Microsoft reported strong earnings on Wednesday, but growth in its intelligent cloud segment is slowing despite high demand for AI infrastructure.

Figure 1. Microsoft's AI Investments Result in Declining Cloud Operating Income Growth.

For the three months ending Dec. 31, its second fiscal quarter, Microsoft posted $25.5 billion in revenue from the intelligent cloud segment, accounting for around 37% of its total revenue. The segment’s operating income reached $10.6 billion, or about 33% of total operating income. Figure 1 shows Microsoft's AI Investments Result in Declining Cloud Operating Income Growth.

This represents a year-on-year growth of just 14% in intelligent cloud operating income, the slowest growth rate in over a year. Throughout 2023, income growth in the segment had surged, driven by generative AI demand, reaching above 30% and peaking at 40% in Q4 2023. Although the segment remains profitable and continues to grow, the pace has significantly slowed.

Investment in AI has slowed profit growth

Microsoft attributes the slowdown in operating income growth to massive investments in generative AI, a trend seen across major hyperscalers.

A Microsoft official familiar with the investor relations group clarified that the numbers on Microsoft's site are not current. The financials are typically revised in the summer, and the official confirmed that the percentages showing a decline over time are still accurate.

The company is investing heavily in AI infrastructure at a faster pace than its competitors, spending more than Google or AWS, according to the official. The rapid growth of the AI market also contributes to the slowdown, with companies like Nvidia struggling to keep up with demand for chips.

Additionally, Microsoft is facing capacity constraints. “We have more customers wanting to buy AI services from us than we have the capacity to sell,” the official said, noting that the company has $298 billion in signed contracts that have not yet been fulfilled.

Forrester Principal Analyst Lee Sustar noted that although Microsoft's earnings continue to show strong growth due to its AI offerings, the operating expenses in its Intelligent Cloud segment, which includes Azure and other services, rose by 10%. This indicates that sustaining AI momentum is becoming increasingly costly.

“Investors and customers are closely watching to see if Microsoft can continue to deliver after the company reported a 70% decline in gross margin for Microsoft Cloud due to the scaling of AI infrastructure,” Sustar said.

Jason Anderson, a principal analyst at Moor Insights & Strategy, expressed that the decline in Microsoft’s growth percentages in the intelligent cloud segment is unsurprising.

“While I cannot comment on specific numbers, the downward trend makes sense. Expect to see more of it,” Anderson said. “This is driven by factors such as fewer humans per system due to business scale and software automation, along with investments in and a successful launch of lower-power technologies like ARM-based Cobalt chips, as opposed to Intel.”

However, Scott Bickley, advisory fellow at Info-Tech Research Group, found little of note in Microsoft’s latest earnings announcement.

“To me, this is just a typical quarterly update. They are still forecasting 30% growth,” Bickley said. “Microsoft is fully comfortable with investing now to maintain its leadership in the AI infrastructure race, viewing scale as a key factor in determining long-term winners. To the hyperscalers, this is an arms race akin to the nuclear arms race during the Cold War. DeepSeek-like innovations aside, nothing is going to stop this momentum.”

Tough pricing questions ahead for CIOs

The massive numbers on both sides of the equation are raising concerns, and Sustar predicts that enterprise CIOs will soon demand clearer answers about why they are being charged so much.

“Commodity cloud services are enormously expensive to scale globally,” Sustar said, pointing out that Google, for example, lost $1 billion in a single quarter. “If DeepSeek proves successful, it could lead to much lower prices, giving CIOs more options.”

This is when CIOs will begin asking difficult questions, according to Sustar. “Are we overpaying for these services? Have we overpaid for commodity services?”

The conversation is likely to shift to distinguishing between routine “mundane cloud compute” services and premium capabilities. Sustar noted that the convenience of bundling many services with the same hyperscaler may come under scrutiny. “You don’t want to end up footing the bill for an overly aggressive cloud provider plan.”

Source: NETWORK WORLD

Cite this article:

Priyadharshini S (2025),"Microsoft's AI Investments Lead to A Decline in Cloud Operating Income Growth",Anatechmaz ,pp.121