- Microsoft's cloud growth excluding AI dropped sharply in the recent quarter, according to UBS' calculations
- While go-to-market changes were partly to blame, there were other factors at play
- Among hyperscalers, Microsoft may be the most exposed to tariff-related pullbacks in enterprise spending
AI is helping drive monster revenue growth for cloud hyperscalers. But at least at Microsoft, there are a few worrisome trends lurking behind the AI veneer.
Azure growth came in at 31% in Microsoft’s recent fiscal Q2, a figure that while strong was down sequentially and on the low end of Microsoft’s guidance range. On its earnings call, Microsoft CFO Amy Hood said AI-related spending actually exceeded expectations and attributed the result to changes the company was making in its go-to-market strategy for non-AI cloud products (that is, things like cloud storage and enterprise workloads).
So, what did non-AI spending look like? Microsoft doesn’t provide breakout figures for its cloud products, but investment research firm UBS pegged Microsoft’s non-AI cloud growth at 18% for the quarter in a note to clients. That was down from an estimated 22% both year on year and sequentially.
For what it’s worth, analyst Jack Gold of J. Gold Associates, who recently argued Microsoft’s cloud hosting revenue is really only about half of reported Azure sales, told Fierce he wouldn’t be surprised if the UBS figures were accurate.
UBS ran the same exercise for Amazon Web Services and concluded that its growth rate excluding AI would have been around 15%. But as the firm noted, it’s not the rate but the sharp decline at Microsoft that has investors concerned. And they’re not buying the go-to market excuse.
Tariff trouble
To get a sense of what else might be going on, UBS polled its channel partners. While these partners indicated the GTM changes were, in fact, a legitimate issue, there were several other takeaways as well. The long and the short of it is that while Microsoft is still a dominant player in the market, there seems to be less cloud migration activity than there was previously, deprioritization of non-AI spending and much closer scrutiny of cloud costs. Yes, cloud optimization is back with a vengeance, baby!
Why? Well, correlation doesn’t equal causation but both UBS and Gold pointed to one other – perhaps less appreciated – factor at play: the wild rollercoaster that is the U.S. tariff landscape.
Gold noted that the tariffs have many economists and enterprises worried about the potential for a coming recession. Enterprises are already bracing by pulling back on hiring, minimizing spending and doing what they can to keep resources (especially money) in house. And among cloud players, this is a big problem for Microsoft in particular given its large installed enterprise base and low penetration among SMBs and startups.
“When things go south, big enterprises stop spending, and so they’re more exposed in that sense,” Gold explained. “That’s not to say that AWS isn’t, but AWS has a much broader base of customers.”
Gold noted Microsoft also has a large base of government customers, and indeed, one partner surveyed by UBS indicated many of its government partners were spinning up Azure instances. But while this segment has likely historically been a stable one for Microsoft, current efforts in the U.S. to slash government spending could pull the rug out from under Microsoft’s feet.
Making lemonade
So what’s a hyperscaler to do when life doles out lemons? Gold said one path is to not only make pricing more friendly for small and medium businesses (which Microsoft is already doing with its shift from fixed to flexible contracts) but also make Azure more user friendly to lower barriers to entry.
“They seem to have a higher exposure to macroeconomic issues than the other guys just because they’re so heavily concentrated in enterprise,” Gold said. “They need to figure out a way to get more of an SMB play, because those guys are still growing their businesses, they’re still investing.”
“It takes a lot of resources to get on Azure. You’ve got to have a lot of expertise. They don’t necessarily make it easy for small players to be on Azure. AWS and Google are better at that,” he concluded.