One of the highlights of Amazon’s re:Invent conference, which happened a couple of weeks ago in Las Vegas, was the clear statement (and constant reinforcement) by Amazon executives that with AWS they are pursuing a high-volume, low-margin strategy. This, they claim, means the replication of Amazon’s retail model to their cloud offerings: selling services at a value close to cost, so that customers benefit from low prices, and trust in economies of scale that will come from high numbers of customers to (eventually) generate profits. Or something along these lines.
Since they’ve said this, there’s been a lot of discussion about AWS’s real profit margins (and revenues, and all other numbers, since they don’t release them publicly) and whether or not they are really a low-margin business. Regardless of all this controversy, to me their statement was the equivalent of drawing a line in the sand: we strive to bring value to our customers at the lowest possible cost, while the “old-school” technology companies are only looking for higher profit margins.
This is, in fact, a very smart strategy. By making such a bold claim, Amazon is trying to create an ideological battle in the cloud marketplace. At the same time, by placing most of its competitors on the opposite side of the fence, it creates a clear distinction between “conventional” software companies that are now making a play for the cloud (Microsoft, HP, IBM and others) and itself and other cloud providers.
Despite all the speeches, claims, and ideologies behind it, “High Volume / Low Margin” is simply a business strategy, one that plays to Amazon’s strengths. Unlike traditional technology companies, Amazon has a background in the retail business, where margins are razor-thin. This means that the company knows how to survive in such an environment. Traditional technology companies, on the other hand, have always operated on high-margin businesses and are, therefore, unwilling or even unable to compete on such terms.
Each time Amazon lowers its prices, it puts downward pressures on the prices of cloud services, not only making it harder for new companies to jump into the market, but also forcing existing competitors to reduce their prices in response, thus reducing their existing margins. This is a strategy that is tied in to the increasing interoperability of cloud services. As it becomes easier for users to migrate from one service provider to another, the natural tendency will be for a migration to the services that offer the best cost x benefit ratio, which for most will be one with the lowest price.
At the same time, Amazon is slowly moving from the Infrastructure-as-a-Service space into higher margin services, such as cloud databases, long-term storage, and even cloud-based data warehousing. On these services, they can enjoy higher margins even with prices that are much lower than what the competition offers.
Pursuing such a strategy, however, is not without risks. Many times, the services or products with the smallest price are also perceived to be of lower quality, which is something that already happens with Amazon regarding the support they offer, and that may spread to other offerings. It also opens up room for other companies to take up a differentiated position, claiming that the higher prices they charge are related to the superiority of their service offerings.
On the cloud, as in everything else, there isn’t a single winning strategy, and only time will tell if indeed the low-margin approach is the best one. Even if it isn’t, however, the mentality behind it can be very useful for all companies. If applications and services are engineered for maximum efficiency, taking as much advantage as possible of the cloud’s cost optimizing features (such as dynamic scalability), they will not only be useful on a low-margin environment, but also be much more profitable in general.