Last week Amazon released the worst possible news for the cloud computing industry: Amazon Web Services (AWS) continues to boom, to the tune of $1.82 billion for the quarter. That's an 81% jump, and led to a 407% operating income increase ($391 million).
It also led to an 18% jump in its stock price, as traders went wild over Amazon's surprise $92 million in profits. That profit should have competitors in retail and cloud worried.
Amazon has always managed to zero profitability, spending its "growing pool of operation cash flow into the future," as Benedict Evans explains, and to own the future. With just 1% of the retail market locked up and maybe less of the global IT pie, Amazon has a long way to go.
But with an increasingly profitable AWS business to fuel expansion of physical infrastructure to support all of its businesses, Amazon is starting to look indomitable.
A profitable future built on unprofitability
It's hard to argue with Apple's impressive profitability, but Amazon is playing a very different game. Amazon may have a richly profitable future, but for the moment it's content to spend potential profits on infrastructure expansion.
As Evans illustrates, this Amazonian spending spree on infrastructure keeps going up:
This "enormous increase in Amazon's physical infrastructure," as Evans writes, supports Amazon's retail business, but also AWS. While some question whether Amazon is by its nature unprofitable, that's not the right question to ask.
In Evans' words, "The question to ask isn't whether Amazon is some profitless ponzi scheme, but whether you believe Bezos can capture the future."
A related question is whether Amazon can afford to continue to invest in infrastructure. The answer to this, based on Amazon's latest earnings, seems to be a resounding "Yes," and AWS gets the credit.
This past quarter, AWS ran at a 21.4% margin. This translates into $391 million in profit, up 47.5% sequentially and 407.8% year-over-year. Putting this in perspective, Sejuti Banerjea writes, "What this boils down to is that despite generating just 8% of sales, the segment generates 36.4% of operating profits."
Imagine if AWS were even more profitable....
The profit train feeds the gravy train
For Amazon's competitors, both in retail and in cloud, the bad news is that AWS profitability seems to be increasing.
Part of the reason is that despite significant price decreases across the public cloud industry, AWS is finding that customers will pay for innovation, as the company's CFO, Brian Olsavsky, indicated in their recent earnings call:
We are seeing continued increases in usage, both sequentially and year-over-year. We are also seeing a great efficiency in the business on a cost basis.
Innovation is accelerating, not decelerating. We had over 350 significant new features and services and we believe that's what resonates with customers.
While pricing is certainly a factor we don't believe it's always the primary factor; in fact what we hear from our customers is that the ability to move faster and more agility is what they value.
Olsavsky went on to argue that price decreases — 49 since AWS launched in 2006 — are part of the model. Indeed, no competitors have managed to keep pace with AWS on this front, in part because few companies are structured to subsist on razor-thin margins in the same way that Amazon is.
And yet the margins aren't as thin as hitherto believed. AWS' 21.4% margin is pretty impressive, and in some ways understates how efficiently AWS runs. As Olsavsky points out, Amazon is "getting great efficiency from our external AWS business but also from our own use of AWS services."
Expect this to continue. And expect it to drive continued disruption in both retail and IT, not to mention other, as yet unannounced businesses.
As Evans concludes, "Amazon's business is delivering very rapid revenue growth but not accumulating any surplus cash or profits, because every penny of cash is being ploughed back into expanding the business further. But, this is not because any given business runs permanently at a loss — it is because the profits from what is already there are spent on making new businesses."
All thanks to that "low-margin" AWS business.
- The cloud is a two-horse race between AWS and Microsoft
- AWS is playing chicken with pricing, and enterprise incumbents will lose
- AWS innovation is what's driving adoption, not price
- Amazon's critics misunderstand the impact of its pricing cuts
Matt Asay is a veteran technology columnist who has written for CNET, ReadWrite, and other tech media. Asay has also held a variety of executive roles with leading mobile and big data software companies.