In many ways the JEDI contract, which runs for 10 years, is the ultimate rolled gold stamp of approval for Nadella's decision to shift Microsoft's strategic direction towards hyper-scale cloud computing, under the banner of Azure.

Not that he needed confirmation of his brilliance. Since he took over as chief executive in February 2014, Microsoft's stock price has risen fourfold, adding about $US850 billion in value.

Nadella prioritised the Azure cloud business before he became CEO. When he took over, he set out to change the Microsoft culture.

At first, Nadella's move into the cloud was a worry to a Microsoft board of directors used to thinking about the world as Bill Gates did, with a PC on every desk running proprietary software that was updated every three years. The company was used to earning profit margins of 90 per cent.

But as revenues grew his vision was recognised. The growth in the volume of new business has compensated for the fall in margins to about 63 per cent.

Nadella prioritised the Azure cloud business before he became CEO. When he took over from Steve Ballmer in February 2014, he set out to change the Microsoft culture. This multi-year task is well described in his 2017 book, Hit Refresh.

Embracing open-source code

Microsoft has positioned itself as a friend of software developers. Nadella pulled down the company's walled-garden approach to software development and embraced open-sourced coding.

The company is the world's strongest supporter of the Linux open source coding system and its purchase of GitHub for $US7.6 billion in 2018 gave it access to 36 million open source software developers.


Nadella recognised early on that everything would become digital and all software applications could live either in the cloud or on servers controlled by customers on their premises.

About three years ago Microsoft's software engineers broke everything in the company's suite of products into modular applications. Instead of offering customers monolithic systems that take years to embed and always cost more than expected, Nadella rebuilt everything on Azure so customers can pick and choose and mix and match.

He had the insight to recognise Microsoft's foundations as a provider of productivity tools for large enterprises through the Office product set could be the springboard for turning the company into the platform for digitisation of just about any task in any industry.

It is this digitisation of everything that makes Hamish Douglass, chairman and chief investment officer at Magellan Financial Group, believe that Microsoft is only at the very beginning of its cloud-driven expansion.

"I think of the cloud as a platform," he says. "When we move to the Internet of Things, businesses and government departments, are going to start digitising processes and moving those processes to the cloud and then start processing the data with machine learning and AI [artificial intelligence]."

"I think they're building an entire platform for digitising the enterprise," he says. "They are developing their own productivity software through Dynamics and Office, but also I think they want to be hosting other people's software.

"Who knows what software's going to be written in the next 10 to 20 years? There's going to be the digitisation of health services, the taxation department, manufacturing processes and all the smart things through the Internet of Things.

"I think because they're an enterprise company and they have all these components, they're so well positioned. The commercial cloud business is already growing at 30 per cent a year and they haven't even touched the tip of the iceberg in terms of this.

"This business has come from nowhere 10 years ago to $US40 billion a year. We're talking about a market that's going to be in the trillions of dollars of addressable market."

Magellan owns $3.1 billion in Microsoft shares as part of its global equities strategy. Douglass says he first bought the shares in 2013 when the stock was $US28 a share and the market thought "Windows was dead".


Nadella says every company is now a technology company and the next big technology breakthroughs will come "not only from technology companies, but from retailers, healthcare providers and manufacturers, working in partnership with us".

"It’s fantastic to see this in action in Australia, where we’re partnering with leaders in every industry and across the public sector to apply technology to address some of their biggest challenges – from improving healthcare outcomes and optimising employee training to empowering first line workers,” he says.

Amazon had a four year head start on Microsoft in cloud computing but Nadella came to the market with a bold growth target of creating a $US20 billion-a-year business by 2018.

This stretch target was sold to Wall Street by chief financial officer Amy Hood, who has all the hallmarks of being the next CEO of Microsoft whenever Nadella chooses to depart.

She has brought stringent discipline to Microsoft's business fundamentals and a laser-like focus on the entire expenses line. Most divisions have flat budgets and must get expansion capital from transformation benefits.

Amazon still dominates cloud computing with a market share of 48 per cent, according to Gartner. But Microsoft is rapidly catching up.

In the year to June the Azure cloud business grew by 63 per cent and its market share rose to 15.5 per cent, while Amazon's share went backwards. Microsoft has more than doubled its market share since 2015.

Microsoft's president Brad Smith, CEO Satya Nadella and CFO Amy Hood.

The narrowing gap in market share partly explains why Amazon is so angry about losing the JEDI contract. It has accused the US government of "unmistakable bias" and is readying a court challenge. It will be fascinating to see whether Bezos, the publisher of The Washington Post, can prove President Donald Trump was involved in the decision.

Is it no surprise cloud momentum is with the company with the JEDI contract, considering Microsoft's co-founder Paul Allen built a pop culture museum in Microsoft's home town, Seattle. It is full of Star Wars memorabilia, including Luke Skywalker's lightsaber.


The JEDI contract is significant from multiple perspectives, according to Microsoft president Brad Smith. During an interview with The Australian Financial Review in his office at the Microsoft campus in Redmond, Washington, he hints it will have ramifications for US military allies such as Australia.

"I think if this contract were awarded in 2016, or maybe even 2017, it more likely would have gone in another direction because Azure was not as full-featured as it is today," he says. "And so it just reflects the incredible investment we made in innovation, especially with an eye towards meeting the needs of large customers like the Department of Defence.

"I think it is a reflection, second, of the degree to which the world is embracing the cloud. In part, the clear philosophy of the Pentagon is they need to move faster to get to the cloud, because that's where the future is, and they can't expect to be the leading military force in the world if they're not using the cloud.

"I think that is a lesson that speaks not only to the military forces of the world, but fundamentally to every type of institution in the world.

"And so, yes, I think that we may well see this speak to people in other industries, or areas of government, as well.

"Third, you know, every contract is important, but some contracts are more important than others, and you know this award is not just a contract, it's a responsibility, you know, and it creates for Microsoft a very important responsibility for the defence of the United States, and fundamentally the protection of the American people," Smith says.

This contract is going to have multiple ramifications over many years for the role that we need to play in many parts of the world. — Brad Smith, Microsoft president

"And, yes, I think the single most important thing that we do, as a company, is act with the acute appreciation of the responsibility that creates for us.

"As we do that, you know, I think that it is an opportunity, almost by definition, to connect with the other governments and military forces that are close allies to the United States. I think that, again, that takes us to the other four of the Five Eyes, and to the 26 other NATO members, in particular.

"And so I think this is a contract that's going to have multiple ramifications over many years, for the role that we need to play in many parts of the world."


There are many aspects to the brilliance of Nadella's strategic shift to the cloud, not the least of which was his decision to use Microsoft as a test bed for a corporate transformation.

After all, how can you possibly convince your customers of the merits of tech transformation tools if you have not used them yourself?

Microsoft's chief digital officer and executive vice-president corporate strategy and operations, Kurt DelBene, says Nadella recognised early on that the old way of running IT was broken and would not enable companies to transform themselves at the pace required in a digital age.

"Two and a half years ago, Satya was really saying, 'We're seeing all this transformation that happens in our customer base or that they want to know what transformation needs.' They have an inkling that the way they do IT today is not going to survive," DelBene says.

"It's just the wrong way to think about it. Essentially, speccing out a system that you need, based on your people inside the organisation, saying, 'I need you to deliver these features.'

"And you then go to somebody like Accenture, and say, 'Deliver me these features', and then they run it, and with no real insight as to what the business processes are and how those are going to change over a period of time, or need to change over a period of time to get where you need to go.

"And so, I think what's put a head on that is this recognition by all industries that digitisation - or this tech intensity, as Satya talked about it - this need to have technology, software, services be a core part of your business, moving forward, is exploding."

Nadella gave DelBene the task of transforming Microsoft's approach to managing IT. He knew the job was in good hands because DelBene had just spent seven months fixing healthcare.gov for president Barack Obama.

"We were two-thirds outsourced, so we did the thing that everybody did of listening to constituents and then just parrot it back and say, 'Build us this'," DelBene says.

"We did not have a deep technical bench, in terms of people being able to really envision what the software can do, and then actually code it. We basically ran the systems that we specced and had delivered."


DelBene says Microsoft's transformation resulted in huge costs savings from in-sourcing software development.

"We're about two-thirds in-sourced now," he says. "We've massively reduced our outsourcing dependency, as a result, in hundreds of millions of dollars.

"We have moved 95 per cent of our systems to the cloud. We have a vision for every single one of our product areas in concert with the stakeholders."

During its transformation, Microsoft moved to what DelBene calls a "DevOps" model, which means the developers who wrote the code also operate the system they wrote the code for.

Under Nadella's leadership, Microsoft has married the perpetual software licensing approach in Microsoft's Office 365 products with the perpetual licensing that comes with cloud infrastructure.

DelBene says Nadella's "superpower" is in "envisioning where the industry's going, envisioning products, stitching together different patterns into new products".

Nadella sees patterns in the way customers are using products and responds by directing software development resources to these areas.

Microsoft's business is broken down into three segments: productivity and business processes, which includes Office 365, LinkedIn and Dynamics 365; intelligent cloud, which includes server products and cloud services; and more personal computing, which includes Windows, Bing, Xbox and Surface computer devices.

One-stop shop

No other company offers under one roof computing as a service, storage, productivity apps, front-office apps, core financials, data analytics, identity security, artificial intelligence and machine learning.


As Microsoft grows more powerful and its services and products become more pervasive across business and government, it is bound to catch the attention of regulators.

This is already happening, with German Chancellor Angela Merkel last week warning of potential "sovereignty" issues from the storage of data on Microsoft servers even though they are located in Germany.

The Financial Times reported last week that Merkel told a union conference: “So many companies have just outsourced all their data to US companies. I’m not saying that’s bad in and of itself — I just mean that the value-added products that come out of that, with the help of artificial intelligence, will create dependencies that I’m not sure are a good thing.”

There is no doubt that whatever concerns Merkel has will be addressed in fulsome detail by Smith, who is sometimes referred to as the US secretary of state for tech.

It his consummate management of regulatory issues that is largely responsible for Microsoft avoiding the intense political scrutiny and public opprobrium directed at Facebook, Google and Twitter.

I think Microsoft is a company that understands responsibility because they have been a broad business enterprise. — Rod Sims, ACCC chairman

Rod Sims, chairman of the Australian Competition and Consumer Commission, says Microsoft was not like the new digital platform companies such as Facebook and Google, which he says have never taken responsibility for what happens on their platforms.

"Facebook and Google say, 'we are just a platform, just like Airbnb', whereas the larger tech companies like Microsoft have never had that approach," he says. "They are a company doing business in a way companies do. They take a broader approach. They can see they have got to get ahead of these things.

"I think Microsoft is a company that understands responsibility because they have been a broad business enterprise."

Smith, who is also Microsoft's chief legal officer, has taken a proactive stance across all the big tech debates including privacy, the digital divide and artificial intelligence.


A company once labelled "the Evil Empire" and at the forefront of attempts by anti-trust regulators in the US to be broken apart 20 years ago is largely missing from US congressional committee meetings.

Smith made sure Microsoft leads from the front on just about every contentious regulatory issue. For example, Microsoft voluntarily adopted Europe's General Data Protection Regulation privacy rules across all its products worldwide.

It was Smith who made sure Microsoft sent a senior executive from head office to Australia when Prime Minister Scott Morrison called a meeting of technology executives earlier this year in the wake of the Christchurch mosque shootings.

Facebook and Google sent local representatives who could not speak on behalf of head office and were therefore berated by Morrison.

Smith wrote a book with Carol Ann Browne called Tools and Weapons. It is the blueprint for showing technology companies how to take responsibility for the technology they create and assist governments left behind by the pace of innovation.

It will come in handy if Elizabeth Warren is elected president in next year's US election. She says technology companies have too much power, engage in anti-competitive behaviour and must be broken up.

Microsoft does exercise its market power. From October 1, newly purchased Microsoft SQL Server and Windows Server licensees cannot be migrated to dedicated or single servers in the cloud offerings of Amazon and Google without paying additional fees. The licence fees are substantially less if the customer migrates to Azure.

Transformative role in Australia

In Australia, Nadella will meet selected clients in business and government, as well as be the special guest at a Chanticleer lunch in Sydney on Wednesday.

"For nearly four decades, we’ve partnered closely with leading organisations of every size in every industry in Australia to help them innovate," he says ahead of his arrival.


"Today, more than two million Australian organisations use our platforms and tools, and we are investing significantly in our local engineering presence, as well as our data-centre footprint in the country, so customers can build the digital capability increasingly required to compete and grow.”

One of Microsoft’s largest customers and partners is Telstra. It is an Azure customer, the biggest reseller of Microsoft 365, and it will be the exclusive Australian partner for the launch of the new Xbox All Access gaming package, a gaming subscription service.

Telstra chief executive Andy Penn says Telstra is using a Microsoft product called Teams to collaborate and work in an agile way as part of its transformation.

"Much of what we're trying to achieve from a transformation point of view and moving to agile is what we see our customers wanting to do as well," he says.

Penn says Telstra needs to be much more closely aligned with companies like Microsoft and their way of working and thinking.

"We need bring together the capabilities of telecommunications and software and that's why we have worked really closely with partnerships and relationships with people like Microsoft," he says.

Westpac chief executive Brian Hartzer says Microsoft has helped boost collaboration at the bank.

"One of the things I find really interesting at the moment is if you combine what the tools can do for normal working people in office environments with new structures of how you manage people, it's really quite profoundly changing what goes on in a big company and the way a big company goes about doing its work," he says.

In the tech bubble heyday of Microsoft, the company was often accused of being arrogant. That is unlikely to happen this time judging from Smith's comments about the possible lessons from winning the JEDI contract.

"Never assume that you're in the leadership position in technology because the leadership position can change quickly," he says. "Never conclude that you're so far behind that you can't catch up."

Disclosure: The author's self-managed super fund owns shares in Microsoft.