Normally, I reflect on Microsoft earnings releases from a business and content point of view, looking at subtle changes that Satya Nadella, CEO of Microsoft, might be making through a lens of the topics on which he speaks. I do that because Nadella launches concepts which then pop up in speeches, interviews, quarterly earnings calls and annual shareholder letters.
Satya iterates on these concepts and you see the refinement with each iteration. These concepts then become strategy. Then structure follows strategy, and finally other supporting processes get adapted to support the strategy and structure. This consistency means that, by studying what Nadella says, you can foresee where Microsoft is going over the next couple of years. There is no surprise.
A world on the move
Thanks to COVID-19, we now live in an accelerated world that is rapidly transforming at the same time. Where we used to react in months, now we need to react within weeks and, similarly, weekly adjustments have become daily adjustments. I decided to focus this review of Microsoft earnings on the past and future impact of COVID-19 for partners.
As Nadella stated in the Q3 earnings call on April 29th, “COVID-19 impacts every aspect of our work and life. We have seen two years’ worth of digital transformation in two months. There is both immediate surge demand, and systemic, structural changes across all of our solution areas that will define the way we live and work going forward.”
Summary of impacted areas of business going forward
- Certain Industries, like travel, tourism, retail
Summary of opportunities
- Accelerated digital transformation
- Healthy Azure consumption and increased usage across:
- Microsoft 365, particularly in Teams and advanced security solutions
IAMCP Covid-19 Impact Survey
The IAMCP conducted a global survey on the impact of COVID-19 on its associates´ businesses at the end of March. Here are some of the key takeaways from that survey:
- More than 90% of IAMCP partners see their business impacted and more the one third see their business impacted by more than 25%.
- The biggest impact is in a reduction of pipeline followed by cancellation of signed projects that have not started yet, and issues with customers allowing remote work for consultants.
The impact of Covid-19 on Microsoft´s Q3 numbers
Microsoft summarized the impact as follows:
“In our consumer business, the landscape evolved quickly following our mid-quarter guidance update. The supply chain in China returned to more normal operations at a faster pace than we had anticipated. And, we saw increased demand from work, play, and learn from home scenarios, benefitting Windows OEM, Surface, Office consumer, and Gaming. This was partially offset by a significant reduction in advertising spend, which impacted our Search and LinkedIn businesses.”
“In our commercial business in March, we saw healthy Azure consumption and increased usage across Windows Virtual Desktop, Power Platform, and Microsoft 365, particularly in Teams and our advanced security solutions. However, we also saw some changes to our sales dynamics particularly in the industries and segments most impacted by COVID-19. We saw a slowdown in our transactional business across segments, but particularly in small and medium businesses. In enterprise services, growth rates slowed as consulting projects were delayed. And on annual contracts in LinkedIn's Talent Solutions business, renewals were impacted by the weak job market.” - Amy Hood, Executive Vice President and Chief Financial Officer, Microsoft Corporation.
Microsoft included an additional slide in the earnings call addressing COVID-19 impact:
- Net revenue: Minimal impact to total company
- Productivity and Business Processes, Intelligent Cloud: Increased cloud usage driven by remote work and learn scenarios in Microsoft 365 including Teams, Azure, Windows, Virtual Desktop, advanced security solutions and power platform. Slowdown in transactional licensing, particularly in small and medium businesses. Reduced customer advertising spend impacting LinkedIn revenue.
- More Personal Computing: Increased demand to support remote work and learn scenarios benefitting Windows OEM and Surface. Supply chain constraints in Windows OEM and Surface that improved late in the quarter. Increased engagement in Gaming following stay-at-home guidelines. Reduced customer advertising spend impacting Search revenue.
- Capital expenditures: Delayed cloud infrastructure spend due to supply chain constraints.
- Operating expenses: Reduced discretionary spend in areas such as travel and marketing.
Current quarter impact
However, this was this past quarter. What I think is most interesting is to see what Microsoft sees for the quarter ahead and the immediate future.
Microsoft sees a higher variability in the range of guidance. However, for Productivity and business processes and Intelligent cloud, 80 percent of this revenue comes from the earnout on existing contracts and agreement renewals. The remaining 20 percent of revenue, primarily from annuity agreements and transactional licensing, is subject to more volatility in the current environment. This is in stark contrast to More Personal Computing where roughly 75 percent of revenue, across OEM, Surface, Search, and Gaming, is earned in-quarter and therefore will be more susceptible to the overall business climate.
Positive impact Microsoft sees
- In Office commercial, revenue growth will continue to be driven by Office 365, with strong upsell opportunity, particularly to advanced security solutions.
- In Azure, revenue growth will again be driven by our consumption-based business, with continued strong growth across the customer base for Azure, but with some moderation in the most impacted industries and segments.
Negative impact Microsoft sees
- Overall transactional weakness (all on-premises transactional licensing).
- LinkedIn and Search ad revenue.
- In Dynamics a slowdown in new projects with longer lead times.
- In Enterprise Services, expect a low, single-digit revenue decline driven by continued delays in our consulting business.
Some additional insights from the analysts’ Q&A
Question on the monetization of some of the first responder help Microsoft is providing
Satya Nadella: “Overall the approach we take is really to be there for our customers at their time of most acute need. We don't go in there with the mindset of what does it mean for our revenue. When our customers do well, we'll do well on a long-term basis, that's at the core of our business model.
Amy Hood on expanding the customer base versus adding seats or consumption within that customer base: “We actually saw both this quarter again, the way you would have seen a little bit of weakness, I guess, in on-premises Office Commercial due to transactional weakness and maybe SMB. The one difference I will say is just because there was so much deployment done in the past 4 weeks, especially around Teams and some of the other workloads, there's certainly a distinction that a lot of that was expanding the footprint as opposed to deployment much faster than I think many enterprises had initially planned to do so.”
Amy Hood on Dynamics: “As long as business applications like Dynamics 365 address the immediate pressing needs, these projects will happen because that's the way for economic activity to return. But at the same time, with business applications that have longer lead time in terms of implementation, people are probably going to take some more time to decide on it. But we think we are well positioned to capture the new scenarios with Power Apps, because we think about Power Platform and Dynamics as both what we do with business applications, and we feel that between these two, along with Azure, are well positioned to address what are going to be increasing digitization needs, where people don't have months to deploy or months to implement.”
Amy Hood: “And I think that you would say that we've seen that in our pipeline and really in the customer demand scenarios. So, I think what we've seen is really more of a shift to some of these quick time-to-value deployments and a real change in terms of new, long lead time projects there, and I think that's probably not surprising.”
Insights and strategies for partners
There is a general impact on certain industries like travel, tourism, retail etc., which is affecting Microsoft customers and, of course, partners that work with customers in these industries. At IAMCP we have also seen the most impact on partners that have a customer base across these most affected industries. Partners will have to devise diversification strategies.
As a segment SMB is more affected than Enterprise, and Microsoft is admitting this impact as well. At IAMCP we have seen strong continued business in the enterprise and a mix of impact in SMB. Most partners have been busy getting their SMB customers up and running in a remote working environment which has caused a spike in business, but we need to wait and see if that continues. Partners that focus on SMB will have to have a diversified portfolio of customers in order to balance the positive and negative impacts. Partners working in the enterprise space can see an increase in work as some customers have decided to accelerate their digital transformations (except for the most affected industries).
Most transactional business is affected as customers will reduce spending where they can. However certain categories have seen growth in demand only restricted by supply chain issues (PCs, Office365 consumer). At IAMCP we do have anecdotal feedback that some SMB customers are reducing consumption of CSP licenses. On the other hand, there is feedback of growth in O365 CSP revenue from distributors because of the spike in home working.
Microsoft sees a delay in new Dynamics projects and a longer lead time for closing deals. At IAMCP we have seen some Dynamics partners more impacted than partners that work on other parts of the Microsoft stack.
Enterprise services consulting business
Microsoft enterprise consulting business is a reflection of most project-based partner business, so if Microsoft foresees a decline in MCS, that is not a good overall sign. Then again MCS is working, in general, on mission-critical, leading-edge projects and less on pure cloud infrastructure projects.
Where are the opportunities?
Before going into detail on the opportunities, I would like to reflect on something I see as a milestone. Microsoft has been on a transformation to become a cloud company but more personal computing (to simplify = Windows) has been the biggest revenue generator all these years. Productivity and business process (Simplified = Office) was structurally the segment that generated most profit. In the figure below you can see that Intelligent Cloud is becoming the biggest revenue and profit generator (Simplified = Azure). This is an excellent trend for partners as this means more complex services will be needed long-term.
In the short-term, Microsoft sees healthy Azure consumption and increased usage across Windows Virtual Desktop, Power Platform, and Microsoft 365, particularly in Teams and advanced security solutions.
If you are a partner specializing in these workloads, you can see a short- to medium-term boost. Long-term, the secular trends of cloud, data and AI will be the most important drivers for business.
Michiel van Vliet has been working for and with Microsoft and the Microsoft ecosystem since 1995 in several positions and within Microsoft Spain as Services Lead, responsible for the EMEA enterprise partner Team, working with some of the largest Microsoft alliances. In 2018 Michiel published a book on how to work with Microsoft called ´Refresh the Road Ahead´, and currently runs his own consulting business focussed on business and work transformation. Michiel is the president of IAMCP Spain, President of the IAMCP in EMEA and is a global IAMCP Board Member.