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Microsoft Rides the Second Wave of Digitalization

GuruFocus.com
·3 min read

- By Panos Mourdoukoutas

Microsoft Corp. (NASDAQ:MSFT) is riding the second wave of the digital transformation of the world economy, according to its CEO Satya Nadella:

"What we have witnessed over the past year is the dawn of a second wave of digital transformation sweeping every company and every industry," he said. "Building their own digital capability is the new currency driving every organization's resilience and growth. Microsoft is powering this shift with the world's largest and most comprehensive cloud platform."


Nadella's comments followed the company's release of financial results for the quarter ended Dec. 31, 2020. The company showed strength across all business segments:

Revenue in Productivity and Business Processes was $13.4 billion and increased 13% (up 11% in constant currency).

Revenue in Intelligent Cloud was $14.6 billion and increased 23% (up 22% in constant currency).

Revenue in More Personal Computing was $15.1 billion and increased 14% (up 13% in constant currency).

Digital transformation, or digitalization, is the growing use of digital technologies in the ways businesses interact with each other and with their customers and suppliers. It's a trend that has accelerated during the Covid-19 pandemic as virtual interaction in consumer and product markets replaced in-person interactions.

IT companies providing the "tools" of digitalization face a "winner-take-all" game in which the company that wins the game accrues almost all the pay-off due to scale, scope and network advantages.

Scale advantage is the cost benefits associated with the mass offering of a product or a service. A scope advantage is the offering of more products through the same sales channel. A network advantage is the revenue gains associated with a large distribution network.

Scale, scope and network advantages create "moats," barriers of entry for "early movers."

Moats allow early movers to set industry standards and "lock-in" relations with customers, which allow them to enjoy a sustainable competitive advantage.

Apparently, Microsoft is one of these winners as it has all of these advantages. It has productivity and business processes products, personal computing products and intelligent cloud, usually offered in "bundles" to millions of customers, allowing the company to achieve economies of scale and scope.

Product bundles further create lock-in relationships with customers that keep competition away. They further allow the company to enjoy a competitive advantage, as evidenced by its economic profit, the difference return on invested capital and the weighted average cost of capital, which is the highest among its peers.

Company

ROIC

WACC

Economic Profit (ROIC-WACC)

Amazon

11.37%

7.97%

3.41%

Microsoft

28.10%

5.85%

22.26%

Google

20.93%

7.26%

13.67%

IBM

5.64%

5.82%

-0.18%



Source: Compiled from Gurufocus on Jan. 26, 2021

A high economic profit means that Microsoft creates plenty of value for its capital holders as it grows and a higher price for its shares on Wall Street, where it has been a stellar performer for more than three decades.

It has been riding one wave of digitalization after another.

Disclosure: I own shares of Microsoft.

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This article first appeared on GuruFocus.