microsoft-business-model

How Does Microsoft Make Money? Microsoft Business Model In A Nutshell

Microsoft has a diversified business model spanning across Office products, Windows, Gaming (Xbox), Search Advertising (Bing), Hardware, LinkedIn, Cloud and more. 

Microsoft is among the largest tech giants, which in 2018 made over $110 billion in revenues. While Microsoft Office remains the most successful product. Other parts of the business related to advertising, with the Bing search engine, has been growing fast in the last couple of years.

Also, the acquisition of LinkedIn has allowed Microsoft to enter the social media market. As a dominant tech company, Microsoft tries to keep innovating and acquiring companies that allow it to enter new markets, quickly.

Micro-soft, the name

When Bill Gates and Paul Allen needed to pick a name, Paul Allen reported in his memoir “We considered Allen & Gates, but it sounded too much like a law firm. My next idea: Micro-Soft, for microprocessors and software. While the typography would be in flux over the next year or so (including a brief transition as Micro Soft), we both knew instantly that the name was right. Micro-Soft was simple and straightforward. It conveyed just what we were about.

So how did Bill Gates end up with the majority of the company? Still, according to Paul Allen memoir “From the inception of Microsoft, Bill insisted he got a 60-40, then 64-36 share of the money.”

While Paul Allen accepted – for some reasons – the 60-40 deal, so that more shares would go to Bill Gates – mostly on the basis that Bill Gates had contributed more on the code – Bill Gates tried again to get hold of more shares of Microsoft. That attempt though wasn’t successful.

In a few years, Microsoft would become the dominant tech company in the world.

It is important to remark this is the side of the story told by Paul Allen, seldom mentioned Microsoft co-founder. The accounts from Paul Allen reflect his perspectives on Microsoft in its first years.

Who owns Microsoft?

microsoft-ownership-structure

While the three principal individual investors are Bill Gates, Mason Morfit, Satya Nadella, and a few others among the board members (this list does not comprise those individual investors with a stake lower than 5% of the company if they are not board members).

principal-shareholders-microsoft

The most prominent institutional investors are The Vanguard Group and Blackrock.

What is the Microsoft pay mix?

Microsoft has a pay based on three main aspects:

  • base salary
  • cash incentives
  • and equity

microsoft-pay-mix-comparison

To create a proper compensation, Microsoft looks at a group of peers that comprise:

Peer group: • Alphabet • Amazon • Apple • Cisco Systems • Facebook • Hewlett-Packard • IBM • Intel • Oracle • Qualcomm • AT&T • Chevron • Coca-Cola • Comcast • ExxonMobil • General Electric • Johnson & Johnson • Merck • PepsiCo • Pfizer • Procter & Gamble • Verizon • Wal-Mart • Walt Disney

Based on that Microsoft compensation comprise 73.2% of base salary, followed by 19.2% of cash incentives, and 7.6% of equity.

What are Microsoft Segments?

Microsoft segments can be broken down into four main types:

Productivity and business processes

Productivity and Business Processes segment consists of products and services in the portfolio of productivity, communication, and information services, spanning a variety of devices and platforms. This segment primarily comprises:

  • Office Commercial, including Office 365 subscriptions and Office licensed on-premises, comprising Office, Exchange, SharePoint, Skype for Business, and Microsoft Teams, and related Client Access Licenses (“CALs”).
  • Office Consumer, including Office 365 subscriptions and Office licensed on-premises, and Office Consumer Services, including Skype, Outlook.com, and OneDrive.
  • LinkedIn, including Talent Solutions, Marketing Solutions, and Premium Subscriptions.
  • Dynamics business solutions, including Dynamics ERP on-premises, Dynamics CRM on-premises, and Dynamics 365, a set of cloud-based applications across ERP and CRM.

Intelligent cloud

Productivity and Business Processes segment consists of products and services in the portfolio of productivity, communication, and information services, spanning a variety of devices and platforms. This segment primarily comprises:

  • Server products and cloud services, including Microsoft SQL Server, Windows Server, Visual Studio, System Center, and related CALs, and Azure.
  • Enterprise Services, including Premier Support Services and Microsoft Consulting Services.

More personal computing

More Personal Computing segment consists of products and services geared towards harmonizing the interests of end-users, developers, and IT professionals across all devices. This segment primarily comprises:

  • Windows, including Windows OEM licensing (“Windows OEM”) and other non-volume licensing of the Windows operating system; Windows Commercial, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offerings; patent licensing; Windows IoT; and MSN display advertising.
  • Devices, including Microsoft Surface, PC accessories, and other intelligent devices.
  • Gaming, including Xbox hardware and Xbox software and services, comprising Xbox Live transactions, subscriptions, and advertising (“Xbox Live”), video games, and third-party video game royalties.
  • Search advertising.

Corporate and other

Microsoft develops most of its products and services internally through the following engineering groups.

  • Office Product Group focuses on Microsoft business across productivity, communications, education, and other information applications and services.
  • Artificial Intelligence and Research, focuses on Microsoft AI development and other forward-looking research and development efforts spanning infrastructure, services, applications, and search.
  • Cloud and Enterprise, focuses on Microsoft cloud infrastructure, server, database, CRM, ERP, management and development tools, and other business process applications and services for enterprises.
  • Windows and Devices Group focuses on Microsoft Windows platform, applications, games, store, and devices that power the Windows ecosystem.
  • LinkedIn, focuses on services that transform the way customers hire, market, sell, and learn.

Microsoft revenues breakdown for 2018 microsoft-revenues-breakdown-2018

From its financial statements you can see how Microsoft has netted over $110 billion in revenues in 2018, compared to over $96 billion in 2017.

microsoft-revenues-2018

Among the primary business operations lines, Productivity and Busines Processes netted over $35 billion in 2018; Intelligence Cloud netted over $32 billion in 2018; More Personal computer netted over $42 billion in 2017.

Productivity and Business processes, together with the Intelligent Cloud were the fastest growing businesses.

How does Microsoft really make money?

microsoft-revenues-2018

If we look at the operating income and operating margin of each segment, it’s interesting to notice how while the More Personal Computing line of business is the segment that contributes most to Microsoft revenues.

It also has the smallest operating margins at around 25%. While Productivity and Cloud have respectively operating margins around 35% and 36%.

microsoft-financials-2018

If we look at each Microsoft product, we can see how the Office products are the ones that most contribute to Amazon revenues, together with cloud services. Windows licensing is also, at this stage, still an important contributor to Microsoft overall revenue.

The company’s pretty diversified and it also makes money in Gaming (with products like Xbox), search advertising (with Bing), Devices and LinkedIn.

How Does LinkedIn make money?

linkedin-multi-sided-platform

LinkedIn revenues jumped from $2.3 billion in 2017 to over $5 billion in 2018, primarily driven by the revenues from Talent Solutions services. LinkedIn comprises services that span from Talent Solutions, Marketing Solutions, and Premium Subscriptions.

Microsoft has been heavily investing in LinkedIn, by updating several times its algorithms and make the platform as compelling as possible to professionals. And it also invested in sales and marketing activities to expand the operations of LinkedIn, which also explains the big jump in revenues.

What is Azure? How the Microsoft cloud service is growing at a fast speed

microsoft-azure

Server products and cloud services revenue rose to $26 billion in 2018, driven by Azure revenue growth. Azure revenue growth of 91%, due to higher infrastructure-as-a-service and platform-as-a-service consumption-based and per user-based services. 

Thus, the increase in revenues for the intelligent cloud is primarily due to Azure growth.

Cloud is powering up the businesses of several tech giants, from Amazon AWS to Google Cloud, this business unit has become a critical component for those companies profitability.

How much money does Bing make?

If we look at the advertising revenues generated by Microsoft – which can be primarily attributed to Bing – those amount to over $7 billion in 2018. That makes Bing another important piece of the pie for Microsoft overall revenues.

However, if we compare Bing advertising revenues with Google’s over $116 billion for 2018; you can understand that Bing is still a minor player. However, Google’s advertising revenues also comprise YouTube, for which we don’t know the revenue breakdown yet, but we can assume to be at least a $15 billion business a year.

Other players like Amazon and Facebook are also dominating the digital advertising industry, which makes the landscape very competitive for Bing.

amazon-advertising-business
In 2018 Amazon made around $10 billion in advertising revenues, compared to Facebook $55 billion and Google $116 billion.
google-advertising-business
Google generated over $116 billion from advertising revenues in 2018, which represented 85% of its total revenues. Of those revenues over 70% came from traffic via Google main properties (Google search engine, YouTube, Gmail, and others). Google’s main properties are monetized primary via a cost-per-click mechanism. Network members sites are primarily monetized on a cost-per-impression basis. Google also spent over $26 billion in 2018 to sustain its traffic on both its properties and as a revenue-share mechanism with its network members (AdSense and AdMob).

GitHub acquisition: how will Microsoft monetize that?

github-pricing-plans

In June 2018, Microsoft bought GitHub for $7.5 billion in an all-stock transaction. GitHub is among the most known open source libraries which enable companies of any size to store their codes. While its free-to-use public open-source library is the most known, the company also offers enterprise solutions.

While presumably the company never managed to turn profits, it seems that Microsft high valuation on the company can be seen as a way to enhance Microsoft product line, by enabling the existing Microsoft customer base to purchase GitHub plans.

The bet is that Microsoft current salesforce can be able to integrate GitHub’s offering within its sales portfolio, thus make GitHub profitable within Microsoft overall operations.

What are the Microsoft distribution channels?

Those can be broken down in:

  • OEMs, OEMs that pre-install Microsoft software on new devices and servers they sell. The largest component of the OEM business is the Windows operating system pre-installed on devices.
  • Direct. Microsoft offers direct sales programs targeted to reach small, medium, and corporate customers, in addition to those offered through the reseller channel. A large network of partner advisors supports many of these sales.
  • Distributors and resellers, license Microsoft products and services indirectly, primarily through licensing solution partners (“LSP”), distributors, value-added resellers (“VAR”), OEMs, and retailers. 

Does Microsoft spend more on Research and Development or Sales and Marketing?

If we look at the accounting books, Microsoft spent 17% of its revenues in Sales and Marketing in 2017, compared to R&D for 14% of its revenues in 2017. Thus Microsoft spent more on Sales and Marketing than R&D:

microsoft-r&d-expenses

microsoft-sales-&-marketing-expenses

What are Microsoft top products and services?

microsoft-revenue-breakdown-by-product-or-service

From the revenue standpoint, Microsoft Office remains the most successful product. The game console Xbox also plays a key role in  Microsoft financial success. While Advertising, mainly through the Bing search engine has been growing fast in the last couple of years. Also, the acquisition of LinkedIn has allowed Microsoft to enter the social media market.

Is Microsoft still innovating?

During fiscal years 2017, 2016, and 2015, research and development expense was $13.0 billion, $12.0 billion, and $12.0 billion, respectively. These amounts represented 14%, 14%, and 13% of revenue in fiscal years 2017, 2016, and 2015, respectively. Microsoft plans to continue to make significant investments in a broad range of research and development efforts.

In fact, as specified in its annual report for 2017, “The core currency of any business going forward will be the ability to reason over its data using AI to drive competitive advantage. Microsoft Research continues to make significant advances in AI technologies, infusing them into product experiences like Bing, Cortana, LinkedIn Newsfeed, Skype Translator, Editor and PowerPoint Designer in Office, Relationship Health in Dynamics, HoloLens, and many more. We are uniquely positioned to take this AI capability and democratize it so that every developer can be an AI developer, and every company can become an AI company.”

Key takeaways from the Microsoft business model

  • The company has a pretty diversified business model. And when we talk about a company like Microsoft it’s easy to fall into simplifications and give it a simple label. The company has many moving parts.
  • While Office products and Windows remain the core products of the company. Microsoft business units span across productivity tools, to cloud services (Azure), gaming (Xbox), search advertising (Bing), social media (LinkedIn), and devices (Microsoft phones and Surface).
  • Microsoft also bought LinkedIn in 2016 for over $26 billion and GitHub in 2018, for an all-stock transaction of $7 Billion dollars.
  • Microsoft has been pushing hard on the cloud, indeed that is the fastest growing business unit, with substantially high operating margins, given its scalability. Azure has contributed to a good chunk of this growth.
  • In search advertising, while Microsoft didn’t manage to create a second player of search (Google still controls most of the market shares) the company still generates around $7 billion in advertising. To put that in a context in 2018, Google passed the $116 billion mark in advertising revenues. Facebook passed the $55 mark in 2018. And also Amazon has been pushing to gain a wider pice of the digital advertising pie with almost $10 billion, in advertising.
  • The company has integrated LinkedIn pretty well within the organization. Bought for over $26 billion in 2016, the LinkedIn revenues jumped from over $2 billion in 2017 to over $5 billion in 2018. Microsoft sales and marketing expenses have increased by $2 billion or 13% from 2017 to 2018 as the company has been investing in sales and marketing activities and improved commercial capacity, which also contributed to such growth.
  • Microsoft also bought GitHub in 2018, with the bet that it could make it profitable within its business, as it could leverage on the existing Microsoft customer base to sell enterprise GitHub solutions. The bet might be that Microsoft sales force is ready, without too much investment, in adding GitHub in its portfolio as potential up-sell of Microsoft products.
  • In short, Microsoft is a moving giant which has its hands in many places, it still has a massive customer base, to whom it’s trying to integrate more innovative tools and products, like LinkedIn and GitHub.

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Published by

Gennaro Cuofano

Gennaro is the creator of FourWeekMBA which he brought to reach about a million business students, professionals, and entrepreneurs in 2019 alone | Gennaro is also Head of Business Development for a high-tech startup, which he helped grow at double-digit rate and become profitable | Gennaro is an International MBA with emphasis on Corporate Finance | Subscribe to the FourWeekMBA Newsletter | Or Get in touch with Gennaro here

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