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The Dark Cloud in Microsoft’s Otherwise Bright Earnings Report

It seems that Microsoft’s bet on OpenAI is paying off.
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In a recent statement, Microsoft released the specifics of their second quarter earnings. The release showed that Azure was one of the biggest revenue drivers for the company in the last quarter, with revenue growing by $27.1 billion on the back of the AI services provided on the platform. 

Other big earners for the company included Office 365, LinkedIn, Bing, and Microsoft server products. However, other offerings, such as Microsoft Surface, Windows, and Xbox, were deemed lossmakers for the company. But, what does this varied profit-loss pattern across offerings entail for the future of Microsoft? 

Lossmakers

While many offerings by Microsoft were evidently profitable, a number of them witnessed a downturn in the last quarter. These included the first-party devices segment, known as ‘Surface’, which recorded a drop of 39%. In hindsight, this could have been the reason for the tech giant to shutter its HoloLens team in the latest round of layoffs. 

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Microsoft has continued to lose money while it acquires more users for Xbox Game Pass, as denoted by their 12% revenue drop in this segment. Even Windows, once among Microsoft’s primary money makers, has recorded a drop of 39% in OEM revenue. The company also had minor loss in revenue for Office Consumer products and cloud services, but added more subscribers for the Microsoft 365 consumer suite. 

The company has conducted widespread layoffs over the last quarter as a long-term, cost-saving measure. This move follows industry trends set by many of its fellow tech giants, with Microsoft cutting over 12,000 employees from its workforce. The severance packages provided to laid off employees accounted for a cost of $800 million to the company. In addition to this, the company also returned $9.7 billion to shareholders in the form of dividends in the FY23 Q2—an 11% decrease compared to FY22 Q2. 


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Another notable inclusion in the release was a few disclaimers pertaining to forward-looking statements. While most of these are boilerplate inclusions, some notable disclaimers included issues regarding use of AI in their offerings that may result in competitive harm, claims that Microsoft has infringed IP of others, along with other claims that may result in adverse legal outcomes. These seem to be targeted towards the ongoing lawsuit against Microsoft regarding the use of GitHub code to train the Codex autocoder. 

In addition to these disclaimers, there was another one against regulatory activity pertaining to competition rules—a direct reference to FTC’s moves against the Microsoft–Activision merger. 

Moneymakers

Conversely, the profits earned from Microsoft Cloud, continuing from the previous quarter, made the headliner in the earnings report. Cloud services have long been Microsoft’s primary source of revenue, with its OpenAI partnership adding more value to its existing services. 

As part of their multi-year partnership with OpenAI, Microsoft has gained access to the powerful models built by the think tank. In the light of this partnership, Microsoft’s Intelligent Cloud services, which consists of its server products and public and private cloud services, grew by 18% over the last quarter. Adding OpenAI’s models, like GPT 3.5, Codex, and DALL-E 2, has resulted in many customers adopting the platform as an easy way to bring generative AI to their workflow. ChatGPT is also set to be added to the platform soon, further expanding Microsoft’s portfolio of generative AI models.

Microsoft Office 365 was also a big hit for the company, drawing in 7% profit over the last quarter. This was primarily driven by revenue growth in the Office 365 commercial segment. Reportedly, this is also another avenue that Microsoft is looking to deploy OpenAI’s models in. MS Powerpoint is a prime example of this consideration, as the company has expressed their desire to add features like real-time subtitles and image generation for better usability. 

Surprisingly, Microsoft also reported an increase in revenue of 10% for search and news advertising revenue. However, this revenue growth notably excluded the costs for traffic acquisition, as Microsoft sunk a considerable amount of money towards the Microsoft Rewards programme. This programme aims to reward users for engaging with Bing across the suite of Microsoft products, and seems to be part of a bigger push to make Bing more relevant to users.

There were also talks of integrating ChatGPT and similar algorithms into Bing—a process which has already begun with the deployment of neural networks like MT-DNN, Unicoder, and more. Bing also has a feature titled ‘Bing Image Creator’, which uses DALL-2 to generate images based on prompts. LinkedIn was also a good moneymaker for Microsoft over the course of the quarter, representing a 10% increase, majoritarily owing to LinkedIn gold subscriptions. 

It is fairly evident that AI is beginning to seep into Microsoft’s product suite beyond just Azure. While competitors like Meta and Google adopted AI as a cornerstone of their products, Microsoft lagged behind in adapting to the AI wave but is catching up quickly. 

Silver lining

Considering these moves, it seems that Microsoft is consolidating towards an AI strategy and reducing resource drain on expensive segments like devices. Microsoft CEO Satya Nadella stated, 

“The next major wave of computing is being born, as the Microsoft Cloud turns the world’s most advanced AI models into a new computing platform. We are committed to helping our customers use our platforms and tools to do more with less today and innovate for the future in the new era of AI.”

Even as they continue to innovate for AI solutions with OpenAI and their in-house research team, Microsoft’s earnings report shows that the cloud remains one of the biggest money-makers for the tech giant. In this context, bringing together AI and cloud seems to be the way forward to ensure Microsoft’s continued success. 

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Anirudh VK
I am an AI enthusiast and love keeping up with the latest events in the space. I love video games and pizza.

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