Cloud wars are a two-horse race

The cloud wars are not as brutal as expected — at least if you are Amazon or Microsoft. The most important trend in corporate information technology — companies shifting their computing tasks from their own data centres to tech giants’ server farms — is supposed to be a bitter fight. Price competition, however, is hardly butchering profit margins. Microsoft reported a 55% gross margin in its commercial cloud business on Wednesday, up from 48% a year ago. That still lags behind the broader company’s 62% gross margin, but it is reasonable to think the cloud should soon be lifting company-wide profits in margin as well as dollar terms.

Not long ago, this was an insignificant business for Microsoft. Commercial cloud made just $700m in revenues in 2012, less than 1% of overall sales, and only $2.8bn in 2014, when Satya Nadella became CE. For a long time, it remained unclear if the profit-sapping spending on new equipment to support the cloud business would prevent it making serious profits. No longer. Capital expenditure increased to $3.3bn in the quarter, from $2.5bn a year earlier, and Microsoft forecast higher spending ahead as it continues building data centres around the world. But revenues surged, with Azure sales increasing by 98% year on year — and scale efficiencies count.

One reason might be the “architectural advantage” touted by Nadella. While Amazon’s remotely based service is attractive to many companies, others prefer to continue to use their existing on-premise systems alongside new alternatives. Another is surprisingly lacklustre competition from elsewhere. A survey of chief information officers from Credit Suisse that asks “who is your cloud vendor of choice?” has IBM and Google at only 11% combined. Amazon has 48% and Microsoft 33%.

We are still a long way from the 1990s, when software licences were Microsoft’s reliable earner and its gross margins were more than 80%. But profitability has turned the corner. London, February 1