Is the Cloud Your Friend

We have been percolating on this one for a while. Back in May Venture investor Martin Casado, a partner at Andreessen Horowitz, published a thought-provoking piece on the true cost of public cloud based software. It is an eye-opening read from a partner at a firm that has risen to prominence on the back of dozens of software companies spending billions of dollars on public cloud infrastructure. We thought it would be worth examining his conclusions in light of our recent work on the way that these same public cloud companies are taking over much of the world’s communications infrastructure and wireless networks.

Casado and team did a lot of research digging around the public filings of some big cloud-based software companies. They then dig into their own expertise and that of others to calculate that these companies are greatly over spending on the cloud relative to what they would need to spend if they built their own data centers. He bases a lot of his calculations on public comments by companies that have done just that. He then goes on to calculate the over-spend on cloud across 50 public software companies, concluding that the excess costs of cloud contribute to over $500 billion in lost market capitalization. These are big numbers and it is hard to fault his math and research. Crucially, his conclusions are that many companies are over-spending on the cloud by 50%

Before we dig into his analysis, we want to go back to 2013. In one of our earliest posts here we published a piece titled “How Profitable is AWS?“, and we think it still holds up pretty well. Put simply, we calculated that AWS has a 160% return on its cloud hardware investments over a two year period. This implies that AWS cloud margins are something like 60% which is pretty close to Casado’s estimate of 50% overspending.

Now there are a few areas where we disagree with Casado’s analysis. First and foremost is the fact that he largely focused his analysis on cloud as a factor in costs of revenue, but one of the big problems with not using the cloud and building your own infrastructure is that that doing it yourself requires a pretty serious internal staff, and these would often be calculated in operating expenses not cost of revenue. So the overspending may not be that big. More importantly, using the public cloud provides a high degree of flexibility. Want to spin up a new service? You do not need to wait six months to build out your data center and train the new staff, you can launch on AWS tomorrow. This is particularly important recently as AI workloads become more important to so many companies, because to do AI efficiently requires special purpose chips (i.e. lots of GPUs or AI accelerators). Admittedly, these do not undermine Casado’s thesis for many companies but they likely do bear significant weight for many others.

Regardless of how companies eventually calculate their own math, it is clear today that the tide is still moving towards the cloud. And one thing we strongly agree with Casado on is the fact that the big cloud companies are making outsize profits from their public infrastructure offerings. We can argue how those profits are divided up amongst AWS, Google, Azure and Ali, but there is still clearly a large pool of profits out there. In turn, these companies are deploying those profits to deepen their competitive moats. Maybe building your own private cloud is cheaper than relying on AWS, but they have built a truly global footprint with a growing degree of control over the fiber optic links connecting all those data centers. This presents a highly potent form of inducement to lock customers in, or it could be a source of profits if AWS have to cut prices elsewhere in their stack.

At this point it is worth pointing out recent moves by Cloudflare. Last month they announced a set of new services that cut very deeply into AWS’s pricing for bandwidth costs (here is the best analysis we have seen of these changes).

There are many more layers to dig through all of this, but we think the point should be clear. The big cloud service providers are making a lot of money with the public cloud services and they are using those profits to buy up the world’s communications infrastructure.

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