Vast Data Center Spending Fuels Race to Cloud Dominance

As top cloud infrastructure service providers compete for share of what they say is a market that’s only getting started, they spend billions of dollars annually on data centers to support those services. And their yearly cloud data center spend is only going to increase.

Amazon, the currently untouchable leader in the space, reported financials of its cloud business for the first time ever Thursday. While contributing a relatively small portion to the company’s total revenue, Amazon Web Services is its fastest-growing business segment.

AWS revenue in the year’s first quarter grew nearly 50 percent year over year, reaching $1.57 billion. The company made $265 million in profit on that revenue. The unit's trailing 12-month revenue at the end of Q1 was $5.16 billion.

Amazon's total revenue for the quarter was $22.72 billion, with a net loss of $57 million.

“Amazon Web Services is a $5 billion business and still growing fast — in fact it’s accelerating,” Jeff Bezos, the company's founder and CEO, said in a statement.

It already costs a lot of money to deliver those results, but company officials believe we’re only seeing the beginning of what the AWS business can do and plan to continue spending to support its growth.

“Usage is growing faster than [revenue], so we will be deploying more capital,” Amazon CFO Thomas Szkutak said on a call with analysts Thursday. “It’s just growing so fast that we want to make sure that we put the right amount of capital in place.”

Brian Olsavsky, who will replace Szkutak when the current CFO retires in June, said AWS was “a business that’s still realy in day one.”

But the costs of cloud data center infrastructure to support this business even in its day-one phase are already enormous and growing fast. At the end of 2014, the AWS unit held about $7 billion worth of property and equipment – up from $3.8 billion one year prior.

Billions Upon Billions Spent Annually

Amazon’s major competitors in the space too aren’t shy to spend big on infrastructure. An apples-to-apples comparison of data center spend among cloud giants is hard, since each of them reports expenditures differently, but it’s clear that everyone is investing billions in cloud data centers every year. All of them have also made clear that they expect their infrastructure spend to continue growing.

Google’s capital expenditures for the first quarter of 2015 were about $2.93 billion, consisting primarily of production equipment, data center construction, and facilities, according to the company. Google said it expects “to continue to make significant capital expenditures.”

Just this month, Google announced plans to invest $1 billion in expanding data center capacity at its Council Bluffs, Iowa, campus. That’s on top of $1.5 billion it already spent on existing data center capacity there.

Microsoft’s Growing Cloud Empire

Microsoft doesn’t break out its capital investment in infrastructure that supports its cloud services alone. It does, however, disclose operational spend on data center and “other online infrastructure.”

Its cost to operate data centers and other infrastructure in the quarter ending March 31 grew $190 million, or 13 percent, year over year. The company said in its earnings documents that the increase was reflective of an increase in data center capacity.

Microsoft also said it expected to continue building data centers and spending more and more on infrastructure to support its cloud strategy.

Just one of the multitude of data center builds the company announced last year was a $1.1 billion facility in West Des Moines, Iowa. It expects to invest another $1 billion in a new Dublin, Ireland, data center, Paul Slater, director of the company’s Applied Incubation team, said while speaking at the Data Center World conference in Las Vegas earlier this week.

The Race to the Bottom

Much of what Microsoft does infrastructure-wise, Slater said, was influenced by the “race to the bottom” in cloud prices with Amazon. Since they have to spend enormous amounts of cash to support growth of their cloud businesses, the only way they can participate in this race other than subsidizing cloud by other products is innovation in data center efficiency (which was the main subject of Slater’s presentation).

All three giants have been slashing prices of their infrastructure services mercilessly. On Thursday’s earnings call, Amazon officials repeatedly said AWS had lowered its prices 48 times since its inception nearly 10 years ago.

Amazon’s Wild Cloud Margin Swings

This of course begs the question of business margins. How sustainable is this level of spending? AWS results revealed that the unit’s margins had gone through a bit of a roller coaster last year.

Its operating margin took a major dip in the second and third quarters of 2014, but mostly recovered in the last two quarters, which Olsavsky attributed to innovation and efficiency improvements. The margin fell from 23 percent in Q1 2014 to around 8 percent in Q2 and Q3 before jumping back up to 17 percent in Q4 and staying there in Q1 2015.

It’s Not Just About Price

Amazon’s finance chiefs assured analyst that AWS was not going to rely on low prices alone in competing for market share. While the unit’s model over the long term has been to use scale and its market position to create and pass savings to customers, the primary value of its services is giving customers the ability to innovate and move quickly, according to Olsavsky. “Benefits of AWS around customers’ ability to be nimble is a primary factor there,” he said.

As a pioneer in Infrastructure-as-a-Service, Amazon had a massive head start in the market. Its lead over the others is still huge today, but its rivals are a lot more aggressive about this space now than they were a few years ago.

Enterprise Cloud is a Different Beast

Amazon, Microsoft, and to a lesser extent Google are also going after the enterprise cloud market, which has many more heavyweight competitors with decades-long customer relationships. These are companies like HP, IBM, EMC, and Cisco, among others. They are all going after the enterprise cloud market with a vengeance and plenty of potent ammunition, making for a more level playing field than individual developers and startups, where Amazon has reigned supreme.

While innovation will continue to be a key factor in winning cloud market share, cloud services giants are going to continue spending on data centers, because in this space, innovation at massive scale is innovation on steroids.