June 5, 2014

In recent blog posts we wrote about the tensions in business strategy being exposed by the market behavior of commodity cloud providers such as Amazon’s AWS, Google’s GCE and Microsoft Azure.  In effect, in a world of public cloud giants commoditising basic compute services, the ability to layer additional product offerings onto infrastructure will become a key differentiator in winning business and boosting margins.

Google recently dropped prices on its basic cloud service, with AWS following suit in remarkably short order. Basic cloud “compute” services are to a considerable degree fungible and, as they are marketed and provisioned over the Web, knowledge of price cuts spreads very quickly. These services are being offered by financially well-endowed behemoths. Amazon (NASDAQ : AMZN), for example, has a market capitalisation of $149 billion: a number dwarfed by the $377 billion equity value of Google (NASDAQ: GOOGL).

When infrastructure is the sole offering it becomes clear that the requisite scale is truly massive. The example of public storage provider Box Inc. (also the subject of recent blog posts) is telling. Box had been expected to go public, but weaknesses in its financial model revealed in the S1 filing were, when combined with a retrenchment in go-go technology valuations, sufficient to postpone the IPO. Box has raised a striking amount of venture capital (~$385 million), but its “freemium / build scale and ignore losses” model means that it has burnt through over 2/3 of the cash. The company has a year and half of cash and available credit lines in its treasury. At almost $175 million this is not a negligible amount, but in the absence of either an IPO or starting to generate cash this will dwindle. It may be obvious, but if the IPO window doesn’t open, in 6 months Box Inc. will have only a year’s cash left… Will customer start to wonder about the long term viability of the company? Will they move to larger rivals? (Another interesting point of contention between management and investors could become the $550 million of liquidation preferences the VCs have put in place.)

That said, many business have more evolved needs, and it is in the domain of additional services that many other market participants will seek to compete.

Rackspace (NYSE: RAX) was a private cloud pioneer. At $5.1 billion of market capitalisation it is dwarfed by its public cloud rivals. Faced with commoditisation of basic public cloud services it has decided to avoid the perils of a price war by offering clients a pairing of “fanatical support” with a managed services offering combining public and private cloud with applications management. Rackspace is also of a sufficient size to reassure customers.

IBM is even bolder in its ambitions. It has moved beyond offering infrastructure and management tools to actual applications. In March we wrote about IBM CEO’ Ginny Romitty’s talk at Mobile World Congress. In that speech she described data as a “natural resource”. Cloud she defined – or perhaps redefined – as being any process or business service offered “as a service” (or aaS in techno-acronym speak). This differs from standalone software or processes run on in-house machines. Ms Rometty noted that by 2016 fully ¼ of applications will be run in the cloud and, even more strikingly, that 80% of all software developed today is for the cloud.

The logical evolution of this came this week when IBM launched a new brand: “Cloud Business Solutions”. This integrates its business process outsourcing, software as a service (SaaS) and infrastructure as a service (IaaS) portfolios into one offering.

“Cloud Business Solutions” is offered out of the IBM Softlayer data centres and encompasses 12 software packages “as a service”. Another 8 are to follow by year end. Softlayer is to provide orchestration, provisioning is to be through an on-demand platform and (interestingly) contracts will be standardised.

It will be fascinating to watch the battle in the marketplace between low-cost commodity infrastructure services and value-added providers. An underlying theme to watch will be the ability of smaller service providers – no matter how talented – to reassure their customers about financial solidity.