After years of frantic growth, cloud computing adoption has taken a breather over the past year or so. There's little doubt that last year's downturn -- accompanied by the worst stock market performances in over a decade -- was a contributing factor as businesses reined in spending and positioned themselves to ride out the macroeconomic storm.
Things appear to have turned the corner in 2023. Each of the major market indexes has rebounded more than 20% from their respective bottoms, with some investors believing we're at the start of the next bull market.
Given the excitement surrounding artificial intelligence (AI) in recent months, investors wondered about the accelerating adoption of AI and what impact it might have on cloud growth. Rivals Microsoft (MSFT 0.41%) and Alphabet (GOOGL -1.51%) (GOOG -1.74%) both issued their quarterly financial reports after the market close on Tuesday, and it was clear that AI hasn't jump-started cloud infrastructure revenue -- at least not yet.
Image source: Getty Images.
Where's the AI boost?
Microsoft helped kick off the current battle for AI supremacy with its $13 billion investment in OpenAI and ChatGPT, as well as integration of generative AI into its Bing search engine. What quickly followed was a wholesale integration of AI tools across its vast software empire -- particularly its Azure Cloud. Given that rapid pivot, investors hoped to see the first green shoots of expanding growth, but that wasn't the case.
For its fiscal 2023 fourth quarter (ended June 30), Microsoft said that Azure and other cloud services grew 26% year over year. Its growth rate has been steadily eroding since Microsoft announced Azure cloud growth of 51% in mid-2021, making this quarter its slowest pace of growth in two years. On the bright side, Microsoft Cloud surpassed $110 billion in annual revenue, with Azure making up 50% of the total for the first time.
CEO Satya Nadella noted, "We continue to see more cloud migrations, as it remains early when it comes to long-term cloud opportunity." Nadella went on to say that "more than 11,000 organizations" had adopted Azure OpenAI Service.
Given the complexity of moving to the cloud, there's a lag between when a business makes a decision and the revenue appears on Microsoft's (or any cloud provider's) financial statements. Furthermore, Microsoft only recently announced the availability and pricing of its newest AI products and services, so it may be another quarter or two before AI begins to move the needle on Microsoft's cloud results.
Holding the line
Alphabet was widely derided as being slow off the mark, responding to Microsoft's AI-infused Bing with a not-ready-for-prime-time Bard, but the company has since made up for its initial missteps. At its I/O developer conference in May, the Google parent announced plans to integrate AI across a broad range of products and services. As with Microsoft, investors had hoped to see a boost to Google's Cloud results, but none was forthcoming -- at least not yet.
For the second quarter, Alphabet said Google Cloud generated growth of 28% year over year -- unchanged sequentially -- and enough to retain its title as the fastest growing of the "big three" cloud providers. Like Microsoft, Google's cloud growth has been steadily decelerating since it peaked at 54% in mid-2021, making this quarter its slowest growth rate in two years. Just last quarter, the company announced that Google Cloud had turned a profit for the first time, a trend that continued in Q2.
On the conference call, Sundar Pichai said, "Our new generative AI offerings are expanding our total addressable market and winning new customers," which the company plans to upsell to its installed base of 9 million Google Workspace customers. He went on to point out that 70% of generative AI unicorns are Google Cloud customers and that the number of customers using its generative AI tools has grown more than 15 times between April and June.
As I pointed out, it will likely be another quarter or two before we begin to see the impact of AI on Google's cloud results.
A birds-eye view of cloud AI
While this slowing cloud growth might concern Microsoft and Alphabet investors, it's worth putting this into the context of the broader cloud infrastructure growth. Global cloud infrastructure services spending is expected to grow 23% in 2023, down from 29% growth last year and 35% in 2021.
Azure and Google Cloud are outpacing the overall industry forecast at 26% and 28%, respectively, which suggests they continue to steal market share from cloud infrastructure leader Amazon Web Services. We'll likely have more clarity when Amazon reports its second-quarter results on Aug. 3.
Finally, the industry outlook likely preceded the current AI gold rush, so overall cloud growth could easily exceed expectations this year. That will be something to watch carefully over the coming quarters.
