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Azure: Winding Down or Gearing Up?

The revenue growth for Microsoft Azure year in and year out is nothing short of stunning.

Microsoft logged yet another quarter of very high double-digit growth for Azure revenues in the earnings report that was released Wednesday for the first quarter of its July-to-June fiscal year.

The figure is a 76% gain over the year-ago quarter. That's impressive, especially considering Microsoft is starting from a relatively high number as the No. 2 public cloud provider after Amazon Web Services (AWS).

Yet the number is slightly worrying to financial analysts, who note that the Azure growth rate figure has been marching steadily downward over the last few years. By comparison, the growth rate for the same quarter a year ago was 90%; two years ago it was 116% for the quarter.

While analysts on the earnings call Wednesday evening were complimentary overall about the quarter, which beat expectations on both profits and revenues, they asked CEO Satya Nadella and CFO Amy Hood repeatedly about Azure and came at it from many different angles.

Nadella and Hood together conjured an extremely positive story about Azure's future built on three major elements.

One element is that Microsoft's hybrid approach to the cloud is not only a strategic advantage, but that analysts should be thinking about it as effectively hiding some Azure revenues. Microsoft's unique attribute, compared to major public cloud competitors AWS or Google Cloud Platform, is that the company has a huge installed base of on-premises server software customers. That legacy encouraged Microsoft to focus more on hybrid solutions that allow customers to move workloads to the cloud at their own pace and to integrate all kinds of services between the on-premises servers and the cloud platform. Over the last year, Microsoft has moved to bring its licensing model in line with that hybrid approach, especially via Azure hybrid benefits.

Hood made that case in an answer to one analyst. "I tend to focus...on the 'all up' server and product [Key Performance Indicator] because the Azure hybrid benefits that exist with Windows Server and SQL Server are really valuable to customers if they want to move to Azure on their own terms," Hood said. "If we start to focus on one number or the other, I think we're missing the fact that our customer method and go-to-market is actually through the overall product portfolio."

Nadella hammered the theme home in response to a different question. "We don't think of hybrid as some stopgap in a move to the cloud," he said. "[It's] not just the old workloads but most importantly for new workloads, and that's where we're seeing some very significant good feedback loops in shaping even our future roadmap. And this is a place where we are leading."

Another basic element of Microsoft's Azure story is one of driving cost out of the platform. Hood said commercial cloud gross margin percentage increased 4 points to 62%, driven by significant improvement in Azure gross margin. Nadella added that the margin improvements are crossing Microsoft's product boundaries as more of the infrastructure is unified. "For the first time, what you see across Microsoft is really one platform, which spans all of these businesses and all of the margin structures that are there represented in it," he said.

The other element is Microsoft's rapid buildout of Azure services. Nadella enumerated some of what he described as 100 new Azure capabilities introduced in the previous quarter (mostly at Microsoft Ignite), including Azure Confidential Computing, Azure Sphere and Azure Digital Twins. He pointed out that new and higher-level services should generate higher margins over time.

Several key Microsoft partners didn't need convincing that Azure has a lot of growth ahead of it.

"It's no surprise that this quarter was another strong one for Microsoft, given its recent push to expand Azure's features and its hybrid cloud capabilities," said Dux Raymond Sy, CMO of AvePoint, in a statement about Microsoft's earnings. "Over the past five years, the cloud industry has become the most competitive IT marketplace we have ever seen, but one of the most exciting things that we have seen from Microsoft is that it has managed to stay unique among its many competitors in the space."

Ryan Duguid, chief evangelist at Nintex, a process automation and management platform provider and Microsoft partner, also feels Microsoft's competitive position with Azure is strong after seeing the quarterly results.

"Azure was always going to be at the heart of Microsoft's transformation and while it got off to a rocky start by focusing on platform versus infrastructure services, it is now clear that it was a winning strategy, and that they're doing a great job of making up lost time against Amazon when it comes to hosting VMs," Duguid said in an e-mail. "Nintex bet heavily on Azure from the onset, and the platform continues to enable us to drive a rapid pace of innovation while the experts at Microsoft focus on delivering scalable, reliable, cost-effective infrastructure."

Posted by Scott Bekker on October 25, 2018