Amazon's critics misunderstand the impact of its pricing cuts

While Amazon took a beating last quarter due to pricing pressure from rivals, that same pricing pressure may be helping the cloud giant in ways its critics misunderstand.


Last week wasn't very pleasant for Amazon Web Services (AWS). Despite usage climbing 90% in the quarter, Amazon reported slowing revenue growth for AWS as it cut prices by between 28% and 51% for various services to compete with Google and Microsoft. Competitors and journalists crowed that "AWS is feeling the pressure of cloud competition."

They may have spoken too soon.

While AWS is by no means invulnerable to competition, its critics may be overlooking the scope of its ambition, not to mention how these pricing cuts could be helping more than they hurt.

Profits down, knives out!

No sooner had Amazon reported that growth at AWS had slowed to 38% from 60% in its first quarter than a barrage of criticism poured in. If you've ever wondered what a dog pile looks like, here's a taste (see Figure A).

Figure A

Figure A
AWS dog pile.

Some of the hyperbolic response is understandable: AWS has dominated cloud computing so completely for so long, any cracks in the empire are news.

While competitors have hitherto failed to match AWS' cardinal virtue ­convenience,­ some thought that maybe this didn't matter; that just charging less could be enough. That's a losing strategy, given that the company that has most consistently dropped prices over the years is... Amazon.

Not that Microsoft and Google are resting on their low-­price laurels. Microsoft has a compelling hybrid cloud story and Google offers exceptionally fast inter-­datacenter network performance.

The natural order of a maturing market

Such competition is normal, as is the pricing pressure on AWS and everyone else in the market. But it's not a sign that AWS is failing.

Indeed, AWS knows that its infrastructure services will eventually become commoditized, which is why the company recently introduced Zocalo, a content storage and collaboration service, and is clearly moving "up the stack" to maintain profit margins even as it furthers its "business of pain management for enterprises," as Amazon CTO Werner Vogels recently declared.

Gartner's Lydia Leong opines that each of the IaaS vendors will need to follow suit as "Over time, the IaaS providers will make most of their margin off higher-level services rather than the raw resources," calling out the significant price differential between "what a customer pays for Redshift data warehousing vs. raw EC2 compute plus EBS storage."

For now, however, the price drops may crimp Amazon profits, but they also serve other valuable, strategic ends, as Leong highlights:

"The magnitude of the price drops is scaring away many rival providers. So is the pace of innovation. Few competitors have the deep pockets or willpower to pour money into engineering and data centers in order to compete at this level. Most are now scurrying to stake out a niche of the market where they believe they can differentiate."

Fewer competitors ultimately means AWS pricing power will resume normal service. In the meantime, lower prices have the effect of simultaneously expanding the market while keeping companies from building their own clouds, as Leong points out:

"Lowering the price expands the addressable market, as well. The cheaper it is to do it in the cloud, the more difficult it is to make a business case to do an on­premises solution, especially a private cloud."

In fact, things have progressed so far in this direction that "Most enterprises no longer look at cloud as an if," as Tom Kershaw, director of Google's cloud platform, told The Wall Street Journal. "They look at it as a when."

Amazon is still the cloud to beat

That "when" is very good for the market leader, with Amazon still claiming five times the utilized capacity as its next 14 competitors combined, as Gartner reports.

No, this doesn't mean AWS necessarily will dominate forever. As mentioned, Microsoft and Google, in particular, offer compelling benefits that AWS has yet to answer. But it's also not the case that a single quarter should tarnish the shine on AWS' impressive cloud business.

After all, as Leong concludes, "[T]he slight dip in revenue, vs. the magnitude of the cuts, makes it clear that AWS is still growing at a staggeringly fast pace." How fast? Perhaps the fastest­ growing software business in history, as Businessweek detailed.

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