The Fight Gets Serious in the Cloud

Chief information officers and IT managers clearly have their heads in the cloud these days. Market research firm IHS Global Insight predicts enterprises will spend $235 billion on cloud computing by 2017, up from $78.2 billion in 2011. A fundamental shift in how information is stored and accessed, cloud computing makes data and programs that were once stored on hard drives and in-house servers accessible over the Internet from multiple locations and devices. The shift has been going on the better part of a decade, but it’s still gaining steam, along with the battle among technology companies to provide cloud-based services.

Cloud providers offer three main varieties of service models. Infrastructure as a Service (IaaS) vendors host hardware, such as storage, servers, and networking components, that companies access over the Internet instead of keeping it in-house. Software as a Service (SaaS) vendors host hardware as well, but also specialized software applications such as Salesforce.com’s sales tracking tool. Finally, Platform as a Service (PaaS) providers host software as well as development and deployment tools. Kulbinder Garcha, a global telecom equipment and IT hardware analyst at Credit Suisse, says costs are the major reason large corporate customers are moving to cloud-based IT. The total cost of using cloud storage, for example, is 70 percent lower than keeping it in-house, with savings on everything from facilities to warranties and maintenance.

Those cost savings also allow companies to spend more strategically on technology, Garcha says, noting that 70 percent of most IT budgets are spent on maintenance, and only 30 percent on applications that drive productivity. IT budget constraints already have companies struggling to keep pace with the eightfold increase in next-generation applications for e-commerce and social media expected over the next three to four years, according to Garcha, and anything that reduces costs frees up more resources to do so. IT managers are also drawn to the cloud’s flexibility, which allows them to get new systems up and running in weeks, rather than months. And tech companies are in a mad scramble to be the ones to help them do so. While a few behemoths, including Google, offer all three kinds of services, most vendors are still rounding out their offerings, making the sector a prime candidate for merger and acquisition activity.

If the cost advantage hasn’t already made the decision a no-brainer, Amazon and Google, two major cloud providers, are making it even more of one by engaging in a price war. On Mar. 25, Google cut its prices for cloud storage by 68 percent, and Amazon responded by cutting its own by 51 percent effective April 1. Major cost savings in IT used to come about only when a new generation of microprocessors delivered Moore’s Law-related savings or a new generation of software offered dramatic increases in productivity. But as Garcha pointed out in a recent note entitled “The Virtuous Cloud World of Amazon and Google” it’s the “sheer intensity of competition” in cloud services that’s moving the needle today. That’s good news for chief technology officers. But also bad news for providers of legacy storage, services and software that are behind the curve when it comes to the cloud. Think Dell. Or SAP. According to a Credit Suisse IT Survey conducted last year, those two companies are most vulnerable to the rise of cloud computing.

Many established IT companies are making cloud-related investments— Credit Suisse thinks Adobe and Salesforce.com, for example, are potential buyers for the likes of SaaS companies such as Demandware or Digital River, which make software to help manage online businesses and sales. In building out their offerings, though, they face an already-established and formidable foe in Amazon. At 8 years old, Amazon Web Services is middle-aged by tech standards, and Garcha estimates it brings in nearly $6 billion a year from clients including Dow Jones and the CIA, and, as shown by its price cuts, is aggressively defending its market share.

But it’s not winning on price alone. After IBM convinced the Government Accountability Office that the CIA should revisit awarding its contract to Amazon in light of Amazon’s significant price premium—$148 million to IBM’s $94 million—Amazon sued, and a U.S. Court of Claims ruling sanctioning the contract revealed that Amazon had been chosen for its superior technical capabilities.

“IBM’s principal issue is that the cloud is net cannibalistic to revenues and profit,” Credit Suisse’s hardware analysts wrote in a January note entitled “Could Be the End of the Road(map).” Big Blue bought database provider Cloudant in February and Silverpop, a cloud-based digital marketing company in April. Software companies are doing it, too: SAP bought Fieldglass, a vendor management system, for a reported $1 billion in late March.

Whether hardware and software providers are competing on their own ingenuity or buying up smaller vendors to try to scale up quickly, the race to dominate the cloud is on. But with powerhouses like Amazon and Google already well established in the space, there’s a question as to whether some legacy companies are already too late off the blocks to catch up.