AWS, Microsoft, and Google are spending big to win big in cloud, but AWS has a secret source of cash that could prove dispositive.
Even as the public cloud providers go gaga for serverless, a quick look at their balance sheets indicates that, while things like AWS Lambda might be serverless for you, they're serverfull for the vendors. As Goldman Sachs tallies it up (and Bernard Golden summarizes), Amazon Web Services (AWS), Microsoft, and Google collectively spent $35 billion on data centers to power their cloud businesses in 2017. However, only AWS has thus far recouped its outsized investments, earning $17.5 billion in 2017 compared to its $9.2 CapEx spending.
Not that this is stopping Microsoft and Google, both of which are outspending AWS in an effort to catch up. As Golden has noted, "Mix webscale and network effects, and companies that want to be winners need to spend, spend, spend." Oracle, IBM, and Alibaba are flat to slowly increasing expenditures, a sure recipe for continued irrelevance in the cloud wars. For "AMG," as Golden has styled the holy cloud trinity of AWS, Microsoft, and Google, the size of their investments is indicative of just how much revenue is at stake.
With Amazon, in particular, it's also worth looking at where this spending money is coming from.
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A once in a century opportunity
The tech industry has never seen this level of CapEx investment before. The numbers involved are breathtaking, but doubly so when you look at the growth rates in those expenditures.
None of the big three AMG companies are resting on their laurels, though. Instead, each year they plow at least $1 billion more than they had the previous year into expanding capacity. The reason, Golden has reasoned, is clear:
Looking at history, there aren't many companies that invest 50% of revenues in capital (AWS), not to mention 100% (Microsoft) or 200%-400% (Google) (adjusting both for the cloud/other ambiguity). To reiterate, this investment pattern reflects the realities of the cloud computing market: it's a platform-based industry with enormous network effects that requires sufficient capacity to support exploding, spiky demand, much of which can emanate from geographies that require local infrastructure. That's a recipe for needing to plow huge amounts of money into the business.
No one will win "small" in cloud. There are no incremental players at the IaaS/PaaS level. You either win big, or you lose big. AMG are investing to win big, with hundreds of billions of dollars at stake, whereas old guard, would-be cloud vendors like IBM and Oracle have money they could be spending, yet continue to try to go cheap with cloud. It won't work. It hasn't worked. It's a declaration of surrender.
Where is AWS getting its cash?
Both Oracle and, to a lesser extent, IBM have cash cows they could milk to fund cloud investments, but they largely don't. Microsoft, for its part, has insane piles of cash from Windows and Office franchises that are being used to buy its future. Google, for its part, owns much of the online advertising market, and can plow profits into buying a place at the cloud table.
AWS, as Golden notes, is different, as it's nowhere near as profitable as a company, yet has managed to turn "canny operational management" within AWS into a profit center for the entire company. And yet this isn't the only place Amazon is finding money to build out its data centers.
As Forrester analyst Collin Coburn has highlighted, a little-known but hugely profitable corner of Amazon's business is its advertising business. How big a business? Upwards of $2 billion each quarter, given "numerous consumer goods marketers that are spending up to 30% of their search advertising budget on Amazon search ads," according to Coburn's analysis. As much as AWS is booming, Amazon's advertising business grew 139% last year, helping to push Amazon's profit up 221% year over year.
In other words, for anyone hoping that AWS would somehow feel constrained to rein in spending in order to maintain profitability, it doesn't look like it will need to. AWS can run profitably in its own right, but bolstered by a massively profitable advertising business? That's enough to push Microsoft and Google to dig even deeper into their CapEx budgets, and likely enough to push IBM and Oracle out of the market entirely. They simply can't keep the pace.
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