$1.3 trillion Microsoft is emerging as a big winner amid the pandemic, but it's showing two big signs of caution as the economy heads toward an uncertain future (MSFT, AMZN)

Satya Nadella Microsoft

  • Microsoft’s business seems on solid footing amid the pandemic, but there are signs that the company is adopting a strategy of caution — a strategy which should be on display when it reports quarterly earnings after the market closes on Wednesday.
  • Microsoft froze hiring except for unspecific “strategic roles,” citing uncertainty related to the coronavirus crisis.
  • Meanwhile, so many more people are using Microsoft services that the company is having a hard time keeping up with the demand.
  • Microsoft’s cloud capacity issues, experts said, are likely due to the company’s strategy to not build excess capacity in order to increase margins for its cloud business, plus truly unprecedented spikes in users during the pandemic.
  • Visit Business Insider’s homepage for more stories.

As Microsoft prepares to report financial results on Wednesday, the company appears to be on solid footing, even amid the public health and economic crises caused by the spread of the novel coronavirus. 

Remote workers are turning to Microsoft Office 365 and the Microsoft Teams chat app to do their jobs while stuck at home. Similarly, the Microsoft Azure cloud platform is powering many of the apps and websites that people are using for work and play alike. Even Microsoft’s Xbox business is booming, with gamers going online to socialize. 

At the same time, Microsoft is showing signs that the pandemic is placing some pressure on its business. In a note to customers, Microsoft acknowledged that the Azure cloud was struggling with capacity issues. The company is also freezing hiring, except for some in unspecified “strategic areas.”

These challenges, according to analysts, point to Microsoft’s strategy of caution as we face the very real possibility of recession. 

The partial hiring freeze helps to ensure that Microsoft won’t have more employees than it needs if the economy worsens further, say the experts. And its cloud capacity issues could similarly be a sign that the company chose a slow-and-steady data center expansion strategy that prioritized maintaining its margins over speed.

“Microsoft is a well-managed company so I’m not surprised to see them proceed with caution on the cost side until they have a clearer picture of where global software demand ultimately settles out,” UBS analyst Jennifer Lowe said.

Microsoft ‘pausing recruitment’

Microsoft earlier this month cited the uncertainty caused by the coronavirus crisis when it confirmed the company is “temporarily pausing recruitment” except for “strategic areas,” but declined to reveal what that includes. 

“We continue to seek industry-leading talent in a range of disciplines as we continue to invest in certain strategic areas,” a Microsoft spokesperson said in early April. “However, in light of the uncertainties presented by COVID-19, we are temporarily pausing recruitment for other roles.”

Microsoft declined to provide more current information about the hiring freezes, but earlier this month, employees told Business Insider the company is still hiring for its Azure cloud business, and that some group are “prioritizing consumer-facing and critical roles.”

Microsoft posted jobs for Azure and its Office 365 cloud software businesses as recently as Tuesday, but posting jobs doesn’t necessarily mean the company intends to fill those roles immediately.

‘Anticipating a sluggish demand environment’

While Microsoft’s cloud and Microsoft 365 suite of cloud-based business applications including Office and Teams are likely seeing a boost, RBC Capital Markets analyst Alex Zukin said, higher-margin businesses such as Windows are under pressure and have a greater impact on earnings. 

Microsoft in February said it would miss its sales forecast for the segment of its business that includes revenue from licensing Windows to PC manufacturers, citing issues with its supply chain and “uncertainty related to the public health situation in China.”

“Microsoft is not immune to a recessionary environment and is perhaps anticipating a sluggish demand environment for an extended period of time,” Zukin said.

Lowe, the UBS analyst, said Microsoft is just one of several examples of software companies being more careful while they wait to see how COVID-19 impacts the economy and causes IT budgets. 

“No one wants to hire people that they might need to let go six to 12 months from now if the global economy takes a big turn for the worse,” Lowe said.

Big companies, Lowe said, are also seeing a reduction in employee churn —  fewer people want to leave a safe job at a large company amid a downturn, so that lessens the need for new employees. Zukin, the RBC analyst, also said the coronavirus crisis is making it more difficult for companies like Microsoft to fully onboard new employees while everybody is working remotely. 

Microsoft’s capacity issues

In a recent note to customers, Microsoft admitted that its Azure cloud business struggled with capacity issues, which it says are related to the coronavirus crisis, and said it’s taking steps to make sure it can meet demand.

“I suspect the problems are due to truly unprecedented usage esp. of Teams given Microsoft’s offer to make Teams free for the time being – as you’d expect, video conferencing requires lots of bandwidth,”451 Research analyst Jean Atelsek said. That, plus increased usage of Virtual Desktop and other work-from-home applications has put quite a strain on the system I imagine.”

One of the reasons Azure could be having trouble meeting capacity, Lowe said, is that Microsoft has improved margins for the business by taking a “balanced approach” in building out its data center network using projected demands without excess capacity. The coronavirus crisis has likely significantly outpaced those projections.

Lowe points out that Accenture recently said the company nearly doubled its usage of the Microsof Teams communications app as its workforce moved remote, up to 30 million minutes per day from 16 million minutes, and that one of its customers worked with Microsoft to bring all of its 25,000 employees on Teams within five days.

‘Nothing is infinite’

Most of the analysts said they expect increases to Microsoft’s capital expenditures as the company tries to build out its cloud capacity to meet the demand. Zukin, the RBC Capital analyst, said there may be supply chain issues affecting Microsoft’s ability to build more server capacity.

“Nothing is infinite,” Forrester analyst Glenn O’Donnell said. “The cloud giants have massive capacity, but when demand surges like it did, even they will experience capacity issues.”

Overall, Wedbush Securities analyst Dan Ives said, Microsoft’s business is strong and its actions during the coronavirus crisis show the company is being cautious and trying to reduce expenses.

“Microsoft is being prudent around hiring and expenses in this unprecedented COVID-19 pandemic with uncertainty abound,” Wedbush Securities analyst Dan Ives said. “While Redmond is extremely well positioned for cloud growth as evidenced by our robust Azure checks, reducing expenses into a near term economic abyss is a smart strategic move.”

Are you a Microsoft employee or customer? Contact this reporter via email at astewart@businessinsider.com, message her on Twitter @ashannstew, or send her a secure message through Signal at 425-344-8242.

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