The Locked Office: Microsoft Economic Moat. Productivity

In the last 4 years, Office 365 subscribers grow from 23.1 million in 2016 to 42.7 million in 2019. In the same period, firm revenue grows from 26.4 B to 41.1 B. A great number especially if we notice that Google via G-suite offers similar services at no cost.

Office That You Have Knew

Businesses today demand the ability to work from anywhere, anytime, and any device. For a firm with employees spread over multiple locations and has an intensive mobile schedule, that demand is even greater. Microsoft tackles this situation by offering Office 365, a cloud-based productivity tools. This technology allows multiple users to access the document (instead of copy version) – change it, and update it in real-time.

Simply speaking, Office 365 is a cloud extended version of Microsoft Office. This software has dominated business solutions since the 90s with a massive installment base. Due to this familiarity, choosing Office 365 is no brainer when business needs cloud-based productivity tools.

Investingdeck believes this situation describes a firm strong economic moat. Even when someday a competitor comes with much richer features, it is difficult for businesses to leave Microsoft solution. Investors need to notice that business is about cost-cutting. Adopting new services means learning new things, and it takes cost both financial and time.

Compatibility Issue

Another reason why it is difficult for a business to switch from Microsoft is a compatibility issue. Taking Microsoft Excel as an example, this data processing software has become a common “language” in most businesses. Converting to another vendor means risking all existing xls or xlsx file into something new. There is no guarantee it works, a missing in little feature or function could be very damaging. Why not just using the cloud version of that excel?

These significant switching costs protect Microsoft’s market share (88.20% in 2018 and 87.50% in 2019) and retain their customer. What interesting for us is how the firm could cast premiums for its services even in the existence of free substitutes.

Downside Risk

The investor has to always manage their risk and investing in Microsoft stock is no exception. One of our considerations is its eroding profit margin. Gross Profit Margin of Microsoft Productivity segment trimmed from 50.22% in 2015 to 36% in 2018 before bouncing back to 39% in 2019. This indicates that the firm needs to make an extra effort in order to keep its market share. However, currently, we do not notice any structural change that could disrupt Microsoft business. Not yet. But investors need to pay attention to its margin and sense business threat if any.

Investor Takeaway

Microsoft have a great advantage by large installment of Windows – Office duo. It creates high switching costs to prevent customers to adopt another solution. A growing number of subscribers and revenue is confirmation of that solid moat. We assess that this business advantage will protect the Microsoft Productivity segment in the long run.

To Consider

  1. The productivity segment consists not only 365. It also contains Team, LinkedIn, etc. We encourage investors to read our article about LinkedIn or Team.
  2. The figures that we’ve taken here is for the sake of illustration. It may not strictly detail but surely it provides insight. For instance, it is difficult to track how much 365 contributions to overall segment revenue.

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