With AWS on deck, cloud rivals eye margin improvements, platform plays

The cloud is maturing and IBM and Microsoft both see improving operating margins on deck. What hasn't changed is that the field is still chasing AWS.
Written by Larry Dignan, Contributor

Amazon this week will outline its second quarter results and Amazon Web Services will be noted as the company's emerging cash cow. AWS's profit margins are so notable that Microsoft talked about them relative to Azure and IBM noted its as-a-service will flow more to the bottom line.

I can't remember a time ever where any part of Amazon was noted by rivals for its profit margins. Retail margins are razor thin, but Amazon's cloud business is materially better.

Here's what Amy Hood, CFO of Microsoft, had to say after the company reported its fiscal fourth quarter results:

We're encouraged by the improvements we've seen year-over-year and we do expect material improvement in FY17, both from the benefits of scale and the investments we've made, but importantly also in the revenue trajectory we're seeing and the makeup of that revenue.

Boeing's agreement is one such agreement, in terms of embedding a premium service at a premium gross margin. We signed many of those this quarter that we feel quite good about. I think I have a strong line of sight to AWS's margin profile and still feel good about the progress we're making.

Not just on the workloads that are relevant, apples-to-apple with Azure, but also in our broader Cloud portfolio and our ability to have very healthy margins across Dynamics 365 as well as Office 365 in conjunction with many of the innovations we're doing across Azure. While I am focused on both the workload improvements, I'm also focused on what's possible across the entirety of the cloud.

Stifel analyst Brad Reback noted the capital spending hit from Microsoft's commercial cloud business is likely to diminish over time.

When IBM reported its second quarter results, CFO Martin Schroeter said that the company's cloud investment will start paying off for the bottom line. He said:

The as-a-service component will start to be accretive to our margins on a year-over-year basis, starting in the second half already. Now, we'll see where the marketplace goes and we'll see how much we rely on getting -- or keeping, if you will, that margin growth as opposed to reinvesting.

Add it up and big cloud players are actually exiting the scale up phase and improving profit margins.

And no cloud provider is set up as nicely to harvest as AWS. AWS is expected to deliver second quarter revenue of $2.64 billion, up 45 percent from a year ago, according to Credit Suisse. AWS utilization is expected to fall below 100 percent and that means more predictable capital spending and cash flow overall, noted Credit Suisse.


Once Google and Amazon report earnings it's likely to be clear that each cloud provider is spinning its own stack revolving around higher end services such as big data, machine learning, Internet of Things, and analytics.

Pacific Crest analyst Ben Wilson recently argued that cloud giants were evolving from generic infrastructure providers to full blown app stacks. "To retain margins and grow share, cloud providers need developers to write apps specific to their cloud architecture. They'll likely seek to do so via proprietary hardware, software and middleware-style functionality," he said.

In a chart, the public cloud appears to be nearing the platform stage. The talk from IBM and Microsoft regarding margins indicates they are gearing up for that phase.


However, just like the previous phases of the cloud, the big guns are still chasing AWS.

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