How profitable is cloud for the vendors?

The cost benefits that cloud computing offers to its users is something that has been discussed ad nauseam.

In a study conducted by researchers from UC Berkeley and INRIA, France showed that cloud computing can offer savings of anywhere between 40-95% depending on resource usage.

This potential for cloud based systems to bring about huge savings in their annual expenditure is what has been driving the massive migration from in-house server based technology sytems to cloud based alternatives. According to Mary Ellen Power, the VP of marketing at Silanis, a major client for cloud vendors like Amazon AWS, the cloud based services could be seeing as much as 50% growth rate annually in the near future.

However, what impact is this causing to the cloud vendor companies? While the mass migration to cloud helps customers avoid upfront technology investments and thus save money, vendor companies are now in a bind over the pace of their infrastructure revamp. Take the example of SAP; one of the leading manufacturers of business software systems. The company has recently revealed that the massive investments that the company has undertaken on the cloud front since 2012 has forced the management to defer their short term profitability goals. The German software maker had initially set a target of 35% operating margin to be reached by 2015. This figure has now been pushed to 2017.

Another company to look at is IBM. This week, the Armonk, NY based technology major announced its Q4 2013 results which showed a steep 5.5% revenue drop which is the seventh consecutive time this has happened. Understandably, the biggest disappointment was in hardware sales that plunged 27%. In absolute terms that was a loss of nearly $1.5 billion. The commensurate increase is in the sale of cloud computing infrastructure that saw a 69% rise in revenues - an absolute increase of around $1.7 billion YoY.

This is a good sign for the future of cloud. Although IBM as a company has been reporting losses due to the drastic drop in hardware sales, the company is already seeing great advances in the cloud alternative. What this technically means is that the losses that are being reported today are short term that could be overcome in the long run when the cloud transition is mature.

At the outset, cloud technology may appear less profitable to the vendors. To see why, consider this: in the traditional set up, businesses make money through the sale of physical servers - the cost of this is paid to these manufacturers upfront. In a cloud setup, customers pay a subscription fee to these manufacturers. In such a scenario, manufacturers like IBM continue to invest in building technology infrastructure. However, instead of an upfront purchase, the cost of this is recovered through monthly subscriptions. Consequently, businesses like IBM face short term issues with cash flow that can however be recovered through a long term subscription.

However, the impressive growth in cloud may be attributed to the wider base of customers that are available today. Unlike the traditional setup where IBM’s clientele consisted exclusively of large corporates who have the need and financial capability to install in-house servers, a cloud setup brings small and medium businesses into the fold as well. IBM’s acquisition of SoftLayer in 2013 brought with it nearly 20,000 customers into IBM’s fold - such large numbers may not have been possible in a physical server business. 

The future for cloud thus seems clear - companies like IBM and Oracle will face financial hurdles in the short term as they ramp up their cloud infrastructure. However, in the long run, as the infrastructure matures, these businesses should see substantial rise in revenues and profitability. What are your thoughts?

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