On Microsoft’s earnings call last week, an analyst asked why the company saw a 7% increase in the gross margin of their commercial cloud offering.
Nadella’s answer (emphasis my own):
When we do CAPEX we're buying the equipment for everything that Microsoft does, which is everything from Azure to Office 365 to Dynamics 365 as well as our consumer services like Xbox Live. And you see the growth that we talked about across all of this.
...as we drive efficiency in our cloud infrastructure... that's an efficiency that we gain across the marginal cost and gross margin that spans everything that we do.
Then also what we think about as the mix, our goal is not to just sell a commodity services, but to actually use commodity services in some cases as a bootstrap for higher level services, because of things like data gravity.
…but I would ask our investor base to think more about the architecture as well as the financial outlays of what we are building. We're not just building Azure. We're building Azure, Office 365, Dynamics 365, as well as our consumer services which are all cloud oriented. And it's the combination of that that's driving margin.
I liked this response and the model of “data gravity” that Nadella put forward.
Nadella stresses that the architectural and financial benefits of the cloud are not just restricted to Azure. That as Microsoft onboards more customers for storage, compute, and other commodity services, they’ll expect them to subscribe to higher level services as well, thereby furthering the efficiency benefits that Microsoft saw in this quarter’s earnings.
This is data gravity, a customer’s predilection to use a single provider for a collection of services, and to select that provider based on the amount of data they already store with them.
This isn’t exactly news. When your service houses data valuable to a customer, it’s difficult for that customer to leave your service. Hence, why everyone continues to put up with the Salesforce UI -- if they left it, they’d lose a lot of historical sales data (or have to orchestrate a complex migration of said data to their new vendor of choice, a fate worse than trying to complete a Salesforce form with required fields.)
Though SaaS pundits and management have long written about the benefits of serving as a store of record, the term “data gravity” really strikes home the model.
Imagine Einstein’s fabric of spacetime, where instead of a planet and its mass, pulling rogue objects into orbit, you have a service provider and its data, pulling in additional services, thereby increasing the “mass” of that provider and the “pull” it has on other service offerings.
This is why Nadella asks investors to consider Microsoft’s commercial cloud as “not just Azure”, but as a larger offering of services that enterprises can adopt in full. It’s his belief that by offering all of these services to the enterprise, he can bring customers (and their data) into the entirety of Microsoft’s commercial cloud offering, thereby driving even more efficiency on their capex.
In practice, I’m not sure that storage and compute customers are going to rush to sign up for Office 365. But Active Directory customers probably will, and if there’s a segment ripe for the low-barrier decision of selecting the vendor you already use for identity management and commodity cloud services, it’s the enterprise.