Cloud Mini-Series Part 2: The Economics Behind the Cloud and the Protectionist Threat

This post is part of a series on the opportunities and challenges of cloud computing in the developing world. The previous post covered the transformative potential of the cloud and the different types of cloud services.

Let us now turn to the economics behind the cloud. It’s a tough, fast-moving business involving substantial investments, and, most importantly, cloud services are effectively competing in a global marketplace. The ‘borderless’, instantaneous nature of online communications means that cloud services can be provided from anywhere in the world, creating almost perfect markets in some areas. At least technically, competition is just a click away. That’s particularly relevant in an environment where many of the competing services are “free” to end-users (supported through ads, donations or other business models).

At the heart of any cloud business is computing power and this is where the economics of data centres come into play. To be able to offer high performing, global services, cloud providers need to be able to exploit economies of scale. Having fewer, larger data centres increases operational and hardware efficiency because the larger a data centre, the less inefficiencies it creates in power and cooling. Also, larger data centres tend to allocate staff resources more efficiently.

Let’s first look at energy, which is one of the fundamental cost factor of data centres. In an average facility, power consumption contributes up to 40% of the annual operating budget. What makes this particularly relevant is that unlike other inputs, such as hardware, which are effectively global commodities, the price and quality of energy varies widely. Not surprisingly, then, energy considerations are one of the main drivers in the selection of data centre locations.

There are a few things to consider here: First, the energy source needs to be stable and predictable over the long term. Second, the closer a data centre is located to a power source, the smaller the power transmission loss. And Third, energy is inherently cheaper in some places. Countries with an abundance in power such as Iceland, which has 100% renewable energy from hydro and geothermal power sources, have a competitive advantage in this area.

Cooling is another important, related cost factor. According to a study by the Emerson Electric Company, it accounts for approximately 37 percent of power usage within a well-designed data centre. Therefore, reducing the need for cooling can increase overall energy-efficiency significantly. One of the ways to do this is to simply bring the data centre to the cold instead of bringing the cold to the data centre. This is part of the reasons why large services like Google and Facebook build data centres in the cooler climates of Northern Europe. Other significant factors driving site location are local labour markets, legal environments and tax codes.

Of course, not all data centres follow the logic outlined above. For example, data used in high-frequency, high-volume trading is so sensitive to latency, banks are willing to pay a premium for real estate just to be close to the physical locations of the stock exchange servers. Other latency-sensitive data, e.g. video games or popular videos, may also be stored closer to end users. On the other hand, data centres that mainly process a large number of small tasks (e.g. email) are not very latency-sensitive. These operators will likely look for fewer but larger, energy-efficient data centres that reduce per capita costs of cloud services and make them economically viable.

Political challenges to the cloud

It is important to note that these large, efficient data centres constitute the backbone of the global Internet. Thanks to the continued improvement of hardware capacity, processing power and energy-efficiency high-performing, innovative Internet services are now available anywhere in the world at little or no cost.

However, this successful model in which data is hosted and distributed based on market incentives is increasingly under pressure. As Governments are starting to look at data from a more strategic point of view, they are becoming more attracted to policies that demand data to be stored and processed in-country. The objectives behind theses local hosting requirements or ‘forced localisation’ laws are manyfold:

• Governments believe they will help protect the privacy and security of Internet users and businesses; or,

• It will help to better enforce local consumer protections; or,

• It will help develop a homegrown IT industry; or,

• They simply want to protect powerful local incumbents; or,

• They see it as a possibility for increased control over content.

Or all of the above.

Not surprisingly, the Snowden revelations have accelerated the trend towards forced localisation. On the one hand, it puts Governments under increased pressure to “do something” to protect their Internet users and businesses against surveillance. On the other hand, the revelations provide them with a welcome excuse to push some of their other objectives. From this perspective, local hosting requirements look like an irresistible strategy, allowing Governments to advance several objectives at once.

The recent developments show that many Governments are trapped in a mercantilist view of the Internet. Instead of focusing on the vast potential of this global network and how it can best be utilized to the advantage of their citizens and businesses, many Governments see it as a strategic asset where Internet companies are a tool to advance national interests. And while some of the initiatives to host data locally may be well-intentioned, they undermine one of the greatest promises of the modern Internet: The possibility to offer innovative services anywhere in the world, with almost no additional costs to connect with users abroad. As a result, forced localisation would likely make the Internet more expensive and less useful, particularly for small businesses and users in the developing world.

This was the Second in a series of posts on the opportunities and challenges of cloud computing. The following posts in this series will take a closer look at how Governments are ‘localising’ Internet services, how that threatens innovation and development, and how the cloud industry is communicating on these issues.

Matthias Langenegger is Deputy Geneva Representative in the Geneva office of the Computer & Communications Industry Association.