"Moving businesses to the cloud" is a common strategy among tech giants. While the basic concept is easy to grasp, it can be hard to estimate a company's cloud-based growth in financial terms.
Research firm Markets and Markets estimates that the entire cloud market will grow from $37 billion in 2010 to $121 billion by 2015. To tap into that growth, let's take a look at two major players in the field -- Microsoft (NASDAQ:MSFT) and Google (NASDAQ:GOOG) (NASDAQ:GOOGL) -- to understand why the cloud market is such a critical battleground for the tech industry.
The business of the cloud
In the past, businesses bought software and installed it on their local computers. But as Internet and processing speeds improved, software companies started delivering software as a service (SaaS) over the Internet.
Businesses no longer wasted time installing software on multiple machines, while software companies saved money on physical packaging. Offering software as a subscription-based service locked in consumers, generating a steadier stream of revenue than periodic upgrades. Companies no longer needed to wean users off older versions by pulling support, since the cloud-based version would always be up to date.
Meanwhile, cloud servers, which host files remotely, rose in popularity, since small and medium size businesses (SMBs) didn't need to install expensive and power hungry servers on-site. With cloud servers, businesses only pay for the data they use, like a utility.
How Google disrupted Microsoft
Google leveraged its strong user base of Gmail users to unite its ecosystem of Web-based apps to promote the use of its Web-based business apps. This tactic won over plenty of SMBs, which were no longer at Microsoft's mercy when it came to Windows and Office upgrades.
Google realized that the key to conquering the enterprise market was through email accounts. Google's email isn't used by any Fortune 50 companies (except for itself), but 60% of midsized tech/media companies and 92% of Y Combinator start-ups host their email on Google, according to Quartz. This means that although Microsoft retains an iron grip on larger companies with its Office/Exchange infrastructure, Google has planted the seeds for future growth.
Google builds on enterprise email dependence with Google Apps for Business, which is priced to compete against Microsoft's Office 365. That tactic is working -- 58% of administrators intended to "cut support or slow the use of" Microsoft Office in the near future, according to a recent survey by the Cloud Alliance for Google Apps and Frost & Sullivan. Research firm Gartner also found that Google Apps' share of the cloud office market climbed from 10% in 2007 to 33%-50% in 2012.
How Microsoft will strike back
Google's advance looks alarming, but Microsoft still has the upper hand in terms of market share.
In the $5 billion enterprise email market, Microsoft controls 75% of all spending, compared to 3% to 5% for Google, according to Gartner analyst Tom Eid. Last year, 50 million enterprise users used cloud office products like Google Apps for Business and Office 365, but that only accounted for 8% of all office software users, according to Gartner. This means that there's still time for Microsoft to curb the growth of Google Apps.
CEO Satya Nadella clearly knows how to halt Google's advance. Microsoft must tether cloud services, like OneDrive and Office 365, to its Windows operating systems, which are still installed on over 90% of all PCs worldwide. It must prioritize user growth over short-term profits by reducing prices or giving away products for free. That's why Microsoft is bundling free trials of OneDrive and Office 365 with new PCs, slashing subscription rates for SMBs, and making mobile versions of Office free for non-business users. Last but not least, Azure, Microsoft's cloud computing platform, will be the backbone of Windows 10 -- which promises to unify phones, tablets, and PCs with a single OS.
What does all this mean financially?
Nadella's efforts have paid off. Last quarter, Office 365 Home and Personal subscribers climbed 25% sequentially to 7 million, and revenue at Office Commercial products and services rose 5%. Microsoft also reported that commercial cloud revenue rose 128% year over year, fueled by strong growth from Office 365, Azure, and Dynamics CRM, although it didn't report exact revenue figures.
Google's enterprise cloud figures are hidden in its "Others" segment, which includes nonadvertising and consumer products. Last quarter, revenue at the segment rose 50% year over year to $1.84 billion, accounting for 11% of Google's top line, but it's impossible to tell how much came from its enterprise apps. During Google's first quarter earnings call, Google CFO Nikesh Arora noted that the company didn't report enterprise cloud revenue separately because the business was still in its "very early days."
Looking ahead, I believe that Microsoft is the better play on cloud computing, because it will keep dominating larger, established businesses for the foreseeable future. Big businesses just aren't eager to switch to a Google-based enterprise ecosystem due to incompatibilities with legacy data and software. Google still enjoys an early advantage among SMBs, but that advantage could quickly fade as Microsoft matches its prices.
Leo Sun has no position in any stocks mentioned. The Motley Fool recommends Google (A shares) and Google (C shares). The Motley Fool owns shares of Google (A shares), Google (C shares), and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.