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Cloud computing giants are racing to protect their big profits

When boss executives ring the closing bell on the Nasdaq stock exchange in New York, usually because their company has just gone public. When Adam Selipsky did it on June 27, he was celebrating a bond with the stock market. He is the head of Amazon Web Services (oooh), the tech giant’s cloud computing arm, and the deal is part of the exchange’s shift from its stock markets to oooh’s cloud. Custom features include data transfer with minimal delay to please high-frequency traders. Nasdaq clients will be able to use ooohAdvanced analytics tools, such as machine learning (ml), through the bag platform.

The deal, first announced in November, came weeks after Google’s parent company Alphabet revealed a similar link between gcphis cloud offering, and CAME, one of the largest derivatives exchanges in the world. A day before the deal closed, Microsoft Azure announced the launch of its financial services cloud. Clients include Morgan Stanley and hsbc, two benches. Not-so-big tech is also getting in: ibm and Oracle also offer financial clouds.

Cloud competition is growing. Alphabet, Amazon and Microsoft have together invested nearly $120 billion in the last 12 months, most of it in data centers and the servers that power them. Amazon and Microsoft have seen their capital expenditures as a share of revenue rise by nearly five percentage points over the last five years to 13% (see chart 1). Customers, increasingly annoyed by skyrocketing bills, are opting for more than one cloud service for fear of being locked out. “It’s not a winner-takes-all market,” says an executive at a large cloud provider. The tech giants are fighting for the upper hand.

This activity should be putting stratospheric earnings pressure. oooh it accounts for three-quarters of Amazon’s operating income. Before this year’s tech stock crash, some analysts estimated it could become a $1 trillion company if it were spun off. Microsoft’s Azure is thought to be just as profitable. Google, by contrast, is taking a hit in its bid to gain market share. It racked up $3.3 billion in cloud-related operating losses in the past 12 months, or 1% of Alphabet’s total revenue. Thomas Kurian, gcpThe boss of, has said he wants to be out of the red by the end of the year.

For now there are few signs of a margin squeeze. the 28th of July oooh reported an operating margin of 29%, four times that of Amazon’s retail business. Azure’s margins, which Microsoft does not disclose, are also believed to be stable. Google’s cloud segment cut its operating loss from 16% of revenue in the previous quarter to 14%.

A combination of a fast-growing industry, hardware upgrades and barriers to switching providers explains why margins have risen. But some of these factors are transitory. So the cloud giants are bracing for a squeeze by trying to sell higher-margin software and making their services even more complicated. The result could be a huge cloud marketplace offering a range of new capabilities to customers.

Cloud computing, still in its infancy, is growing rapidly. oooh It created the industry in 2006 as a way to make money from its excess storage capacity by offering to host other companies’ data. gcp joined the fray two years later, followed by Azure in 2010. Partly because it moved in first, oooh it has 34% of the cloud infrastructure market, which is still the largest share (see chart 2), according to data from Synergy Research Group. But Azure and gcp they are catching up.

This year, global industry-wide sales are forecast to exceed $495 billion, according to Gartner, a research firm. That includes an ecosystem of companies that sell services in addition to or related to the cloud, such as Okta, a maker of authentication software, and Mongo.database, a database company. It could grow to more than $1 trillion by 2030. Today, only 30% of enterprise workloads—applications, software programs, or work that would have run on a local server—have moved to the cloud.

The revenues of the big three “hyperscalers” continue to grow at a decent pace. Last room oooh’Sales of s grew 33% compared to a year ago. azure and gcp handled 40% and 36%, respectively. Amazon and Google have a backlog of multi-year contracts that have yet to be reported as sales of $100 billion and $50 billion, respectively. (Microsoft does not publish this number.) Such growth has meant less pressure on margins.

Companies have also been able to reduce hardware costs by making better use of older machines. Servers need to be updated less often than previously thought, making clouds cheaper to run. All three tech giants have announced extensions to the average lifespan of their servers from three to four years. On July 28, Microsoft was better, saying it would extend it to six years, saving the company around $4 billion in 2023. oooh it’s still running some servers it bought in 2006.

Taking chip design in-house has lowered hardware costs by clawing back margin from chip vendors. oooh’s Graviton chips, designed by a team it acquired in 2015, lead the market. Google offers Tensor Processing Units, designed to power machine learning (ml) capacities, among others silicon. Microsoft is also trying to develop custom chips. In January, he snapped up one of Apple’s top chip designers. Even when costs have come down, prices have not followed suit, keeping margins high.

Margins are also protected by the fact that few companies have moved workloads from one cloud to another. David Linthicum of Deloitte, a consultancy, says that companies like to have the ability to change, but they rarely have. One reason is that the benefit may be small, while the costs may be prohibitive. Hyperscalers charge “egress” fees for moving data out of their cloud.

Another barrier to change has been that cloud providers tend to serve different markets. oooh It started as a service for developers and many of its clients are tech startups. Microsoft, by contrast, sells more to large organizations. It uses its long-established enterprise software business to cross-sell Azure. I like it oooh, gcpClients of are more often tech startups, in part due to their reputation for using advanced technologies, although it also includes cloud services with their advertising and productivity offerings for large clients.

However, the concern now for cloud providers is that the factors that supported margins are starting to give way. Hyperscalers are hunting more and more in the territory of others. oooh other gcp they are hiring bigger and bigger sales teams to help big companies. Microsoft is trying to attract more technicians. It offers free Azure services to startups, including some from Github, a system for tracking changes to software code, which Microsoft acquired in 2018.

Exit fees may also be falling. oooh cut some in December. Big customers are said to be able to negotiate discounts, sometimes forcing tech giants to forgo them altogether. Costs may start to rise as limits are reached to extend the life of the server. And, more importantly, growth will slow as the industry matures. One executive says he expects competition to drive down margins in the medium term. He also believes there is room for more competitors further up the “tech stack.”

Faced with the prospect of shrinking margins, hyperscalers are trying to move themselves up the tech stack. One promising area is creating software that runs on top of their servers for specific industries. Selling software is more profitable than selling hardware, because costs are lower and scaling is easier. And the software can also be more complicated. It is easier for a hospital to change its data storage providers than its health records database providers. The trend is showing up in hiring, executive recruiters say. Amazon, Microsoft and Google have been busy hiring heads of specific industries with the goal of selling cloud services in their markets again.

Cloud providers offer software for a variety of organizations, from gaming companies and government to finance, such as the oooh– Nasdaq offers shows. They’re also buying their way into a healthcare cloud. In 2021, Microsoft announced the acquisition of Nuance, a provider of cloud health services, for $20 billion. In June oooh invested in Oben Health and PeerCapsule, two health startups. Oracle spent $28 billion on Cerner, which develops electronic medical record software

Another draw is high-end analytics, using techniques like artificial intelligence (ai) other ml. Microsoft offers 26 of these services, Amazon 25, and Google 12. Customers can analyze video images, convert speech to text, and receive recommendations to improve their code. Google and Microsoft have invested heavily in quantum computing. The idea is to sell something that is difficult to replace, making it difficult to change. “The Hears other ml offers are all unique. They’re done in radically different ways,” says Bernstein’s Mark Moerdler, a broker.

The shift to software may not be a huge success for cloud providers. Regulators may take a dim view of Big Tech’s attempts to dominate cloud-based technology it’s services. And many companies, like Databricks and Snowflake, already sell cloud-based software. Customers may resist being locked into a tech giant’s software services, just like they do with storage services.

Still, the momentum shows where the cloud industry could go. Companies first adopted cloud computing to gain flexibility and reduce data center spending. Now, advanced analytics sitting on top of the cloud could offer customers new capabilities. use of groceries Hears and video cameras to know when to restock the shelves; Cirque du Soleil uses similar technology to analyze the emotional reactions of its audience when performers perform death-defying stunts. these new ml The capabilities, provided by the cloud at lower prices and combined with more data, greatly expand the upper limit of the cloud computing market, notes Keith Weiss of Morgan Stanley.

These are the kinds of things Satya Nadella, the head of Microsoft, is referring to when he says that it’spart of gdp could double in a decade. If true, then cloud market dominance is worth fighting for. And the war is just beginning.

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