After so many years of intrigue and secrecy, there was one major reason why Amazon released its income and expense figures surrounding its cloud services division last week: to pump up its value to spark more incoming cash and prepare for an AWS spinoff. While AWS is the largest cloud infrastructure player in the business, it is coming at the expense of an incredible cost of investment, and its numbers show a disturbing, razor-thin margin that can be traced back to its position as a commodity player.
Amazon is in a precarious market position, and it’s counting on a big story to take it over the line to carry on another day. Behind those stories are some serious problems; one of the consequences for these results will have to be ever-escalating costs and continuously dropping prices. The story line we need to pay attention to resides between the lines. How does Amazon maintain and increase profit on AWS? The answer is to continue to charge exorbitant fees for bandwidth and other ancillary cloud services.
The Numbers Say: Spinoff
As we recently predicted at Codero, this is likely the first step towards selling AWS, or spinning it off entirely as its own separate entity. The numbers show how big a share of the market Amazon owns, but there certainly are significant problems with profitability. We have only witnessed part of the story and, unfortunately, there are many companies like Google and Microsoft repeating it.
When you dig in and look at a number of different elements from free cash flow, return on invested capital, net sales, shares, and segment results, there’s cause for real concern. For example, while the division was able to increase the year over year revenue by 49%, the profitability only moved up 8%. Where did all that extra revenue go? That ratio indicates how much this commoditized share is costing Amazon, and it should have customers and analysts downright worried.
Another problem: Amazon margins are under tremendous pressure. Companies don’t volunteer to lower margins out of the goodness of their hearts. This was caused by the pressures of the market, watching tech-giants Google and Microsoft (among many other smaller players) barge into the cloud space and give AWS a run for its money.
Another key point missing from these numbers is how Amazon accounted for its own operations. There is no accounting of costs between internal and external services at all. Amazon is its own biggest customer, and surely it must be reporting this ‘revenue’ at a high rate of ‘profit’. On the same topic, these same costs are also not there. These are curious omissions to say the very least.
Indeed, many holes are to be found, but within those holes a story is told. AWS is a bonafide juggernaut, but it is one built on a massive commoditized model that doesn’t scale to a degree that delivers real value to AWS customers. It is a model of continual spending and buying of market share with little hope of delivering a true profit on the services alone. The question is: Why? Don’t we all need to make money and show a profit?
AWS is in a race to the bottom. Amazon is doing with its cloud services business what it’s done with all of its businesses: live within the thinnest of margins. Every other business Amazon participates in has almost non-existent profits. While Amazon’s AWS may compete with industry giants like Google, Microsoft, and IBM, these three businesses are able to run their cloud divisions at a loss. All three of these companies are massively profitable outside of the cloud services business, and the revenue they generate is the means to an end.
For example, Microsoft sells software at a massive profit, IBM sells services and software, and Google makes money through search and software. Each has a profitable application stack or revenue source that is far beyond the AWS profit margin. Since these companies are not counting on this low-margin business, they can (and do) take this market to the absolute bottom to make money where the sales (and profits) are high.
Amazon has no choice but to follow suit every time a competitor cuts their prices. There is no way for Amazon to win with that pressure and those margins. Market share and cash don’t mean anything if you aren’t profiting, and it is totally unsustainable… unless customers start to pay — and pay big. It comes back to roach motel analogy: You can go in, but you can’t get out!
Customers: On the Hook
It’s time to face facts. Amazon is a low-margin retailer mired in a cut-throat market where attrition is imminent as a massive price war continues to play out. Just look at what happened to HP Cloud Services/Helion: even HP could not sustain life with these thin margins. Profits cannot be made under these situations unless you start to gouge your customer base in a non-apparent way, use your commanding market share to lure customers in with easy entry and low costs, then turn around and reap it back from extra costs and expensive add-on options.
Look at the bandwidth, database and storage bills that AWS burdens customers with already. This, in particular, is a shame, as Codero’s position has been that these services can easily be offered for a fraction of the cost by means of dedicated cloud and hybrid cloud services.
Now, imagine the fees for those add-on services going even higher. Soon enough, you won’t have to imagine it because high ticket items tacked on to the ‘giveaway’ cloud is the only way forward. Profits have to come from somewhere, and if they aren’t coming from the base, and Amazon keeps building the way it has to build, profitability will have to come from all these ‘extra’ services. Not a good deal in the end.
Spinoff, Selloff, Ripoff: A Storm of Bills is Coming Your Way!
Everything is riding on this inflated value, this neat-but-partial story. At the end of the day, all roads lead to a spinoff or selloff. If the story is to be believed, AWS is a division that is poised to go off on its own. Many people like a good story, and will buy a piece of the illusion. At the same time, the size and influence of the company are there, and the potential to leverage massive profits out of the existing customers may attract a suitor. One thing is for sure: regardless of which way Amazon goes, customers will get hurt.
The question is whether a business can endure under those conditions, gouging customers, locking them in to a rigid ecosystem, and absolutely nail the timing to turn this into something sustainable. Not to rain on anyone’s parade, but profit problems in the numbers and will only get worse from here. If you are a customer, a storm of hype – followed by a storm of massive bills – may be coming, so prepare yourselves.
Also: What happens when AWS really does spin off? It’s on its own. There’s no mothership to wash away problems or to fund infrastructure growth. There’s no big brand behind AWS, and no big massive customer called Amazon. The spinoff will have to have a laser focus on margin and market sentiment, it will start feeling the same pressures Rackspace started to feel in many ways, and it’ll have to “innovate” with its model to add on more price. They will start acting differently because they will be under a different level of scrutiny.
The Alternative? Don’t Believe the Hype and Scale Smart
The dedicated and hybrid hosting market tells a different story. With fixed capital costs, high customer retention rates, and new dedicated-cloud hybrid capabilities, providers offering the appealing power of dedicated infrastructure paired with instant cloud scalability are gaining acceptance by customers and analysts alike because they offer the highest level of flexibility, the strongest SLAs, and the lowest total costs for customers.
Hybrid hosting can be defined as dedicated AND Public Cloud resources connected via a native private network and controlled from one single control panel or API. The Hybrid market has been projected to capture 15% of the hosting market in 2015, indicating we may be seeing a new “next big thing.” Stay tuned to the Codero blog to watch how we’re pushing the envelope for our customers in terms of hybrid IT infrastructure that leverages the best-of-breed of technologies and approaches.
On a final note, everyone here at Codero is at your service. Please give us a call, send us an email. We are here for you.