Spoiler Alert: Microsoft Is a Cloud and AI Business Now

Software titan Microsoft (NASDAQ: MSFT) released its Q3 2023 earnings report this week, and it was a doozy. The company is storming head-first into the cloud computing and artificial intelligence arenas, leaving its traditional office and Windows products in the dust.

None of this is breaking news, exactly. It's more of a continued long-term trend.

The intelligent cloud segment accounted for 36% of Microsoft's sales in the second quarter of 2021, two years ago. But that division keeps outgrowing its legacy cousins. In the fresh third-quarter update, intelligent cloud delivered 42% of Microsoft's total sales. The cloud computing segment, organized around the Microsoft Azure flagship, has been Microsoft's largest business operation for years, and it only grows more substantial every year:

Infographic showing Microsoft's revenue streams, expenses, and profit flows in the first quarter of calendar year 2023 (the third quarter of its fiscal 2023).

Now, Microsoft has not yet defined artificial intelligence (AI) as a business segment with reporting requirements. Instead, the company is baking AI brainpower into many of its cloud-based tools and services. It's a natural match, since Azure provides plenty of AI-oriented processing power in the cloud. Microsoft resells these assets to Azure customers, but where it makes sense, it also eats its own dog food.

Partly as a result of the rising interest in AI, Azure revenue jumped 27% year over year, proving once again that Microsoft is a force to be reckoned with in the cloud market.

The pattern of strong cloud sales and weaker old-school business results repeated itself across Microsoft's entire report.

At the same time, enterprise-oriented segments outperformed Microsoft's consumer-facing operations at every turn. For example, the cloud-based customer relationship management and enterprise resource planning software known as Dynamics 365 saw a stunning 25% year-over-year increase in revenue. However, Windows OEM and Office Consumer sales continued to wilt, with just 1% growth in both cases. The Xbox gaming division posted slightly stronger results with a 3% top-line increase, but that's still weak sauce compared to the business-grade subsectors.

The sea change continues

This earnings report confirms what we've known for some time -- Microsoft is undergoing a sea change in its business strategy. Traditional software products like Office and Windows used to be the company's bread and butter. It took its first step toward its current cloud computing focus with subscription-style licenses more than a decade ago. That strategy shift turned out to be a game-changer, with strongly positive effects on Microsoft's ultrareliable revenue streams and equally sustained profit margins.

What can we learn from these ongoing business trends? Well, Microsoft is making a bold and highly committed move toward the cloud and AI technologies, leaving its legacy products in the dust. This company has a long history of successful pivots and new product launches, and the future looks bright as Azure, Dynamics 365, and Microsoft Cloud post impressive revenue growth quarter by quarter.

It's not all wine and roses, of course. Nobody expects perfection in this difficult global economy. So, as impressive as Microsoft's cloud and AI businesses are, it's worth noting that the company's consumer-facing operations, such as Windows OEM and Office Consumer, have continued to lag behind. With just 1% growth in both cases, it's clear that Microsoft still has work to do in shoring up these legacy businesses.

How to invest in Microsoft's AI and cloud ambitions

Keep a close eye on how Microsoft addresses these challenges, particularly as the global economy grapples with an inflation-based crisis. As the economy recovers, it will be interesting to see how Microsoft adapts its strategy to address changing consumer preferences and behaviors.

Despite these challenges, Microsoft's continued investments in cloud and AI -- not to mention cloud-based AI -- suggest that the company is positioning itself for long-term success. It won't miss this game-changing market revolution, as it did in the race to dominate the formerly explosive smartphone business. This time, Microsoft is catching other companies napping instead.

With a solid foundation in these high-growth areas, Microsoft is well positioned to weather any short-term storms and emerge even stronger in the years ahead.

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Anders Bylund has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Microsoft. The Motley Fool has a disclosure policy.