Competition and sky-high margins are driving cloud giants up the stack, where they are redefining the cloud with specialization, software and analytics.

Boyden's perspectives on the news and trends that are transforming industries

Cloud computing is a young, rapidly growing industry dominated by Amazon, Microsoft and Alphabet. According to Synergy Research Group, Amazon Web Services (AWS) has 34% of the cloud infrastructure market. This is the biggest share, but Microsoft Azure and Google Cloud Platform (GCP) are progressing. Global industry sales are forecast to reach over $495 billion this year, according to Gartner. And there is plenty of room for growth, since only 30% of enterprise workloads have moved to the cloud so far. By 2030, the industry could grow to more than $1 trillion.

The cloud business has been especially profitable for Amazon and Microsoft. AWS accounts for three quarters of Amazon’s operating income. Microsoft’s Azure is believed to be equally lucrative. Google, in its efforts to gain market share, has been hindered by $3.3 billion in cloud-related operating losses over the past 12 months. The competition is intensifying. Together Alphabet, Amazon and Microsoft have invested nearly $120 billion in 12 months, mostly on data centres and servers.

All three are showing healthy revenue growth: AWS’s sales grew by 33% last quarter compared with a year ago, while those of Azure and GCP rose by 40% and 36%. The firms have also cut costs by optimizing their servers to have longer lifecycles and require fewer upgrades. They are also reclaiming margin from suppliers by designing chips in house. AWS has the market-leading Graviton chip, while Google’s Tensor Processing Units can boost machine learning capabilities.

The cloud giants also benefit from the stickiness of their services. It is rare for a company to switch from one cloud to another. Doing so is cost prohibitive and offers little gain. Further, cloud services tend to be tailored to different markets. Many of GCP’s and AWS’s clients are tech startups, while Microsoft mostly serves large organizations, having built Azure through its ubiquitous enterprise software business – though this landscape is changing as they begin to encroach on one another’s territory.

While they have erected strong pillars to support their sky-high margins, the cloud computing leaders are not invincible. Some of the conditions that have allowed them to flourish are subject to change: The industry will mature, meaning slower growth. Hardware improvements will hit their upper limits, driving up operating costs. Customers are growing less tolerant of the “egress” fees companies charge for migrating to another cloud platform, forcing providers to show more lenience.

Alphabet, Amazon and Microsoft are preparing themselves for these inevitabilities by moving up the tech stack into higher-margin software and even stickier, more specialized services. This includes software for specific industries that runs on top of their cloud servers. All three companies are recruiting executives from the industries to which they plan to sell tailored software. The cloud providers currently offer software for customers in gaming, government, finance, and increasingly healthcare.

Another area of opportunity is high-end analytics using artificial intelligence and machine learning techniques, where the three giants already offer multiple services. Further, Google and Microsoft are investing in quantum computing. Such advanced analytics sitting atop the cloud could give customers new capabilities, delivered by virtue of the cloud at lower prices along with more data. As The Economist observes, “the push shows where the cloud industry could go.” Transformation is in the making. 

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