How Investing in OpenAI Makes Microsoft Way More Profitable

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When Microsoft got early access to GPT-4, you knew it had a massive opportunity.

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Let's explore in a bit more detail what made this investment and early access to GPT-4 so crucial supercharging Microsoft's business model.

Microsoft’s Investment in OpenAI was Actually Cheap

For the incremental value it could create, its investment in OpenAI was not even that expensive. Microsoft confirmed its biggest investment in OpenAI less than a year ago, on January 23rd, 2023. Sure $10 Billion sounds like a lot, but consider the scale we are talking about. Consider that Google paid Apple and others $26 Billion back in 2021, just to be the default search engine. Google ads, with Search Ads as the backbone of Google’s dominance, generated $209.49 billion in revenue in 2021.

Microsoft’s investment in OpenAI as expensive as it seemed at the time, was actually cheap for the value it was getting. As we head into 2024 and 2025 this will become even more obvious.

Read the original post with images and embedded video.

So how much could Microsoft make with GitHub Copilot and in particular Copilot 365? Consider that Microsoft has in the neighborhood of 345 million people as of the start of 2023. How many of those enterprise customers need to convert at $30 per person to make incremental value for enterprise productivity? Microsoft in the short term at least, cannot lose.

Microsoft has now started offering its Microsoft 365 Copilot tools to the largest customers as of yesterday, Nov. 1, 2023. It already has over 1 million GitHub Copilot users. GitHub Copilot for Business subscription is $19 a month. If A.I. keeps improving for coding, software developers and Enterprise 365 users, these subscriptions will easily be worth it.

Microsoft could make a deal to bundle ChatGPT, Microsoft 365 Copilot for GitHub Copilot for in the area of $60 and it would be a good deal for a lot of workers for their productivity. One of the reasons Microsoft is such a great diversified business, is that they have all of these various subscriptions.

While Satya Nadella’s legacy will likely be Azure, A.I. could also be a part of that. Microsoft’s cloud saw accelerating growth in the third quarter likely due to the A.I. boost, taking market share from AWS and growing far faster than Google Cloud.

Copilot 365 is a generative artificial intelligence that can create human-like text and other content with just a few words of human direction. Businesses willing to pay the premium will be able to use Microsoft 365 Copilot to summarize documents, generate emails, create plans from notes, and even improve Excel analysis, among other things. As the workforce get more used to these A.I. tools, the idea is they will become more productive creating more value for the company they work at.

Try Copilot

How Profitable will Copilot 365 Be?

Piper Sandler analysts estimate the tool could generate more than $10 billion in annualized revenue by 2026.

I think that’s a reasonable estimate. But to understand Microsoft’s Generative A.I. play you need to factor in Azure growth, Azure AI services and GitHub Copilot among other things.

While Microsoft Research has in recent years become a lot stronger, if Microsoft’s Cloud can become more synonymous with AWS, it can begin to rival it and continue to grow faster in the 2020s. Microsoft will also use Generative A.I. know-how to grow its advertising revenue. If you combine these things then already by 2025, Microsoft’s investment in OpenAI will have been already “worth it”.

The thing is not how they do in 2024 or by 2026, but by how they compound over time and create incremental value across Microsoft’s software services and forrays into the AI of healthcare and education and in particular its pillars of gaming and cybersecurity. Because Microsoft was already the most diversified company in the world, it had the most to gain being first to GPT-4 and in Generative A.I. broadly speaking.

Functionally in the real world, Generative A.I. accelerates Cloud and Advertising revenue. In the case of Microsoft, it also could accelerate software services revenue. Even Bing’s sliver of search advertising revenue, is significant.

What did Earnings Say?

Microsoft on October 25th, 2023 posted revenue of $56.5 billion, up 13% from a year ago, and $2 billion ahead of Wall Street estimates. Analysts praised Microsoft’s results and expressed optimism about the company’s product pipeline, including Microsoft 365 Copilot.

Copilot in Windows 11

Microsoft Copilot is available first to larger companies, but when it’s more widely available to small businesses and individuals, that’s when it will be even more interesting to watch. How will adoption fare relative to ChatGPT and things like GitHub Copilot?

The A.I. upgrade at the Office

Microsoft’s software services also was given a huge boost in how Microsoft managed to scale Teams. Think about it, Microsoft released its figures for FY23 Q2 with news that Teams hit more than 280 million monthly active users in the quarter. So Teams and 365 means Copilot actually becomes fairly useful and well, almost necessary. What more is there to say here? If you are a Monopoly, people “have to buy the latest upgrade” just to give their employees the best basic tools.

It doesn’t even matter how good Copilot is per se, because like a game at launch, it will have some bugs and will improve over time. As Generative A.I. improves, all of these so-called productivity upgrades will improve as well.

Looking Ahead

Microsoft will continue to get better at merging Generative A.I. into its gaming and cybersecurity pillars as well, which are now considerable both in scale and future revenue they will be able to drive for the company.

The feature that appears in Word, Excel and other Office programs will cost $30 per person per month. So not counting tools such as Microsoft’s Purview for managing data, Copilot could conservatively speaking, add up to more than $10 billion in annualized revenue by 2026, Piper Sandler analysts Brent Bracelin and Hannah Rudoff wrote in a note to clients earlier this week.

If you don’t like Bing AI or Copilot today, in 2024 they might be significantly better. Remember this is all relatively new tech that will be fine-tuned for millions of customers.

Microsoft will be a Profit Machine

Given how diversified Microsoft is and how integrated Generative A.I. is now in a timeframe significantly ahead of its competitors, Microsoft is set up for exceedingly good profits for mid 2020s. Let’s think again about revenue growth: from the latest earnings MSFT 0.00%↑ :

1. Revenue was $56.5 billion and increased 13% (up 12% in constant currency)
2. Operating income was $26.9 billion and increased 25% (up 24% in constant currency)
3. Net income was $22.3 billion and increased 27% (up 26% in constant currency)
4. Diluted earnings per?share?was $2.99 and increased 27% (up 26% in constant currency)

Remember this was before the full impact of Generative A.I. and the evolution of Copilot 365 and GitHub Copilot takes place. Microsoft could change how developers, office professionals and game developers work with A.I., starting in 2024 but for forever.

Microsoft Was ‘Right’ to Invest in OpenAI

On its quarterly conference call, Microsoft said 3 points of the 29% growth in its Azure cloud revenue came from AI, exceeding the 2% contribution from AI that the company had predicted going into the quarter.

As A.I. improves in Copilot and Azure, how it spurs Microsoft’s Cloud growth relative to Google Cloud and AWS will be among the biggest stories moving forward to how much return on investment (ROI), Microsoft actually gets from the deal with OpenAI. As you may know also Microsoft will reportedly get a 75% share of OpenAI's profits until it makes back the money on its investment, after which the company would assume a 49% stake in OpenAI. OpenAI says it has revenue of around $1.3 Billion ARR, crossing that mark as of October 12th, 2023.

So on top of Copilot and all these other things, it’s making around nearly $900 million more just from OpenAI itself, paying back that stupendous investment. From a purely business standpoint, investing in OpenAI was already one of the smartest thing Microsoft has done in recent memory.

Whether Microsoft was right from an AI trust and safety standpoint investing so much in OpenAI, is another matter beyond the scope of this article. History may see things quite differently.

The Launch

Starting November 1st, 2023 Copilot is generally available. Microsoft 365 Copilot combines the power of large language models (LLMs) with your data in the Microsoft Graph, the Microsoft 365 apps, and the web to turn your words into the most powerful productivity tool on the planet. And it does so within our existing commitments to data security and privacy in the enterprise.??

How to get Started

Enterprise customers can call their Microsoft account representative to purchase Microsoft 365 Copilot. Or simply ask your manager if your company is getting it. Customers who already have Microsoft 365 E3 and E5 (or Business Standard / Premium) can start using Bing Chat Enterprise today.

A lot of people don’t know about Bing Chat Enterprise. Bing Chat Enterprise is available as a standalone for $5 per user per month and is included in Microsoft 365 E3 and Microsoft 365 E5. Yes there are so many other subscriptions at Microsoft related to A.I.

Microsoft’s so-called first mover advantage funding OpenAI also meant it was easier to do viral marketing for ChatGPT, this was supposed to look organic. I think Microsoft may have been surprised how poorly Bing AI fared and how relatively well ChatGPT did, at least in its first six months. Consumers also took notice of ChatGPT, at around the GPT-3.5 mark.

This means by the time Copilot 365 has rolled around, early adopters of AI at the office know what to expect. Well in advance of Google’s launch of Gemini or competition products, namely Duet AI in the Google Cloud. I will officially make note that “Duet” and “Bard” are terrible names. ‘Copilot’ at least give you the basic idea of what it is.

The issue is to some extent ChatGPT competes with Bing AI and so forth. But if Microsoft is getting 75% of the profits, you understand how OpenAI has to raise even more funds soon. Particularly with Anthropic getting significant funding from Amazon and Google.

Microsoft 365 Copilot, A not so Original in an Era of Copilots

Microsoft’s?365 Copilot AI assistant?is now available for certain enterprise customers. Microsoft is quietly launching its Microsoft 365 Copilot system for a $30-per-month premium per user, but enterprise customers will need to commit to at least 300 users and pick up the phone to Microsoft to get on the list to access this new AI-powered assistant that Microsoft “promises” will change the way Office documents are created and edited. This means Microsoft is asking for a minimum order of $9,000 a month, just for Copilot.

Microsoft’s dominance in 365 is massive so many of these companies will need to adopt Copilot, even if this means layoffs in order to afford it. Think about it, Office 365 is used by over a million companies worldwide, with 145,844 customers in the United States alone using the office suite software, as of April 2023, per Microsoft. So that’s 300 million or more users and over one million companies, even a poor conversion rate to Copilot means the subscription revenue Microsoft will be raking in from this product alone is going to be pretty considerable.

We are talking easily in the multi-billion dollar arena. Copilot alone would quickly pay for the OpenAI investment itself. Meanwhile Github Copilot is ahead of schedule in how developers can use it to become more productive. Coding is by far one the biggest value propositions for Generative A.I. actually making us more productive.

Try GitHub Copilot

In 2024 Microsoft will struggle in some areas, but the boost of AI might help offset this. It’s not clear if Google Duet or Google Gemini will be much of a threat to Copilot and and how Microsoft is utilizing Generative A.I. to its advantage. Making existing products more appealing is a trick many Enterprise customers of OpenAI’s GPT-4 API think is worth doing.

If Copilot adoption mirrors GitHub Copilot adoption, Microsoft will be very happy. It turns out paying customers for its GitHub Copilot software rose by 40% in the September quarter from the prior quarter.

So How does Copilot really work?

There’s also a Microsoft 365 Copilot Reddit.

Copilot is launching now to select Enterprise customers, but in 2024 should get a lot better. Microsoft rushed out Bing AI and I hopefully think it learned its lesson. Nobody can deny that Microsoft with GitHub Copilot, 365 Copilot, Bing AI Enterprise and other Generative A.I. tools isn’t contributing to advancements in how we use LLMs on a day-to-day basis.

What it does for Enterprise

Microsoft Copilot combines the power of large language models (LLMs) with your organization’s data – all in the flow of work – to turn your words into one of the most powerful productivity tools on the planet. It works alongside popular Microsoft 365 Apps such as Word, Excel, PowerPoint, Outlook, Teams, and more. Copilot provides real-time intelligent assistance, enabling users to enhance their creativity, productivity, and skills.

A.I. can help Microsoft accelerate and continue growth levels in those businesses where it’s doing the best. Office applications contribute 24% of Microsoft’s total revenue, and the category grew 16% in the fiscal fourth quarter, more than 30 years after the company began offering the bundle.

So obviously this is a team effort and would be impossible without OpenAI’s GPT-4. Microsoft is not doing any incredible innovation here. Across Microsoft 365 Copilot and several other products announced this year, Microsoft is relying on OpenAI’s underlying GPT-4 large language model, which underpins ChatGPT and can summarize information or generate human-like text in response to a written prompt. Microsoft’s Azure public cloud does OpenAI’s computing work.

Microsoft’s investment in AI here lifts its already commanding lead in the productivity software market. Until Canva goes public and other changes in the macro environment, this is all fair and well. It’s able to use its monopoly power to grow even faster.

What is a Realistic Conversion rate of Enterprise 365 Users?

I think it’s realistic to suppose 10 to 15% conversion rate.

Piper Sandler’s model assumes that 18% of eligible users will use Copilot. That might be aggressive, but “there’s going to be a FOMO element to this”, they said in interviews with the press.

I don’t think it’s Microsoft’s iPhone moment or anything like that.

But it compounds well over time, accelerates Cloud revenue, improves the quality and speed of software engineers, and is a multi-pronged attack by Microsoft to exercise its own monopoly power. As Copilot gets better for 365, more users will convert. It needs to demonstrate real value.

When you have 100 million businesses, even a 10% conversion rate for Copilot is going to be pretty stellar for Microsoft.

Microsoft’s Bet on OpenAI

1. Is a revenue source from OpenAI itself (75% of profits until they pay back)
2. Has and will continue to meaningfully accelerate Azure Cloud growth for a number of years
3. Will convert more customers with Copilot 365, Bing AI for Enterprise, etc…
4. Improves efficacy of GitHub Copilot in a meaningful way growing huge demand from engineers.
5. Over time it will improve the productivity and capabilities of game developers and Microsoft’s advertising revenue.
6. Will continue to improve Azure AI services and intersects well with its Enterprise RPA offerings.
7. Gives Bing more visibility and may meaningful increase Search Advertising revenue.
8. Among other use cases that are frankly too many to count.

Mission Impossible, OpenAI was Always Going to be a Winning Bet for Microsoft

Microsoft’s investment in OpenAI and gaining first access to GPT-4 couldn’t have failed, because Microsoft is already a monopoly in so many ways.

Furthermore it accelerates Microsoft’s profitability in gaming, cybersecurity, the Cloud and advertising in ways that aren’t fully appreciated in nascent 2023.

Microsoft’s fiscal estimates for the next quarter revenue are in the range of $60.4 billion to $61.4 billion, how much of that will be due to OpenAI? A more meaningful segment than you think. This was not a sponsored post, I simply like to try to break down investments in AI.

I believe Microsoft’s AI investment has and will continue to materially help its cloud business outpace rivals Amazon and Google. Although I am less sure if the average employee will be more productive who are users of Copilot, some time will be saved.

I don’t know if Google Duet or Gemini will be able to compete with Copilot anytime soon.

Microsoft’s Stock Performance and Cloud Growth Benefited Significantly from GPT-4 Early Adoption

MSFT 0.00%↑ Microsoft’s stock is up 44% year to date in 2023 and A.I. has been a big part of it. But when the AI hype narratives fades a bit, Microsoft will by that time have very real AI products that make its suite of tools more appealing for enterprise customers and individual users.

Microsoft’s Intelligent Cloud segment produced $24.26 billion in revenue, up 19% in Q2. Microsoft reported revenue of $56.52 billion for the quarter, boost by OpenAI’s tech. But how much faster is Azure growing compared to Google Cloud and AWS?

Microsoft reported growth of 29% at Azure. Compared to Google Cloud at 22% growth (that’s significantly smaller) whereas the leader Amazon Web Services, had just 12% growth. Overall Azure is thought to have about 23% marketshare while AWS has around 34%.

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