Amazon Web Services is ramping its sales and marketing investments amid signs that the battle with Microsoft Azure is accelerating. The big question is whether the laws of large numbers is catching up to both cloud titans in terms of growth.
Microsoft Azure grew revenue at a 59% clip in the fiscal first quarter, but that was down sequentially. Analysts weren't exactly worried since Microsoft was basically firing on all financial cylinders.
AWS grew sales in its third quarter at a 35% clip and that was the lowest growth since Amazon broke the company out in its results. Analysts weren't freaking out over the results per se, but Amazon's e-commerce business spurred worries because one-day shipping is eroding profit margins. On the bright side, Amazon's advertising business is accelerating. Simply put, Amazon's "Day One" approach ain't cheap.
In background talks with Azure sales folks, you can smell the confidence in Microsoft's cloud standing vs. AWS. You can also feel the frustration of Microsoft's sales people given AWS has the mindshare (and market share until proven otherwise). Incidentally, AWS is investing in adding sales people.
For now, there is enough cloud growth to go around, but there are signs that IT spending is slowing. Cloud providers are likely to see some of that slowdown. That reality means that the battle between AWS and Azure is going to get interesting.
Wedbush analyst Daniel Ives summed up Microsoft's incursion on AWS following the company's most recent report:
This quarter was a major positive data point for Redmond as well as overall cloud spending, which has been a concern among investors given some cracks in the armor of cloud plays such as Workday and ServiceNow and fears that IT spending is hitting a speed bump heading into 2020. On the contrary, Microsoft delivered strength across the board with no blemishes and importantly gave stronger than expected December quarter guidance which speaks to an inflection point in deal flow as more enterprises pick Redmond for the cloud and thus further narrowing the competitive gap vs. Bezos and AWS.
Indeed, Microsoft CFO Amy Hood said: "In our commercial business, we again saw increased customer commitment across our cloud platform. In Azure, we had material growth in the number of $10 million-plus contracts."
Hood added that Azure gross margins improved as commercial cloud delivered gross margins of 66%. That tally includes Office 365. It appears that the Microsoft 365 strategy is going to pull along Azure sales too. That approach is hard for other cloud providers to replicate.
Meanwhile, Brian Olsavsky, CFO of Amazon, explained that the company is investing in AWS and has banked savings from infrastructure investments made in 2017. He said:
We continue to feel really good about not only the top line but also the bottom line in that business, but we are investing a lot more this year in sales force and marketing personnel mainly to handle a wider group of customers, a increasingly wide group of products. We continue to add thousands of new products and features a year, and we continue to expand geographically.
So the biggest impact that we saw in Q3 year-over-year in the AWS segment was tied to costs related to sales and marketing year-over-year and also, to secondary extent, infrastructure, which, if you look at our capital leases or equipment leases line, it grew 30% on trailing 12-month basis in Q3 of this year, and that was 9% last year. So there's been a step-up in infrastructure cost to support the higher usage demand. So we see those trends continuing into Q4, and that's essentially probably the other element of operating income year-over-year that's shorter than in prior quarters.
Olsavsky said that AWS margins will likely be under pressure.
We will price competitively and continue to pass along pricing reductions to customers both in the form of absolute price reductions and also in the form of new products that will, in effect, cannibalize the old ones. what we're doing is renegotiating or negotiating incremental price decreases for customers who didn't commit to us long term. And if you look in our disclosure on our 10-Q, it shows that we have $27 billion in future commitments for AWS -- from AWS customers, and that's up 54% year-over-year.
Now we'd love to give you that tech zero-sum storyline because it's easy. But AWS vs. Azure is way more complicated. Here are the moving parts that'll determine how this battle plays out going forward.
The sales ground war. AWS is ramping its sales team, but there has to be a talent shortage. Google Cloud Platform is hiring aggressively. Microsoft Azure is drafting off its parent's sales team and enterprise footprint already. And then there are other cloud providers that'll retool sales teams. Rest assured new ServiceNow CEO Bill McDermott is going to be recruiting heavily. It's a good time to be a cloud sales person.
Artificial intelligence. Microsoft CEO Satya Nadella mentioned AI and Azure a bevy of times. Compute, storage and infrastructure frequently is just a cloud precursor to more the AI and machine learning upsell. Azure, AWS and Google Cloud are all betting AI and machine learning will differentiate them.
Multi-cloud realities. The dream is that enterprises will all mix and match the public cloud providers based on needs and pricing. The reality in the short term is going to be that enterprises are likely to bet on one cloud provider with others being involved as leverage. The battle between AWS and Azure will be about which vendor is preferred in the enterprise.