Media & Tech Tuesday - The Emperor's New Clothes? An influential analyst calls time on the Cloud

  • Oct 2014
  • Media & Technology

Gathering Clouds

With the promise of sticky, recurring revenue, rich margins and economies of scale that would afford the first large operators a durable barrier to competition, the expected transition to Infrastructure as a Service (‘IaaS’) or Cloud has attracted massive investment by tech industry titans – Amazon, Google, IBM, Microsoft, Oracle – and allowed a swathe of smaller pure-play cloud operators to raise growth capital in public and private markets.


As the chart below shows, the seemingly enormous opportunity presented by this transition of computing power and data storage off users’ premises, hasn’t quite delivered as expected – a good number of listed cloud operators, either pure-play or within larger hosting groups, are worth a lot less now than they were a year ago.  Some have focused on pushing harder to fill platforms, sticking with the plan and feeling heat from investors for the continuing cash burn.  Others have pivoted away from pure IaaS towards managed services, seeking to add value through something other than scale.


The Emperor’s New Clothes?

One man – Steve Bezier of Canalys, an IT market research firm – spoke out recently, questioning the public cloud concept, and the seemingly endless negative cashflow of even the most successful cloud operators.  He cited both the cashflow strain of continually adding capacity without enjoying good returns on the existing platform, and a potential backlash against the security implications of a global public cloud in a post-Snowden environment.

Continuous pressure on pricing, combined with a remorseless expansion of capacity by the largest public cloud providers, particularly Amazon Web Services (‘AWS’), present a commercial stalemate in which all players continue funding growth in infrastructure, but none have a clear idea when – or whether –  their investments will yield meaningful free cashflow.  Enterprise cloud users may of course welcome this, as huge amounts of providers capital is drawn into providing them with infrastructure at prices that are far below its capital cost.  Many players in the industry will anticipate that as in previous technology cycles, this financial war of attrition will eventually result in consolidation which in turn will deliver a less fragmented, more sustainable industry, earning reasonable returns on current capital investment, although potentially far from attractive returns on past sunk costs.

If you build it, will they come?

Pursuit of this long run equilibrium following capacity growth and ensuing industry shake-out is crucially predicated on public cloud evolving to become a large, stable market and it is around this assumption that Mr. Bezier raises the most fundamental question; will enterprise IT migrate to public cloud in the volumes that providers anticipate?  Economic reasons for this to happen are good; specialised providers operating at massive scale have come to dominate the provision of many elements infrastructure.  However, enterprise computing has many more dimensions of complexity and risk than most infrastructure services.

A recent study by Netskope, a cloud-risk consultancy, showed that 72% of businesses surveyed would not fully trust the cloud with sensitive user data, and that 53% were concerned that cloud infrastructure would increase risk to their organisation.  The amount of their computing needs that users will entrust to it will ultimately determine the size of the public cloud market.  Current data suggests that it will take significant time for trust to be built to the levels required for widespread adoption.  If trust cannot be consistently increased – due perhaps to occasional high profile data breaches – it could limit the public cloud market to a much smaller size than some expect.

Despite these concerns cloud majors – aiming to capture a market estimated to be $47bn last year, growing to $108bn within three years – are so far staying the course, continuing to expand their infrastructure with capex across the industry potentially exceeding $10bn this year.  Whether investors will continue to support this investment is a question for all in the industry; some smaller cloud providers already face very real funding uncertainties, whilst larger businesses with substantial internal cashflows have greater flexibility but must ultimately deliver returns acceptable for the risks they incur.


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