Cloudonomics: The race to zero is moving up the stack

Amazon CEO Jeff Bezos

Chessboard chess gameThe trademark margin-cutting strategy of Amazon CEO Jeff Bezos has disrupted brick-and-mortar commerce and forever changed consumer spending, but that’s only the prelude to the future impact on the enterprise. The retail-turned-cloud-giant’s model is now redefining the fundamental economics of technology services in a new area: software.

Amazon spearheaded the shift from selling hardware by the box to selling it by the hour nearly a decade ago with the explicit intent of undercutting traditional vendors and repeating its success in the consumer world. The company has since expanded the effort with value-added features to help customers take advantage of its infrastructure, attracting numerous contenders along the way, but the underlying pricing strategy remains centered on the equipment even as the competitive focus moves up the stack.

That disconnect is generally perceived to have divided the cloud race into two separate lanes in which Amazon and its main rivals, Microsoft and Google, compete over functionality on one side while chasing lower rates on the other. The strategic shift beyond infrastructure is now forcing the fight in a new direction.

“Although Amazon, Google and Microsoft can continue to drive down the costs of their infrastructure-as-a-service offerings to win new customers, they must develop better methods to satisfy the expectations of these low-paying customers so they can ensure their loyalty and generate greater margins from these accounts via up-selling and cross-selling,” Jeffrey Kaplan of THINKstrategies Inc. told SiliconANGLE.

That is reshaping the long-held competitive lines of the public cloud with software as a new battleground. And just like when the public cloud first emerged in the mid-2000s, Amazon is once again at the crest of the wave.

While the infrastructure-as-a-service giant still asks an extra fee for certain services such as its managed Hadoop implementation on top of the basic hardware charges, many other of its value-added offerings, including the ultra-reliable relational database introduced last year, only cost as much as the resources consumed. And in typical fashion for the public cloud, the competition is close behind.

Microsoft reportedly plans to bill its upcoming hosted Hadoop alternative based only on the infrastructure that customers will take up to process their data in what is an unmistakable jab at Amazon. And if its track record on staying ahead of the curve is anything to go by, Jeff Bezos’ firm will match that pricing once Redmond’s service launches.

Economies of scale

 

In cloud computing as in retail, one vendor’s margins represent an opportunity for another, and software is one of the most profitable types of products around. That stems from the fact that software costs are fixed whereas hardware costs are proportional to usage, which means that big providers like Amazon can afford to offer value-added services at a lower cost since the development expenses are amortized across many customers.

Hardware, in contrast, carries an unavoidable marginal cost with a growth curve linear to usage requirements. As a result, the big providers are not so much racing one another on cloud rates but rather Moore’s law to pass along savings as their suppliers lower equipment costs. That is becoming all too evident from what some perceive as the stagnation of the price wars, with big players matching each other’s price cuts but not really breaking new ground. Prices can only fall so far.

“We’ll see more decreases in the cost of compute,” said Sharon Wagner, the CEO of Cloudyn Ltd., which provides cross-platform management services. But “many vendors are bounded by network costs, so you won’t see significant network cost reductions coming soon,” he added.

The increasing difficulty of competing in the hardware layer is what is ultimately driving providers to try to differentiate up the stack with value-added features. With much of that new functionality already available for free and the rest poised to follow suit, the industry may be headed toward a future in which software won’t cost much more than the infrastructure needed to run it.

That’s good news for enterprise technology buyers, but not so much for traditional vendors that make their living selling licenses and small providers that can’t afford to relinquish profitsgenerated from value-added features that larger competitors are now effectively giving away. It’s a recipe for disruption that could tilt the competitive balance of power more firmly toward the major providers.

“Expect Amazon to add more management capabilities for hybrid clouds, expect more focus on backup and recovery-as-a-service,” said Cloudyn’s Wagner. “When enterprises move to the cloud there is a new set of requirements that you don’t get from SMBs.”

Amazon, at least, is bearing out Wagner’s predictions. It launched a new hybrid feature last week that extends its updating service to on-premise environments. And in recent quarters it’s added on-demand code executionrelational databases and continuous delivery, among other value-added services.

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