Cloud Computing: Microsoft's Saving Grace

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Microsoft (NASDAQ: MSFT) has been facing quite a few headwinds lately. Research firm IDC reported the largest year-over-year decline in PC sales last month. Forecasters expect the decline to continue with the proliferation of mobile devices.

Microsoft showed up late to the mobile game, and still trails Apple and Google (NASDAQ: GOOG) by a huge margin. Meanwhile Windows 8 has largely failed to become the catalyst for the PC market many expected it to be as Windows sales remained flat last quarter.

However, Microsoft’s cloud-computing solution, Windows Azure, surpassed $1 billion in revenue in the last year and is growing fast. Could cloud computing be the saving grace for Microsoft?

Bursting onto the scene

Microsoft started offering its Platform as a Service in 2010, again late to the game. Amazon (NASDAQ: AMZN) had been offering its servers to developers since 2006. Google wasn’t too far behind, releasing its App Engine in 2008.

But unlike its slow growth in mobile, Microsoft has been able to grow Azure to a 20% market share – more than Google’s, but significantly trailing Amazon’s 71%. Azure subscriptions have grown 48% in the last six months.

Last month, Microsoft unveiled the addition of Infrastructure as a Service to the Azure suite, and vowed to match Amazon’s pricing. Since then, the company added 10,000 new subscribers.

Microsoft’s fantastic growth in cloud computing led Forrester Research analyst James Staten to estimate Microsoft could command 35% of the market by next year while doubling its current revenue. That would make Microsoft a realistic threat to Amazon’s dominance, and relegate Google to the sidelines.

Growing market

But it’s unlikely Microsoft will be able to take much business away from Amazon or Google. Switching costs are just as significant, if not more, in the enterprise world as in the consumer world. Even after giving away free software to cloud users, Microsoft couldn’t convince many companies to switch despite its new price and capability parity with Amazon.

It’s really battling for the next $25 billion in market share. Gartner expects the Infrastructure as a Service to be the fastest growing part of the cloud market over the next five years climbing from $6.17 billion last year to over $30 billion by 2017.

That’s why Microsoft announced its entry into the segment last month -- again, late to the game. Google announced its IaaS product nearly a year ago. Rackspace, and its consortium of OpenStack partners, have been carving out a nice sized chunk of the market for some time now. And of course, Amazon still dominates the market.

Capturing it

Even with similar pricing and capabilities, big enterprises and small startups alike are choosing Amazon over Microsoft because as Staten put it, “they haven’t really answered the question ‘Why Azure?’”

Microsoft is now giving startups a good reason – it’s free. The company is teaming up with venture firms and investment groups, and often giving away its services. That way, as startups grow, they’re already Azure customers and likely willing to pay for scale.

This is similar to how Facebook’s (NASDAQ: FB) recent acquisition, Parse, grew from 0 to 60,000 subscribers in just two years. Parse, a cloud-computing solution for mobile app developers, has a free tier, and as developers expand, the service scales out to paid tiers. As a result, Parse has captured a significant part of a growing market from the stalwart Appcelerator.

A similar strategy is certainly viable for Microsoft to continue growing Azure. After all, startups and frontline developers are what got Amazon where it is today, and what will continue to drive growth in the industry going forward.

Microsoft can afford to take losses on Azure, and there’s no real pressure yet for the segment to be profitable. That’s evident in the constant price wars between the company, Amazon, and Google.

Then again, Amazon and Google are capable of doing the same thing. Amazon has no qualms sacrificing margins for market share, but with its current dominance in the market it doesn’t need to. Google, however, could deploy a similar strategy. Coupled with its perception as startup-friendly, Google could become a big threat to Microsoft’s growth.

Saving grace?

I think Staten’s 35% market share estimate may be a bit too optimistic. Still, the potential for Microsoft to grow its Azure business is quite significant. With Windows sales falling, Microsoft will need a new product to take its place. While it’s still a long way from the $20 billion revenue machine that Windows was at its peak, Azure has the potential to get there.

Interestingly, that $20 billion mark is where Gartner expects Amazon’s Web Services to be by 2020. By that point, Azure could be a much closer second than it is today, providing a similar revenue figure.

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Adam Levy owns shares of Amazon.com. The Motley Fool recommends Amazon.com, Facebook, and Google. The Motley Fool owns shares of Amazon.com, Facebook, Google, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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