Can Office 365 Boost Microsoft’s Topline In The Future?

Microsoft Corporation (NASDAQ:MSFT) is the leader in the productivity software segment with its flagship Microsoft Office productivity suite. With the launch of Office 365 in 2011, Microsoft ensured that is would remain relevant in the cloud productivity market. The Office productivity suite is Microsoft’s biggest revenue driver and makes up 37.9% of its estimated value. This segment generated approximately $25 billion in revenue in 2015, and we expect this to grow to $30 billion by 2023. At 48%, this division has the highest operating margins for Microsoft, primarily due to a dominant 84% market share in the productivity suite market.

However, the competition in the productivity software is heating up with Alphabet (NASDAQ: GOOG, GOOGL) making a concerted effort to improve its foothold in the cloud productivity software industry. Alphabet has recently formed an alliance with Box to integrate their productivity offerings for cloud productivity suite. ^[1]

Despite the competition, Microsoft Office 365 continues to be the favored productivity application for the enterprise clients. According to Gartner research, 8.5% of public companies use Office 365 while 4.7% use Google’s cloud-based productivity offering. The remaining 86.8% use an on-premise application.  We will also look into how Office 365 will impact Microsoft’s top-line going forward.

See our complete analysis of Microsoft here

Office 365 Vs Google Apps

According to reports last year, Office 365 was a leader in the cloud productivity suite with 25.5% market share in the industry. ^[2] Microsoft Office 365 has the advantage over the competition as most of the enterprise users use the on-premise Office software. Therefore, it has been easier for Microsoft to switch these users over to Office 365.

Office 365 has a broader appeal as it offers bespoke solutions at varied price points compared to the competition, especially Google. The Office 365 website offers seven different packages, with varying pricing structures. While the basic subscription starts at $5 per user/month for an annual commitment to the Business Essentials package, the full enterprise E4 subscription costs up to $22 per user/month. Google, on the other hand, has two plans available. The base package will cost $5 per user/month, or $50 per user/year. The premium package will cost $10 per user/month or $120 per user/year, and adds unlimited storage with more than five users.

Nevertheless, the price structure of cloud productivity suite has been one of the factors for small and medium businesses (SMB) as these businesses tend to be price sensitive. For small businesses, Google’s pricing could be seen as a more attractive prospect as Google undercuts Microsoft by $1 per user/month.

Due to the difference in price structure, Google has seen multifold growth in its subscription among SMBs. According to Google’s website, nearly five million businesses deploy Google apps. However, Microsoft continues to maintain its stronghold in the enterprise with one in four of Microsoft’s enterprise clients using Office 365 and over 50 million business Office 365 users. ^[3] In FY 2016, Office 365 Commercial seats grew 74%, and Office 365 was deployed in four out of five Fortune 500 enterprises, with more than half of that installed base using premium. ^[4] Additionally, Office 365 has 23.1 Million retail consumers, and Office has been downloaded 340 million times on iPhone, iPads and Android devices.

Office 365 Will Boost Revenues In The Future

In Q4 FY2016 (fiscal years end with June), Microsoft’s Office division reported 5% year-over-year growth in revenues to $6.97 billion. One of the primary reasons for growth was the sales momentum in Office 365, which reported a revenue growth of over 54% for the commercial segment. Considering the adoption of Office among enterprise clients, we expect this trend will continue going forward and the revenue run rate from Office 365 will increase further.

With the current perpetual license fee structure, Microsoft realizes revenue from a one-time sale of license. However, most of Microsoft’s clients continue to favor a hybrid model for its productivity needs, wherein these clients want to deploy both a cloud and on-premise productivity suite. However, in the last few quarters, Microsoft’s clients are favoring the subscription-based Cloud SaaS service. With the subscription fee structure, Microsoft will have recurring revenue over the period of the software’s use. Although this tends to negatively impact revenues over the short term, Microsoft will be able to monetize Office 365 over this extended period of usage, as users tend to use a software over a longer period of time. We currently project revenue to increase from $25.0 billion in 2015 to $30.5 billion by the end of our forecast period. If revenue were to increase to $35.0 billion by the end of forecast period, our price estimate will increase by 5%.

Opportunity To Cross Sell Other Products Through Bundling

With Office 365, Microsoft has a unique option of providing collaboration software that encompasses most of its products. Office 365 currently bundles SkyDrive storage and Skype services. Some other variants of Office 365 bundle LYNC and Exchange at higher price points. We believe that Office 365 can further leverage Microsoft’s ecosystem of products to sell other products (such as mobile devices) by bundling more value added services with it. We think that Microsoft will maintain its market share in the office software division due to evolving technology, changing business needs and seamless integration of its products across platforms.

We currently have $56.10 price estimate for Microsoft, which is in line with the current market price.

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1. Lookout, Dropbox: Box And Google Just Formed An Alliance To Integrate Their Products, September 7 2016 [↩]
2. Microsoft Office 365 is beating Google Apps in enterprise adoption – Gartner research, 1^st February 2016 [↩]
3. Google Apps vs Office 365: Comparing the Usage, Adoption, and Effectiveness of Cloud IT’s Power Players, July 8 2015 [↩]
4. Microsoft Annual Report [↩]