Microsoft is one of the largest enterprise software companies in the world, which competes with other biggies like Oracle, SAP and Salesforce.com. Most enterprise software giants have started offering cloud-based, on-demand versions of their software, aiming to capture market share in the rapidly growing cloud computing market. Microsoft itself has launched Office 365, a cloud version of the Office suite, as well as hosted services like Exchange Online, Sharepoint Online and Lync Online. However, Microsoft’s push into cloud-based applications and services may hurt its profit margins going forward.
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Profit Margins Lower in Cloud Based Applications
Microsoft has traditionally enjoyed very high operating profit margins on its enterprise software products like the Office suite as the incremental costs of producing one more copy of the software are very low. However, hosting software on servers in its data centers and offering it over the cloud is more expensive than simply selling packaged software as it incurs operating cost throughout the usage period. [1] By offering cloud-based software, Microsoft will be able to defend its market share in enterprise software and grow revenues, but at the expense of the relatively high operating margins it has enjoyed so far.
We estimate its operating margins for Microsoft Office to be around 63% in 2011, and forecast a steady decline in operating margins throughout the forecast period.
Since Microsoft Office generates a majority of Microsoft’s overall revenues and accounts for more than 30% of Microsoft’s Trefis price estimate, we expect the decline in operating margins to have a significant impact on Microsoft’s stock price.
We currently have a $32 Trefis price estimate for Microsoft, which stands nearly 25% above its current market price.
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Notes:
- Microsoft Shrinking Margins Loom, Bloomberg [↩]
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