay more.

Posted by: Charlie [TypeKey Profile Page] at May 19, 2008 10:44 PM

Charlie - You're a CIO with your head up your proverbial ... with a 401K over-allocated to MrSoFTy.

Posted by: Sam [TypeKey Profile Page] at May 19, 2008 11:01 PM

I'm sorry guys, I just don't get it with "Cloud Computing"! Really... think about it... All this talk about dispensing with the in-house IT staff and not having to buy and maintain servers?? Passing off the application to the "Cloud"? Come on! All this would have held true in the days when companies were spending 250K for a mini mainframe, but you can buy one heck of a server for 10,000 bucks; enough of a machine to run a 40 million a year company on. Desktops are under a $1000. Believe me, it's not a compelling argument for cloud computing.

Also, most companies have a hardware and network person visit them by the hour when needed. Even for a company using MS Server 2003, it's bullet-proof enough that it just sits there and works. It may not be Linux or Unix, but it's good enough for a reasonable price. So the "IT guy" isn't going to break the bank. Computing has become a commodity, so there ARE no big savings there - PERIOD!

Now let's say you rent sofware like Netsuite or Salesforce.com... You pay and you pay! Every two years you'll be paying the equivalent of a one-time software purchase for a product outright. It doesn't even make financial sense. Software rental is not cheap. What if the network or Internet provider goes down? At least with a desktop system you can still work on a local version.

Most desktop systems are rapidly becoming cloud systems anyway. Like Foundation 3000 accounting software from Softrend Systems Inc. http://www.softrend.com/ This software you buy only once and you get both desktop feature and cloud features included. It's not an either/or decision.

Using Online features in software in no way makes the desktop redundant. What the heck do most people use to connect to the Internet with...? A desktop computer! Some software will be Internet-based and some will be desktop based. Most computing platforms of the future will be a mix of both. What we're really talking about here is the software pricing model - not whether your application is sitting on "somebody's" server out in a cloud somewhere.

So let's bring the discussion back to Earth and get our heads out of the Clouds!

Come on... let's debate this!

Posted by: Sandy [TypeKey Profile Page] at May 20, 2008 04:47 AM

They say Cloud Computing is going to grow exponentially. But even ten times 0.01 percent is still nothing.

The computing market doesn't seem to have much else to make a noise about, is this why cloud computing is getting so much oxygen ?

Posted by: Greg Ferro [TypeKey Profile Page] at May 20, 2008 05:22 AM

I agree with Greg that there is a lot of "cart before the horse" here. I wonder if current build-outs aren't going to create a lot of embarrassingly dark data centers with 0-ROI equipment rusting on the racks.

Sandy:

So, for your $10K server you'll need space, climate control, software vendors supporting your platform in future years, commodity hardware vendors supporting your platform in future years, a backups solution, etc. You can get by with hourly support for many things but to make all of the purchases you need to make you'll need something like an (at the very least) part-time CIO.

There are a lot of prisoner's dilemmas in those costs. If nobody moves to the cloud, your $10K server solution is a level playing field and the various vendors will compete to make it easy for you. If there's a spike of growth in the cloud at some point, and meanwhile the big-gorilla vendors are pressuring third party software vendors towards the cloud, who is going to want to sell stuff for your $10K server? In addition to supply problems, for the stuff you can get, you'll be paying larger and larger slices of the vendor's costs for retail marketing to you.

Yet, I agree with you that in-house and private ownership isn't going away anytime soon. Just that it might shift so that what you own looks more and more like a low-flying cloud (what we call "fog" in the Bay Area).

At the very high-end, as well: buying rather than subscribing, sure. But "cloud form."

Sometimes under-emphasized is that this "cloud stuff" is, as much as anything, a reconsideration of the entire software stack. Firms might still buy their own hardware, hire hourly support, and so on but software vendors will treat that "fog" as just an extension of the "cloud": additional nodes on which to install their wares.

Also overlooked: capability limitations have caused many first generation web hosted apps to be "dumbed down" compared to locally hosted apps that they replace. That might be permanent not because capability won't grow but because firms will discover that it lowers training costs, increases the portability of skills in the labor force, and is "good enough". The cloud can (at least appear to) save money that way, too.

-t

Posted by: Tom Lord [TypeKey Profile Page] at May 20, 2008 12:42 PM

Why would Google, Amazon, Microsoft and other lesser players be plowing so much investment into the server farms if that is not where they are anticipating the future of computing to be?

I don’t know what the historical ratios between combined incomes and capitol investments are in this realm but where there is movement, oxygen follows.

There appears to be a very heavy thrust toward real estate and hardware investments that are designed to jump-start the trend! It would also be surprising for such massive investments to be made on a gamble!

They are closer to the action than the pundits are and in fact are actively shaping the process industry wide to that end.

Mist, fog, cloud, but just as it might be any of those, there is a change a-happening!

Cheers, Alan

Posted by: alan [TypeKey Profile Page] at May 20, 2008 01:00 PM

Why would [....] if that is not where they are anticipating the future of computing to be?

It would be surprising for such massive investments to be made on a gamble!

It would be surprising (near impossible) for such investments to be made on a Vegas-style craps shoot. Chess is also gambling, though, until you reach and end-game position (a fully analyzable position).

Google must spend heavily or, well, not much other choice there. They could do dividends if they believed that their revenues were sustainable without massive spending (investment in future business). They rightly do not. They can't just sit on cash both because shareholders would disapprove and because they'd run into regulatory problems. So, they must spend heavily.

As in chess, the game is too hard to analyze. They can make informed choices but it is still with partial knowledge and comes down to guesses. So, it is gambling in that sense. (Which is fine. That's what the securities markets are for.)

As in many kinds of betting, they are hedging. Note that they haven't made any firm commitments as to how these centers will generate profit. They sometimes show or give hints as to why investors might want to think they are but, as in chess, they are improvising.

"Things are changing" -- well, maybe. They aren't necessarily changing under the influence of rational market choices, though. Google has a lot of weight. If they get many to believe in their version of the cloud, then that version of the cloud may get built out by others as well and purchased by many for no other reason. And that's a big risk. That's how we got social networking services, for example.

-t

Posted by: Tom Lord [TypeKey Profile Page] at May 20, 2008 03:07 PM

One of the major hurdles that is considered to hinder adaption to cloud computing is data sensitivity. I think this is only a hesitation for change, owing to the fact that companies already have that trust established with their banking and financial service vendors. The company's financial information and transactions are stored at the Bank's database and owned by the Bank [which is worse that the cloud storing a clients data]and there is no company that is worried about that.

Posted by: jayasimhan [TypeKey Profile Page] at May 20, 2008 04:48 PM

The true costs of "cloud computing" have not been passed onto consumers yet -- it is being heavily subsidized by its providers (google, VCs funding startups paying amazon, etc).

So if you build your business based on the "cost savings" of cloud computing, you may be in for a rude awakening down the road.

Posted by: dubdub [TypeKey Profile Page] at May 21, 2008 12:44 PM

The debate here is interesting. It is true that private ownership will continue for some time; in some applications probably forever. (Would anyone really want the Department of Homeland Security to house their data on Amazon's S3?)

However, it is also true that private ownership is not all that it's been cracked up to be, and the combined costs of energy, licenses, salaries, space and maintenance can certainly benefit from economies of scale. Google can offer their infrastructure for less than you can build it yourself precisely because they can build and operate their giant data centers with consistent, scalable practices (including automation) at a price that smaller data centers can't hope to achieve. This savings is passed on to the consumer in the form of lower subscription fees.

This claim that "gee, hardware is cheap, so it can't possibly matter" is the same argument that was used to build large data centers of underutilized, energy sucking application silos. Now we are spending billions to undo that fallicy. While the long term costs of the cloud remain to be seen, you'd be a sucker not to investigate it as an alternative to your private capacity.

Oh, and its a godsend for the individual software developer.

Posted by: James Urquhart [TypeKey Profile Page] at May 23, 2008 02:01 AM

James (and Nick!)

You should look into the RAD Lab at UC Berkeley, if you aren't already familiar.

-t

Posted by: Tom Lord [TypeKey Profile Page] at May 23, 2008 03:42 AM

Data security and governance are far more of an issue than many of the comments here seem to imply. It’s not just a question of products but corporate culture. Google, for instance, already has a culture of cookie keeping, knee jerk data snooping and lack of transparency. This may not matter to individuals but it’s anathema to a CIO. Even the corporate use of Gmail is almost certainly in violation of European Data Protection legislation.

Posted by: Greg Quinn [TypeKey Profile Page] at May 23, 2008 04:22 AM

There's a huge difference between Exchange Online [Microsoft runs your mail server], and the VPS market [hosting firm rents you an OS instance and you run your own mail server] . I don't think that the word 'Cloud' is meaningful if they don't distinguish the two...

(At the moment, the only firms I know that do click-deploy "servers" at decent prices are Slicehost and Linode. LayeredTech offer entire virtualised datacentres (if you pay). Why don't they get more attention here? Everyone talks about Google, but in the real world, they simply do not have a hosting product anyone can deploy.)

Posted by: Thomas [TypeKey Profile Page] at May 25, 2008 06:40 AM

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