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Amazon Cuts Cloud Storage Pricing 25%: Message to Enterprise Incumbents, “How Low Can Your Margins Go?”

· November 28, 2012

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Amazon’s sharp 25% price cut of its cloud storage offering, S3, is a reminder that, at its heart, Amazon is a disruptive company aimed at putting intense pressure on its competitors.

It pioneered e-commerce and has left traditional brick-and-mortar giants struggling to catch up–just ask Best Buy how that is going. However, it didn’t stop there.

Amazon’s experience running one of the world’s largest and most scalable data centers — the guts of its e-retailing operation — gave senior engineers at the company an idea.  They set about transforming their back-end, data center expertise into a pioneering Infrastructure-as-a-Service (IaaS) offering available to the public.  The leading enterprise providers at the time dismissed the phenomenon.

Companies like IBM and Oracle made huge profits (and high margins) providing major companies with sophisticated hardware and software offerings.  In fact, both IBM and Oracle publicly scoffed at the whole concept of cloud computing saying–paradoxically–that they didn’t know what is was and that they were already doing it.  (The two have changed their tune these days though.) Their customers — especially the big money medium to large size businesses — would never rely on offsite computing, right?  Wrong.

Following the classic disruptive trajectory, Amazon (and a wave of similar companies like Rackspace and Savvis) started out in the low-margin, small business segment of the market.  Their capabilities grew and offerings exploded and now they are competing for the biggest customers–particularly web-centric businesses.  These IaaS providers soon became Platform-as-a-Service (PaaS) providers because they offered operating systems, customizable applications and robust APIs to go along with the infrastructure they leased to their clients.  Amazon Web Services is now growing exponentially, gaining major new customers (like Netflix, Instagram, Reddit and Pinterest) and accounts for at least one percent of North American web traffic.

Now, the likes of IBM and Oracle are racing to catch up.  However, they have a problem: their historical margins.  (Compare Oracle’s 27.55% profit margin and IBM’s 15.53% profit margin to Amazon’s .07% profit margin.)

One of the reasons why successful incumbents are so vulnerable to disruptive technologies — as Clayton Christensen pointed out in his seminal work — is that they have a hard time adopting a lower margin business model that would mean sacrificing their current hefty profit margins.  This initial hesitance is often their death, as they are quickly forced out by new, more efficient competitors.

Leasing companies on-demand computing power has significantly lower margins than selling corporations multi-million dollar mainframes (the “cheap” ones are only 75k–but don’t forget the software and services!) and database software.  Obviously, that is not a problem for a scrappy new entrant.

So in the wake of announcements by Oracle, HP and IBM that they are a primed to compete with Amazon (as well as newer entrant Google), Amazon today announced it was cutting its cloud storage prices 25%.  In the process, the company also threw down this gauntlet:

Jassy [SVP of Amazon Web Services] said the differences between AWS and its competitors come down to margins. The large, enterprise giants such as Oracle, IBM and HP work on high margins. That has been the way they have historically made their revenues. But now the world is different. The new reality is scale and super-thin profit margins.

The big technology giants of the past are making up for this lack of capability to scale with “private cloud” solutions that are nothing more than an effort to “cloudwash,” a term that refers to the habit of these big tech providers to put the cloud name on its legacy hardware.

No doubt this battle will be interesting.  What remains to be seen is how low the old guard can go. 

Competition

Some, if not all of society’s most useful innovations are the byproduct of competition. In fact, although it may sound counterintuitive, innovation often flourishes when an incumbent is threatened by a new entrant because the threat of losing users to the competition drives product improvement. The Internet and the products and companies it has enabled are no exception; companies need to constantly stay on their toes, as the next startup is ready to knock them down with a better product.