Microsoft’s Ozzie Says Cloud Services Will Yield Lower Margins

Ray Ozzie, Microsoft’s chief software architect, caused quite a splash June 4 when he told the audience at an event in Silicon Valley that cloud computing will probably lower Microsoft’s profit margins. Online computing services, which many observers say will be the tech industry’s new golden goose, aren’t as profitable as packaged software sales, Ozzie said. Microsoft’s profit margins will likely suffer as a result. “The margins on services are not what the margins on software are, so it will increase our profit. It will increase our revenue. But you won’t have that margin,” Ozzie said.

The comments by Microsoft’s top technical executive during an on-stage interview in Palo Alto, Calif by Wired magazine senior writer Steven Levy, generated a lot of buzz in the Valley. “Everyone’s talking about it,” says SAP executive vice-president John Wookey. Here’s Microsoft’s transcript of the event.

Microsoft’s traditional products like Windows, Office, and Exchange, which companies install on their PCs and servers, yield phenomenal profit margins. The company’s gross margin for the quarter ended March 31 was 79%. If profitability begin to ebb, investors could find less to like about Microsoft’s stock, which has gained 45% since March 6.

Ozzie, who took over the company’s top technical job after Bill Gates announced his planned retirement two years ago, has been slowly trying to transform Microsoft from the king of packaged software into a maker of computing services delivered to users over the Internet. Ozzie said when he arrived at Microsoft in 2005, many at the company thought first about the PC, not the Web. “I felt like it was back to the future in a lot of ways,” he said.

Since then, Microsoft has developed products designed for the cloud computing era, including its upcoming Windows Azure platform for building and running Web software, and the Live Mesh service, which lets users share files among their PCs within an online version of their desktop. Cloud applications like e-mail will likely yield more profitable sales than the platforms companies use to build Web software, like Windows Azure, according to Ozzie.

Microsoft’s chief competitors in the race to help companies create cloud computing software are, VMware, and Google, Ozzie said. He singled out Amazon for “amazing work” with its Elastic Compute Cloud service, which lets developers quickly run applications on Amazon’s servers for a fee. “They are the leader,” Ozzie said. Then he pointed out Microsoft’s advantages, including its world-class research division, operating systems expertise, and the estimated 5 million to 7 million developers who write software based on Microsoft technology.

Ozzie wrapped up his talk by saying that Microsoft isn’t as fazed by new competitors as some would think, a legacy of Gates. “Bill brought to the company a culture of crisis, that any day now, two guy in a garage will be there to take down the company,” Ozzie said. “That’s why, when new things come along, people don’t get freaked out by it.”

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