In the 1970s, Microsoft’s (NASDAQ:MSFT) realized that software could be a huge business. Until then, most computing companies profits came mostly from selling hardware, such as mini-computers and mainframes.
But with the growth in PCs came demand for applications. Of course, this turned out to be a disruptive change for incumbent players like IBM (NYSE:IBM), and, in fact, many computer manufacturers simply vanished.
Interestingly enough, it’s Microsoft that looks like a technology dinosaur now. Its software often requires installing CDs on computer systems, which makes things cumbersome for updates as well as real-time analysis of data.
In addition, over the past 10 years, there has been a new approach to business software: the cloud. Essentially, this involves delivering applications via the Web. This means seamless updates and a stronger use of real-time data. Often, the software is much easier to use, with the feel of an interface for a consumer website like Amazon.com (Nasdaq:AMZN) or eBay (Nasdaq:EBAY).
What’s more, the cloud has proven to be much easier when handling mobile applications. No doubt, this market is expanding at a torrid rate.
Microsoft’s response to the cloud has been typical – it’s been similar to Gandhi’s famous quote: “First they ignore you, then they laugh at you, then they fight you, then you win.”
Right now, it looks like Microsoft is at the “fight you” stage. This week, the company made a splashy announcement of its cloud offering, called Office 365. It not only includes its productivity applications like Word, Excel and PowerPoint, but also communications and collaboration tools.
But the fact is that Microsoft is extremely late to the game. There are already a variety of options on the market, such as those from Google (Nasdaq:GOOG) and VMware (NYSE:VMW). More importantly, those companies are selling their offerings at much lower price points.
Thus, even if Microsoft is successful in spreading Office 365 – which is likely to be the case – there will likely be an overall erosion of the nose-bleed margins. It’s inevitable, and in addition, the competition will relentlessly increase.
For shareholders, the move to the cloud isn’t necessarily good for Microsoft, at least for its high-margin franchise businesses, because it’s really about cannibalizing what it already sells.
If investors want to benefit from the cloud, a better approach is to look at the pure-plays. Some names include ServiceSource (Nasdaq:SREV), Cornerstone OnDemand (Nasdaq:CSOD) and SuccessFactors (Nasdaq:SFSF). They are all growing nicely and offer the potential of solid long-term gains.
Tom Taulli’s latest book is “All About Short Selling” and he has an upcoming book called “All About Commodities.” You can find him at Twitter account @ttaulli. He does not own a position in any of the stocks named here.
