AWS Feels The Cloud Price War Pinch
The public cloud business of retailing giant Amazon is nearly doubling in terms of capacity sold to customers in the past quarter, but it looks like the aggressive moves by Microsoft and Google with their respective Azure and Cloud Platform clouds is taking their toll on the revenues and perhaps the profits at Amazon Web Services. And the normal and aggressive price cutting by Amazon that it has instituted from the beginning of its cloud eight years ago is also putting pressure on sales.
Wall Street has been waiting a long time for Amazon to show a profit that is commensurate with its size and influence in the retail business, and it looks like investors will have to wait even longer. Amazon is more interested in expanding into new markets like AWS, tablets and now smartphones, and the creation of original television shows (just to name three), which get the company into new markets and interacting with new customers. In the second quarter ended in June, Amazon's overall sales rise by a stunning 23 percent to 19.34 billion, and the company posted a net loss of $126 million in the period, much more pronounced than the $7 million loss in 2Q 2013.
Amazon does not break out sales of the AWS cloud unit separately, but has conceded that AWS does indeed dominate its Other category, which also includes revenues from advertising services and co-branded credit cards. This Other category accounted for $1.17 billion in sales in North America and only $50 million in the rest of the world, for a total of $1.22 billion and an increase of 36.5 percent year-on-year. On a conference call with Wall Street analysts to go over the numbers, Amazon chief financial officer Tom Szkutak said recent and deep price cuts, announced in March and ranging from 28 to 51 percent, had an impact on the quarter's revenues, but he would not quantify it further. He did toss out a statistic that AWS usage was up 90 percent in the second quarter compared to the year ago period, but precisely what that is measuring is not clear. Szkutak said to "think of it as almost a proxy similar to unit growth on our retail business" when pressed about what this metric was and added it was a "proxy to say how fast the physical volume is growing." How this is measured across compute, storage, and networking services plus platform services that run atop them is not obvious. But the most obvious way to measure raw capacity in a datacenter is the number of racks of gear or megawatts consumed, so this might be how Amazon is doing it.
The concerning bit for Amazon but not so much for its customers is how the revenue stream from the Other category has fallen off sequentially and how the latest and future price cuts might eat into it further. In the first quarter of this year, the Other category accounted for $1.26 billion in revenues and grew at 57.5 percent year-on-year. So in one quarter, the growth rate for Other has been cut nearly in half and there was in fact a 3.1 percent sequential decline.
AWS may rule the public cloud, and Amazon may be investing heavily in its datacenters for AWS and its own uses for its retail and media operations, but it does not have deep pockets like Microsoft and Google, or even IBM if that company really decides to build out its SoftLayer cloud even more aggressively. Amazon ended the second quarter with $5.06 billion in cash and another $2.93 billion in securities, but it has $3.12 billion in long-term debt on its balance sheet. Google, by sharp contrast, has $18.9 billion in cash in the bank and another $39.8 billion in marketable securities and has only $5.25 billion in total debt. Microsoft may be laying off 12,500 people in the wake of its Nokia handset business acquisition, but as it exited its fiscal fourth quarter at the end of June, it had $8.67 billion in cash and another $77 billion in marketable securities in its war chest against total debt of $22.6 billion. Google and Microsoft could afford to keep building out their public clouds and giving capacity away for free for years to try to unseat AWS.
Amazon is obviously committed to growing that AWS business, if for no other reason than it essentially makes the startups and now enterprises of the world help pay for its own IT expenses since AWS is really just a revved up IT shop that is outsourcing its services and making them available to its parent. (Imagine if all IT vendors were as aggressive with their own internal operations, and they most certainly are not.) If all AWS was breakeven it would be worth it because of the innovation the AWS customer base is spawning, creating that flywheel effect that Amazon itself benefits from even as AWS customers do.
But that is not the only reason why Amazon will continue to pour money into AWS. The public cloud gives Amazon a perpetually happy story to tell, where its influence is disproportionately large compared to its size – call it a $4 billion to $5 billion tail wagging a $1.5 trillion IT industry dog. Moreover, it is fair to guess that the AWS business is more profitable than the rest of the retailing operations at Amazon, which operate on razor-thin margins. Another way of saying that is: Imagine how much more money Amazon would be losing if it did not have a wildly popular public cloud right now?
While Wall Street was looking at the impact of price cuts on AWS revenues, Szkutak wanted to shift the focus to the long term, which is what Amazon is always doing regardless of what business segment it is discussing.
"Another thing to keep in mind as you look out related to AWS is we're continuing to invest in that business," Szkutak. "And with the great, strong usage growth rates that we are seeing, we are also investing in capex and infrastructure to support that growth. So again, the team has done a fantastic job innovating on behalf of customers. And as I mentioned earlier, the new releases both from a service and feature perspective was about 250 year to date, which is at a pace that is much faster than we have seen over the last few years with very high bar, given all the innovation that has happened from that team in that space."
It is safe to assume that Amazon will continue to crank the innovation and capacity on the AWS cloud and try to make it up in volume.