Shooting For The Stars Through 'The Cloud'

Adam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited. (NASDAQ: AMZN) is not content with taking over the world. The company is spending aggressively to build 19 new fulfillment centers by year’s end and it continues to provide customers with miniscule markups on its inventory. But it’s not enough for Amazon to become the shopping destination for millions of consumers. It recently set its sights on completely conquering the virtual world of cloud computing.

Conquering Enterprises

Amazon has always been a leader in the growing cloud computing industry. It rolled out its Amazon Web Services (AWS) in 2006, and has added new, innovative, products and features to both the B2B and B2C sides of cloud computing ever since. Most recently, Amazon announced its newest cloud computing product, Redshift, at its AWS conference at the end of November.

So why is Redshift such a … shift for Amazon? Amazon has traditionally targeted small to mid-size businesses, mostly startups, with AWS. Redshift focuses on the big enterprises, the guys with petabytes of cloud storage needs. This is the area where competitors like Teradata (NYSE: TDC) and Oracle (NYSE: ORCL) have thrived by charging client tens of thousands of dollars to store their data and run  their applications remotely.

Redshift charges less than $1000 per terabyte per year, a 95% discount from the average competition. It does this by offering the same low-margin rate as the company’s retail segment. What it loses in margin, Amazon hopes to make up in volume.

While Amazon doesn’t disclose the details of the AWS segment separately, it is estimated that its net profit margin is below 10% and gross margin in the typical Amazon range of about 22%. Comparatively Oracle consistently has net profit margins around 25% and Teradata realizes about 15% of revenues as net profits at the hands of high gross margins near 80% and 60% respectively.

The advantage Amazon has over competition like Teradata is that the company’s core business is not actually in cloud computing. There’s no pressure on the business segment to make a profit. In fact, there’s very little pressure for any part of Amazon to make a profit with its aggressive growth strategy. This means, there’s potential for pricing to go even lower for all of Amazon’s web services.

Who’s The Real Threat To Amazon?

Amazon should be less worried about Teradata and Oracle, and more worried about software giants Google (NASDAQ: GOOG) and Microsoft (NASDAQ: MSFT). These are the companies that will compete with Amazon’s compelling low-margin pricing strategy because they too have little pressure to profit off of the service right now.

Amazon and Google, in particular, are currently caught up in a pricing war for their web services. After Google announced a price drop of about 20% early last week, Amazon was quick to respond with an even greater discount of 24% to 28% effective December 1. Not to be outdone, Google came back with a further 10% reduction on its pricing for cloud storage. Microsoft is likely to follow suit, cutting prices on its Windows Azure cloud solution, just as it did in March after a previous round of price-cutting by Amazon and Google.

However, price is not the only thing that matters. Businesses are also interested in the capabilities of a web service. Last week, Google announced an increase in the number of options available for its infrastructure as a service (IaaS) from 4 to 40. Here’s how the competition stacks up.

<table> <tbody> <tr> <td> <p><strong>Company</strong></p> </td> <td> <p><strong>Maximum Virtual Cores</strong></p> </td> <td> <p><strong>Maximum Memory (RAM)</strong></p> </td> </tr> <tr> <td> <p>Amazon</p> </td> <td> <p>16</p> </td> <td> <p>68 GB</p> </td> </tr> <tr> <td> <p>Google</p> </td> <td> <p>8</p> </td> <td> <p>30 GB</p> </td> </tr> <tr> <td> <p>Microsoft</p> </td> <td> <p>8</p> </td> <td> <p>14 GB</p> </td> </tr> </tbody> </table>

While Amazon currently leads the competition in terms of concurrent processing power, it’s unlikely to remain that way for long. Microsoft and Google are fierce competitors with plenty of cash to put behind their cloud computing services. Undoubtedly, Amazon will continue to improve its service features and roll out new options as well.

Taking Over The Universe

Investing in Amazon means that you believe in Jeff Bezos and his vision for growth. Retail continues to improve at a fantastic pace, with the company’s overall revenues growing 27% last quarter. Cloud computing is even better; Bernstein Research estimates the unit's Q3 revenue at $474 million, up 88% from Q3 2011. Evercore analyst Ken Sena expects AWS revenue to increase 45% per year, from nearly $2 billion in 2012 to $20 billion in 2018, potentially making it a larger part of the business than the retail segment.

Cloud computing is an integral part to many modern day businesses. From big enterprises to small start-ups, all of them use the cloud. With significantly lower prices than most of the competition, and better capabilities than those that can compete on price, Amazon ought to capture a large portion of the rapidly growing market. 

adamlevy owns shares of The Motley Fool owns shares of, Google, Microsoft, and Oracle. Motley Fool newsletter services recommend, Google, Microsoft, and Teradata. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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