Microsoft (NASDAQ: MSFT) has revamped its business model under CEO Satya Nadella. While some products including the Windows operating system remain available on a purchase-and-own basis, many of the company's offerings have moved to a subscription model. That, plus growing cloud and device businesses represent the way forward for the brand.
Nadella's changes have been working. The company's fiscal year, which closed in June, saw revenue jump by 14% to $110.4 billion. The company also had adjusted earnings per share rise from $3.29 in 2017 to $3.88 in 2018.
"We had an incredible year, surpassing $100 billion in revenue as a result of our teams' relentless focus on customer success and the trust customers are placing in Microsoft," said Nadella in the earnings release. "Our early investments in the intelligent cloud and intelligent edge are paying off, and we will continue to expand our reach in large and growing markets with differentiated innovation."
Microsoft has moved to a different business model. Image source: Microsoft.
A base for the future
Subscription revenue nearly guarantees Microsoft's continued success. Revenue in the company's Productivity and Business Processes group (where Office is housed) grew by 13% in Q4 2018 to $9.7 billion in the year-ago period. Office commercial products and cloud services posted a 10% gain, while business was up 8% in those areas on the consumer side. The company also grew its Office 365 consumer subscription base to 31.4 million.
It's hard to downplay the significance of the subscription model. It essentially opens up the pool of Office customers to more people by having a lower entry price and then keeps those people generating new revenue each year.
The same is true of the company's cloud business. Once a customer has been locked in, they're likely to stay on board and keep producing for the company.
"Exceptional sales execution delivered double-digit revenue growth across all segments and strong progress against our strategic priorities, anchored by commercial cloud revenue growing 53% year over year to $6.9 billion," said CFO Amy Hood in the earnings release.
What's next for Microsoft?
The company will continue to build its business based on recurring revenue. That includes moving its Xbox business model into that type of business as well, with Microsoft recently launching Xbox All Access, which allows customers to get an Xbox and access to the company's subscription game service for one monthly price.
It's not hard to fathom that the company may consider doing the same thing with Office and Skype and its Surface tablets and laptops. That could work in a similar fashion as to how consumers pay for smartphones via financing and lease plans.
What's clear is that Microsoft has changed from a dying model built around Windows' one-time dominance to one that's sustainable for the next five years and beyond. That's a major credit to Nadella, who has completely changed how the company thinks.
Essentially, he moved Microsoft from acting like a monopoly to being a company that puts consumer needs first in a way that ties them to the company for the long term. That's a very rare pivot that many companies have struggled to make, and Nadella's ability to change his company's culture as well as its thinking should go down as a major accomplishment.
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Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Daniel B. Kline owns shares of Microsoft. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.