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Crazy Eddie prices to traditional IT services. One result is that a large number of established IT companies are at risk, says a report from Morgan Stanley research.
"Most at threat are VMware and Red Hat," the Morgan Stanley authors concluded. "To the extent companies move workloads from private cloud type environments to AWS, the $4 billion virtualization market could face headwinds," the report said.
But Oracle, SAP, Microsoft, IBM and Brocade are also at risk. EMC and NetApp are likely to gain share in the storage market from server vendors, such as IBM, the report said. It should possibly have included Dell and HP as well, since all three tend to sell storage associated with servers. Brand name server vendors in some cases are being replaced by no-name, white box server manufacturers, such as Quanta and Wistron, the report said.
VMware is at risk because some observers think server consolidation in the data center is just a transition phase to the larger movement to greater use of public cloud services. VMware is dominant in data center server virtualization. But server sales for data center installation are slowing, while server sales for cloud use are picking up.
[ Analysts think Amazon will ultimately spin out AWS. See Amazon Unlikely To Spin Off AWS Cloud Unit. ]
VMware's recent statements show concern, if not nervousness, about whether it will be able to transition virtualized data centers into cloud computing. On May 21, it announced four IaaS locations in the U.S. to interoperate with its customers' data centers. The move was meant to provide a VMware-compatible public cloud alternative and stave off the Amazon threat.
The Morgan Stanley equity research by Scott Devitt, Keith Weiss, Ehud Gelblum, Simon Flannery, Katy Huberty, Joseph Moore and Adam Wood was the subject of a long report in Barron's Tech Trader Daily by columnist Tiernan Ray. Amazon is "an emerging IT mega-vendor," and it could take away 3% to 17% of spending with traditional IT vendors as it matures, Ray wrote.
That's 3% - 17% of what they describe as a $152 billion market, which includes compute, storage, networking, database service and application deployment and management. Seventeen percent of $152 billion is nearly $26 billion. The writers pegged AWS's revenue as likely to reach $24 billion by 2022.
Why Red Hat was named as an IT vendor at risk is not clear. It plays a much smaller role than VMware in data center virtualization through its KVM hypervisor and related virtualization software. KVM, on the other hand, is the default hypervisor in OpenStack clouds, which may prove one of the few long-term competitors to Amazon. It's also possible the Morgan Stanley authors didn't understand that many of the workloads sent to Amazon's EC2 are running under Red Hat Enterprise Linux.
Oracle is at risk because Amazon is seeing some uptake of its database service offerings, which include MySQL, SQL Server and Oracle itself. Whatever gains Oracle may see in the public cloud may be offset by losses to AWS's SimpleDB or the AWS NoSQL system, DynamoDB.
Microsoft is also likely to see database revenues erode if cloud-based systems catch on. Oracle, SAP and Microsoft are all exposed to the possibility that online applications from software-as-a-service specialists will replace their CRM, ERP and other applications.
AWS's content delivery system, CloudFront, is expected to exert "pressure on premium solutions operating at the high end of the market over time." The Morgan Stanley authors specifically mentioned Akamai Technology.
Consulting and systems integration vendors, on the other hand, will experience at least short-term benefits due to "the increased need to link on-premises workloads with those sitting in the public cloud," the authors said.
In one sense, the report signals that the investor community is starting to recognize what senior VP Adam Selipsky and other AWS officials statements have been saying for some time. Amazon has brought a retailer's low-margin attitude to IaaS, and is piling on top of that infrastructure what appears to be more and more like traditional IT services -- load balancing, automated deployment and scaling, etc.
Selipsky launched that line of thought more than a year ago in an InformationWeek interview, when he said, "A lot of technology business is a good business with high margins. But that's not Amazon's strategy ... Amazon's approach reflects its roots in the business of retail. We drive the scale of business and lower prices."
Amazon.com, the online retailer, doesn't break out revenue for Amazon Web Services, but best estimates from Macquarie Capital, an Australian equities research firm, put them at $2.1 billion in 2012, likely to grow to $3.8 billion in 2013 and $6.2 billion in 2014. On that basis, Macquarie analyst Ben Schacter concluded that AWS as an independent business could be valued at $19 billion by 2015. But the Morgan Stanley authors are the first researchers to take Amazon's early growth and project it forward a decade to $24 billion in 2022.
There could be reason to doubt that projection. As its online retail operation has grown rapidly, Amazon.com has cloaked what it was spending on its Web services unit by declining to break it out as a separate business unit. The retail operation now runs on the same cloud infrastructure as AWS services, so the expenses of the two are intertwined, and Wall Street analysts haven't had the opportunity to criticize Amazon's AWS spending because they don't know what it is.
On the other hand, it's clear at least some of the AWS build-out has been financed by Amazon.com's strong cash flow. As long as retail sales are increasing rapidly, CEO Jeff Bezos and the rest of Amazon.com management don't have to explain how much they are spending on AWS. The infrastructure can be built out, financed out of free cash flow, where the money coming in always exceeds expenses. That's easier than being limited by AWS's early revenue-generating capability.
That surplus has been shrinking of late, according to Amazon.com's first-quarter earnings report. Free cash flow peaked in 2010 as Amazon's sales expanded rapidly, amounting to $2.32 billion for the year. In the first quarter of 2013, it was $177 million, an 85% decline over the year before, although the quarter included the purchase of $1.5 billion of office space. While sales continue to increase, the rate of increase has slackened, inhibiting spending from free cash flow and bringing Amazon closer to a more detailed accounting of its costs. Another measure: sales have increased an average 31.4% a year for the last eight years; net income has increased 2% a year.
Instead of net income and profits, Amazon is entering new businesses, such as its expanded Kindle Fire tablet business, its Zappos acquisition, its Instant Video movie and TV show streaming business, and its Prime retail business, where it eliminates customer shipping costs and guarantees quick delivery in exchange for an annual fee. All of these, like AWS, require investment in distribution centers, video production by Amazon Studios and other infrastructure.
Bezos and company are bent on building a juggernaut of future cloud services and online retailing. And they are likely to succeed in doing so as long their investors have confidence in the way they're managing the company. Its stock price is up 600% over that previously mentioned eight-year period, and closed Thursday at $266.83.
But Amazon is also facing increasing competition from Google, which just started its own B2B online retail service, eBay, Apple, Microsoft, Yahoo, and Wal-Mart, among others. To some extent, it's set a pattern that other successful Web companies can emulate, and Amazon is now in competition with other growth companies for the same space. That may mean sales and free cash flow continue to slow and, potentially, its soaring stock price will start gliding back to Earth.
If that happens, then Bezos' ability to justify his investments will come under review, if not criticism. And the threat that Amazon poses to the traditional IT companies may abate somewhat, as they gain time to adjust to the new circumstance and try to stage their own entrants into the field.