In his opening comments on Microsoft’s Q1 FY23 conference call, CEO Satya Nadella said the following: “To start, I want to outline the principles that are guiding us through these changing economic times. First, we will invest behind categories that will drive the long-term secular trend where digital technology as a percentage of world’s GDP will continue to increase. Second, we’ll prioritize helping customers get the most value out of their digital spend so that they can do more with less. And finally, we’ll be disciplined in managing our cost structure.” The need for that preface is telling; Microsoft is not immune from the broader macroeconomic pressures being felt throughout the economy, and it seems likely more pain lies ahead.

The specific impact of those macro headwinds, in combination with some COVID pull-forward over the past few years, will largely be felt in the Consumer businesses, most notably due to weakening advertising spend and PC demand. On the other hand, the Commercial businesses appear set for ongoing strength, with management guiding to ~20% constant currency revenue growth in FY23. (In Q1, the consolidated business continued to perform solidly, with constant currency revenues +16% YoY.) The reason why is largely attributable to the next focal point of Nadella’s discussion on the Q1 call: Microsoft is a key technology partner as client’s pursue “digital transformation”, which is imperative to their long-term competitiveness.

This need is structural, with Nadella arguing it’s importance rises during tough times (like now): “Moving to the cloud is the best way for organizations to do more with less. It helps them to align their spend with demand and mitigate risk around increasing energy costs and supply chain constraints.”

As he often does during the prepared remarks, Nadella spoke on the Q1 call about a few clients who are employing Microsoft solutions to operate more efficiently and effectively. For example, he spoke about Azure Arc, a service that enables customers to run Azure services regardless of the complexity within their IT environment (which may span on prem, multi-cloud, etc.).

While I do not deeply understand these things from a technical perspective, what’s evident to me is that services like Azure Arc are built to flexibly serve a wide range of client needs (his discussions on SAP workloads and Oracle databases are another example). It may be a somewhat obvious point, but this is reflective of a mindset that starts with customer’s needs first, not Microsoft’s; this mindset enables Microsoft to truly be a partner who’s working in service of their end clients. (From there, it helps when you’re able to offer a number of best-in-class solutions across the tech stack, alongside potentially meaningful cost savings for clients: “Security continues to be a top priority for every organization. Microsoft is the only company with integrated end-to-end tools spanning security, compliance, identity and device management, and privacy across all clouds and platforms… [Clients] can save up to 60% when they consolidate our security stack…”)

Microsoft Cloud reported another solid quarter in Q1, with constant currency revenues +31% YoY. As shown below, the Cloud businesses ended Q1 with run rate revenues of ~$103 billion, up >5x from five years ago (~$20 billion in Q1 FY18). Over this period, Cloud gross margins expanded by ~1,500 basis points, which speaks to the inherent leverage that this business offers at scale. At a time when the investment community is obsessively focused on quarterly results (even more so than usual), a review of the long-term results serves as a useful reminder that this is what ultimately matters. In the case of Microsoft Cloud, I’d argue you can own a best-in-class competitor operating in a structural growth market with an immense TAM; that doesn’t tell us much about how the results will shake out over the next few quarters, but it leaves me highly confident that the Cloud businesses will be much stronger when we look back in five years. (On that point, if Azure misses quarterly estimates by a point or two because Microsoft is helping customers optimize workloads, that’s a good thing in my mind; as CFO Amy Hood put it, “This is how you drive share gains, build customer loyalty, and help customers grow”.)