Hooked on public cloud? It could be eating a big chunk of your margins

Is it time for some companies to start looking at bringing cloud services back home?

Spending on cloud computing infrastructure is booming thanks to digital transformation, but there's potentially a lot of wasted money being spent on it. Then there's the question of extricating your infrastructure from the public cloud when your company matures and growth slows.

What happens when not running your own IT infrastructure no longer makes financial sense? 

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Analysts from noted tech investor firm Andreessen Horowitz have raised a flag about public cloud spending that's becoming more apparent as the industry matures.

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At some point in a software startup's journey, after it has scaled up and gained millions of users, there might come a point at which the cost of cloud harms margins, which may prompt companies to start repatriating computing infrastructure. But can they do this after growing up on variable IT costs and dodging capital expenditure?

The costs of cloud computing can begin to take up a big part of the total cost of revenue (COR) or cost of goods sold (COGS), write Martin Casado, a general partner at Andreessen Horowitz, and Sarah Wang, a partner at the firm.

"It's becoming evident that while cloud clearly delivers on its promise early on in a company's journey, the pressure it puts on margins can start to outweigh the benefits, as a company scales and growth slows," they write in a joint blogpost.  

"Those who have done this have reported significant cost savings: In 2017, Dropbox detailed in its S-1 a whopping $75M in cumulative savings over the two years prior to IPO due to their infrastructure optimization overhaul, the majority of which entailed repatriating workloads from public cloud."

Dropbox makes for an interesting case study on repatriating cloud infrastructure, which it did from Amazon Web Services in 2016 to its own data centres. Per TechCrunch, Dropbox needed to build three US data centres and a network backbone to connect to other parts of the world. It was motivated by quality, control and management.

The VCs aren't arguing for wholesale repatriation from the cloud, but they estimate that the top 50 public software companies that use cloud infrastructure are losing about $100 billion of market value because cloud costs are eating into margins compared to if they ran their IT infrastructure themselves.

"Extending this analysis to the broader universe of scale public companies that stands to benefit from related savings, we estimate that the total impact is potentially greater than $500B," they write.

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Looking at Dropbox, it reported improving gross margins from 33% to 67% between 2015 to 2017, primarily because it moved workloads from the public cloud to cheaper in-house and co-location infrastructure. That happened as its growth rate was falling. 

The exact savings will vary depending on the company, the VCs write, "but several experts we spoke to converged on this 'formula': Repatriation results in one-third to one-half the cost of running equivalent workloads in the cloud."

"Across all our conversations with diverse practitioners, the pattern has been remarkably consistent: If you're operating at scale, the cost of cloud can at least double your infrastructure bill," they add.

The VCs report that a billion-dollar private software company said their public cloud spend was 81% of COR.

The industry analysts argue that companies building for scale need to optimise early and sometimes do that outside of the cloud.