Microsoft: We make more money on cloud-based Exchange than legacy email

Per-user income greater in cloud, or so Microsoft claims

Microsoft claims it can make more money from each user in the cloud, but it's no lock.

Microsoft claims it earns more money per user from cloud-based Exchange email accounts than it does selling the legacy version of Exchange Server most businesses deploy today.

That's what Microsoft investor relations GM Bill Koefoed said at the Oppenheimer Annual Technology, Media & Telecommunications Conference Tuesday, according to a transcript on Microsoft's website. Customers who purchase Exchange as part of the Office 365 cloud service pay roughly $10 per month, less than they would in the back-end costs of running their own Exchange servers, but nearly all of of it goes directly to Microsoft, he said.

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That doesn't mean Microsoft actually makes more money in the cloud than it does with its traditional business of selling software licenses. For one thing, Microsoft's cloud customer base is mostly small businesses. To gain the kind of per-user profits Koefoed is talking about, Microsoft needs Office 365 to lure in big enterprises.

"Within an enterprise, let's say it costs $15 per user per month today to run Exchange, and that's about $2 for Microsoft, and that's $13 in rent, power, the data base administrator that's running the thing, the hardware and all the kind of services that are associated with kind of running Exchange in your premise," Koefoed said.

"With Office 365, or with Exchange Online, the Exchange part of that, we charge $10 per user per month," he continued. "So, that ends up being a savings to the CIO of roughly 33%, and we make 5X more revenue and our profit ends up being somewhere, $3 or $4 per user per month. So, we make more revenue and we make more profit and we save our customers money."

The profit ends up being $3 or $4 per user per month because it costs Microsoft $6 or $7 per user to run the data centers powering the cloud service. "We can do that at scale," Koefoed noted. "Interestingly, one of the things that we've learned in our search business is how to run data centers at scale."

Koefoed gave the example in response to investors' questions about how Microsoft's revenue in the cloud compares to its traditional business model of selling software licenses. The popularity of Google Apps with small businesses is among the factors that forced Microsoft to expand its Web-based offerings, but investors are likely concerned these offerings will cannibalize Microsoft's existing revenue streams.

Koefoed's example leaves out the fact that Office 365 is appealing mostly to smaller businesses with few users. The small business version of Office 365, which includes Exchange, SharePoint, Lync and Office Web Apps, costs only $6 per user per month. An actual Exchange Server license, meanwhile, costs $700 for a standard edition and $4,000 for an enterprise edition, plus extra charges for client access licenses.

Enterprises can lessen the financial hit because of their scale, making the economics of running their own servers worthwhile for the customer, which is why Koefoed can say enterprises pay Microsoft only $2 per user per month to run Exchange. For small customers, the per-user cost of running Exchange Server without a cloud subscription would be higher, and therefore more profitable for Microsoft. Whether Microsoft actually makes more per-user profit from cloud services than packaged software is therefore questionable.

Beyond that, Koefoed's example does not mention the profitability of SharePoint, Lync and Office Web Apps. Office Web Apps in particular could cannibalize Microsoft's revenue, because it can be used for free by consumers, and comes with most Office 365 packages. To prevent revenue loss, Microsoft has limited the functionality of Office Web Apps compared to the pricier client versions of Office, and offers a higher-priced version of Office 365 that comes with the desktop client version of Office Professional Plus.

Google Apps for Business, which offers email, calendar and documents, costs $50 per user per year or $5 per user per month.

Microsoft is quickly growing revenue and profit in most of its businesses with the exception of the Bing search engine and mobile devices, but has not succeeded in convincing investors to pump up its stock price. Longtime rival Apple passed Microsoft in market cap last year, and this week briefly became the world's most valued company ahead of Exxon. In the eyes of investors, Microsoft's mobile phone and tablet failures have overshadowed sales of 400 million Windows 7 licenses and 100 million Office 2010 licenses.

"We had super good results ending the year," Koefoed said, referring to the end of Microsoft's fiscal year in July. "In addition to the fact that we're making the investments to move into the cloud, our revenue for the year was up 12%. Operating income was up 13%. So, we saw another year of year over year margin expansion. And then, earnings per share was up 28% as we rounded out the year."

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