As Microsoft’s Cloud Business Grows, so Does its Data Center Spend

As Microsoft continues to push growth of its cloud services business, company executives expect to continue increasing investment in Microsoft data centers to support those services.

Cloud services are a very small portion of the company’s overall revenue picture today, but Microsoft CEO Satya Nadella and CFO Amy Hood spent the bulk of Monday’s earnings call talking about this part of the business, illustrating just how important it is to Microsoft’s future.

The company’s revenue for the second quarter of fiscal 2015 was $26.5 billion – up 8 percent year over year. Its quarterly earnings per share were $0.71, or down 9 percent.

Cloud and consumer devices are two areas that are crucial to Microsoft’s strategy. The company plans to invest more in data centers and computer systems for research and development, among other things, in support of its cloud and devices businesses.

Microsoft’s commercial cloud revenue, which includes Office 365, Azure, and Dynamic CRM Online, grew 114 percent year over year to $696 million. This business segment is growing quickly. Last quarter was a sixth consecutive quarter of triple-digit growth, Nadella said. Its annual run rate is now $5.5 billion.

Microsoft Data Center Spend Up 24 Percent

As it grows, however, so does the cost of running it. The cost of revenue for commercial cloud and enterprise services went up $328 million, or 24 percent, year over year, in the second quarter, according to a company SEC filing. This increase was primarily due to higher data center and other infrastructure expenses.

Microsoft owns and operates its own data centers and leases from commercial data center providers. Most recently, it announced plans to establish Azure data centers in Australia and India.

The company has been expanding capacity in the U.S. as well. In 2014, for example, it leased 6 megawatts of data center capacity from DuPont Fabros Technology in Santa Clara, California, and 13.65 megawatts from Yahoo in Ashburn, Virginia (also in a DFT-owned facility), according to North American Data Centers, a commercial real estate company.

Existing Install Base as Advantage

While well behind Amazon Web Services in on-demand cloud infrastructure services market share, Microsoft believes it has a strong competitive position because of the amount of servers in enterprise data centers running Windows Server. Many enterprises want a combination of in-house data center resources and cloud, and Microsoft claims it is easier to extend customers’ existing on-premise Windows environments with Azure infrastructure hosted in its own data centers.

VMware is going for a similar angle with its vCloud Air services, promising customers easy and seamless integration of their in-house VMware environments with cloud services provided by VMware out of colocation data centers around the world.

The other two big players in public cloud, AWS and Google, don’t have the benefit of a huge existing install base in enterprise data centers.

As Nadella pointed out on Monday’s call, companies often engage with Azure Infrastructure-as-a-Service first and add more products from the menu as they go along. They may, for example, move a VM onto IaaS, and later decide to build a mobile app using data from that VM and the Azure Platform-as-a-Service.

Analytics, Machine Learning as Cloud Growth Drivers

Microsoft is also investing a lot in “advanced data analytics and machine learning driven capabilities that improve with more customer adoption and usage of the cloud,” Nadella said. It has been acquiring companies that specialize in these areas. Just this month, it announced acquisition of Revolution Analytics, a statistical computing and predictive analytics specialist, and Equivio, a provider of compliance solutions driven by machine learning technology.

Microsoft’s bottom line continues to be impacted by the restructuring plan it announced in July 2014 and integration of Nokia. These restructuring and integration expenses for the most recent complete quarter were $243 million, or a negative impact of $0.02 per share.