Microsoft says cloud demand waning, plans to infuse AI into products

Microsoft on Tuesday said it expects the growth across its cloud business to temper down through 2023 as enterprises brace for economic headwinds.

The Windows-maker reported 29% growth in total cloud revenue to $21.5 billion for the second quarter of fiscal year 2023, slowing from Q1, 2023 where the company posted 31% growth for the segment. These numbers exclude the impact of currency fluctuations. Microsoft said it expects its third quarter cloud gross margin to decrease by one percentage point, driven by Azure.

Microsoft Azure and other cloud services grew 38% in constant currency terms on a year-on-year basis, slowing down by 4% from the previous sequential quarter. 

“As I noted earlier, we exited Q2 with Azure growth in the mid-30s in constant currency. And from that, we expect Q3 growth to decelerate roughly four to five points in constant currency,” Amy Hood, chief financial officer at Microsoft, said during an earnings call.

The growth in cloud number is expected to slow down further through the year, warned Microsoft Chief Executive Satya Nadella.

“As I meet with customers and partners, a few things are increasingly clear. Just as we saw customers accelerate their digital spend during the pandemic, we are now seeing them optimize that spend,” Nadella said during the earnings call, adding that enterprises were exercising caution in spending on cloud.

Explaining further about enterprises optimizing their spend, Nadella said that enterprises wanted to get the maximum return on their investment and save expenses to put into new workloads.

“…at some point, the optimizations will end. In fact, the money that they save in any optimization of any workload is what they will invest into new workloads,” Nadella said, adding that Microsoft was getting ready to ensure that it gets a large pie of the spend on new workloads.

Nadella asserted that the optimization phase for enterprises was temporary and was expected to last about a year.

The company’s financial results weakened through December, and geographically the US performed weaker than expectations, Hood said, according to the earnings call transcript.

Microsoft has also scaled back its outlook for other segments of the business for the next quarter.

“Within the segments, we anticipate roughly four points of negative impact on revenue growth in Productivity and Business Processes, three points in Intelligent Cloud, and two points in More Personal Computing,” Hood said.

“In our Consumer business, Windows OEM and devices will see continued declines as the PC market returns to pre-pandemic levels. And LinkedIn and search will be impacted as ad market spending remains a bit cautious,” the CFO added.

Microsoft to bet heavily on AI

Nadella, during the earnings call, made it clear that Microsoft was betting on infusing AI into all of its products and services as the company believes that artificial intelligence will be in demand across enterprises.

“The age of AI is upon us, and Microsoft is powering it. We are witnessing non-linear improvements in capability of foundation models, which we are making available as platforms,” Nadella said, adding that the company was positioned to capture new AI-based workloads.

Microsoft has been investing billions more into OpenAI, the company behind ChatGPT, and plans to roll out new enterprise services based on the company’s generative AI products.

Other AI-based Microsoft products include GitHub Copilot and Azure ML services, which the company said has grown over 100% in revenue for the past five quarters.

Segment-wise results

Microsoft posted a total revenue of $52.7 billion for the reported quarter, an increase of 7% when compared to the corresponding quarter last year, without considering the effect of currency fluctuations. Net income for the company rose by just 1% year-on-year.

The company also took a charge of $1.2 billion during the quarter on expenses over severance, hardware-related impairment, and lease consolidation costs.  

Across different segments, the company saw increase in revenue with the productivity and business processes unit posting total sales of $17 billion, up 13% in constant currency.

Revenue for LinkedIn, which is a part of the productivity division, increased 14% in constant currency.

However, revenue for personal computing division of the business declined 16% in constant currency to $14.2 billion. Several parts of the personal computing division, such as Xbox, Windows OEM and Windows Commercial products, registered a decrease of 8%, 39% and 3% respectively.

Devices revenue, which also forms a part of the personal computing division, showed a decrease of 34% in constant currency.