Oracle: Can it really sacrifice margin for commodity cloud?

Oracle says it'll be price competitive with AWS, Microsoft Azure and Rackspace. Is infrastructure as a service really a gateway to buying Oracle's cloud applications?
Written by Larry Dignan, Contributor

Oracle has big plans to compete in the infrastructure as a service market and apparently will sacrifice profit margins to do it. Will Oracle get a profit margin pass to match Amazon Web Services, Microsoft Azure and Rackspace?

oracle iaas

The early returns indicate that CEO Larry Ellison won't get the pass that Amazon CEO Jeff Bezos gets in the growth-over-profit department.

On Oracle's earnings conference call Wednesday, Ellison said:

Down at the infrastructure level, we intend to be price competitive with Amazon and Microsoft Azure and Rackspace. So we intend to compete aggressively in, what I will call, commodity not being a bad word, the commodity infrastructure as a service marketplace. But we are not going to that alone. It is not going to be just infrastructure as a service. Our intention is to sell our customers infrastructure as a service and the same customer a highly differentiated platform as a service will let us get better margins and highly differentiated suite of enterprise applications for the cloud.

So we are going to be cost competitive and price competitive at the infrastructure level while being highly differentiated at both the platform level and the application level.

More: Ellison defends Oracle's cloud strategy and pricing against Amazon, Microsoft | Oracle's Q2 better than expected; Hardware sales stabilize

Moving to IaaS: An overview

What Oracle is really saying is that if the company doesn't compete in infrastructure as a service it's going to have trouble selling its cloud applications, which are much stickier.

Cue the profit margin worries. Cowen & Co. analyst Peter Goldmacher sums it up:

We were surprised to see operating margins down 120 bps, and management's comments during the Q&A are making us question whether margins have peaked. Specifically, bringing lower cost engineered systems to market and competing against AWS and Azure sound cannibalistic and deflationary. Commentary on investing ahead of growth in the Cloud is both vague and scary because we aren’t exactly sure what Oracle means when it says Cloud, and this investment ahead of revenue could go on for a very long time. We are concerned that the Street won’t respond positively if Oracle sacrifices margin for growth, because one or two points of revenue growth won’t matter, but decelerating EPS growth will.

Bottom line: Oracle will have to really juice growth to get a pass on profit margin declines. The laws of large numbers and a model that revolves around software licensing and maintenance mean it's unlikely Oracle can get to the double-digit revenue growth that would silence the peanut gallery. As Goldmacher noted, Oracle's infrastructure as a service has a different spin: Today it's on-premise gear priced on a pay as you go model. 

Ellison argued that the cloud business can be more profitable though.

The mix has changed somewhat in our software business where a larger percentage of our software business are annuities or are renewals versus new licenses. That renewal business is a more profitable business. We think, as our cloud application business gets larger, that's also when annuity business that promises to be even more profitable than our license business.

For now, Oracle has teams specifically focused on taking sales away from Workday and Salesforce. How that trench warfare turns out will directly impact whether Oracle can weather cutthroat pricing to land infrastructure deals from AWS, Azure and Rackspace.

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