Microsoft (NASDAQ:MSFT) and Sony (NYSE:SNE) recently announced a strategic partnership across the cloud gaming, AI, and semiconductor markets. The cloud gaming announcement attracted the most attention, since the two rivals seemingly joined forces to counter Alphabet's Google Stadia.

However, the AI and semiconductor partnership was also significant. Microsoft and Sony will jointly develop new image sensors for enterprise customers that will integrate Microsoft's Azure AI technology into Sony's chips. This deal could give Sony's oft-overlooked semiconductor business a shot in the arm, while expanding Microsoft's cloud business.

A smartphone being used to take a picture of a sunset.

Image source: Getty Images.

How this deal helps Sony

Sony's semiconductors unit mainly sells image sensors for cameras and mobile devices. The business supplies image sensors for roughly half the smartphone market, and its major customers include Apple, Samsung, and Huawei.

This business enables Sony to profit from the growth of the smartphone market even as its own Xperia phones control less than 1% of the global market. Rising demand for image sensors for multi-camera phones is offsetting declining sales of sensors for traditional cameras. The unit's revenue rose 3% annually in 2018 and accounted for 10% of Sony's top line.

Sony expects its semiconductor revenue to rise 13% this year as smartphone makers buy more mobile image sensors and 3D sensors for multi-camera phones. That growth could help offset the slowdown in Sony's core gaming unit, which is expected to generate flat sales growth as its hardware sales decline.

Building AI-powered image sensors for enterprise customers with Microsoft could give Sony's chipmaking business a second growth engine alongside its mobile image sensors. It could also offset any further declines in its image sensors for traditional cameras.

The companies also stated that they would incorporate Microsoft's AI platform and tools into Sony's consumer products "to provide highly intuitive and user-friendly AI experiences." This indicates that Sony's partnership with Microsoft might extend to its other business segments in the future.

How this deal helps Microsoft

Microsoft's core growth engine is its commercial cloud business, which grew its revenue 41% annually to $9.6 billion last quarter and accounted for nearly a third of the company's top line.

That business has three pillars of growth: Office 365, Dynamics CRM, and Azure, the second-largest cloud platform in the world after Amazon (NASDAQ:AMZN) Web Services. Azure generated 75% year-over-year constant currency sales growth last quarter, which easily outpaced the growth of Office and Dynamics.

Microsoft is expanding Azure by leveraging Windows' dominance of the PC market to expand its enterprise presence, tethering IoT (Internet of Things) and edge devices to Azure, cross-selling new services to existing customers, and forging big partnerships with brick-and-mortar retailers that don't want to feed Amazon's most profitable business.

Image sensors play a key role in that expansion. For example, Microsoft recently developed next-gen stores with Kroger (NYSE:KR) that use a smart retail system powered by IoT sensors, image-recognition cameras, and digital shelves that display prices, promotions, and nutritional information on screens.

A cashierless shopping system.

Image source: Getty Images.

Microsoft is also reportedly developing its own cashierless store technology, which runs on image and motion sensors, to help retailers counter Amazon Go. Those sensors are all tethered to Azure, which accumulates and analyzes the data for Microsoft's retail partners.

Partnering with Sony ensures that those efforts receive a steady stream of image sensors that are already integrated with Azure -- which could widen its moat against Amazon, Google, and other cloud platform rivals.

A win-win deal for both companies

Sony and Microsoft's AI and semiconductor partnership will help both companies as demand for AI-powered image sensors rises. Sony gains another growth engine for its semiconductor business, while Microsoft extends Azure's reach into more IoT and smart retail solutions.