A Big Part of the Cloud Business Model Is on the Verge of Breaking

By | 10 months ago

The sky is falling. Or, should I say, the cloud? No, I’m not Chicken Little. You might want to pay attention to this one…

The no frill infrastructure-as-a-service (IaaS) business model is in trouble. Maybe you will agree with me…maybe not… but everyone seems to be looking at infrastructure providers with rose colored glasses. It all seems a little too rosey, if you ask me. Companies are being secretive (red flag, anyone?) and some of them won't be able drum up enough monthly recurring revenue to offset their hefty depreciation expenses coming down the pipe for early capital expenditures.

(FYI — I’m not talking about cloud platform-as-a-service (PaaS) ecosystems. They’re still in good shape; although, I still firmly believe all software-as-a-service companies must play well with others to survive.)

While the tech giants and heavy hitters in IaaS (e.g., Amazon Web Services [AWS], Windows Azure, Rackspace Open Cloud, and IBM SmartCloud Enterprise) aren't going anywhere, there will be some marketplace consolidation. Startups? Good luck trying to play with the big dogs from now on…

Where are the margins?

Let’s start with commodity pricing. AWS' UK managing director, Iain Gavin, said in 2014:

[IaaS] just doesn't work from an economic perspective. When you look at the commodity pricing we have, it's high volume, low margin and there's no margin to give away. If you look at a server that's running two cents an hour for five hours, what's the resell value in that?"

Accordingly, “AWS has administered 42 price cuts in eight years [2006-2014].” Competition is brutal and providers have to convince companies to ditch their own data centers. That’s tough.

Cloudy reporting with a trace of transparency

This leads me to believe that we might not be getting the whole story from IaaS companies. And Bloomberg's Leonid Bershidsky agrees with me in an article from May, stating that we really don’t know how the major players are doing in the cloud:

There have been calls for more transparent cloud-business reporting. In March, for example, Om Malik, a veteran tech writer and now a venture capitalist, wrote an open letter to the cloud business leaders asking them to adopt some common metrics. Malik would like to see some tech parameters such as total storage and computing capacity, as well as more clarity on the business side: cloud-related gross margins and per-customer revenue.

Blogger Brian Tankersley also brought up a great point earlier this year about the “excessive focus on HOW the products are delivered (e.g. browser/public cloud) instead of WHAT the products actually do for their users.” Razzle dazzle them, right?

The forecast calls for: Customer satisfaction

To combat commoditization and maybe give IaaS providers a more profitable future, Network World proposes that vendors “add higher-level application services on top of their clouds to grow their businesses” arguing that:

As the price for cloud compute continues to fall toward zero, the hyperscale vendors will [need to] add higher-value cloud services as quickly as they can…recognizing that the margins currently enjoyed on bulk sales of compute resources are not sustainable.

A storm is brewing and infrastructure providers better start looking at higher-level services. Cloud guru Jeffrey Kaplan said in March:

having the best technology or most-aggressive sales tactics doesn’t translate into long-term success in the cloud. Instead, it’s even more important to deliver user-friendly functionality and quality customer service. Ultimately, it’s about demonstrating your customer empathy and giving them a sense of community among like-minded peers.

You know, it sounds a lot like Blake Oliver’s discussion on commoditized accounting

Is my prognosis of future of pure IaaS inexcusably grim or do you think I went too easy on these guys? Comment away!

Image: iStockPhoto

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