"Your margin is my opportunity."
It's a quip often attributed to Amazon CEO Jeff Bezos to explain his zeal for high-volume sales at teeny-to-nonexistent profits. It's ironic, then, that in Amazon's cloud business it is Bezos' margin that is providing an opening to rivals like Google.
Amazon Web Services has become essential plumbing for the technology industry and a darling of Amazon investors because it's a lush island of profits within the company's notoriously profit-challenged seas. RBC estimates AWS could have a value of $128 billion to $160 billion, or about half the current stock market value of Amazon.
Without AWS, Amazon's segment operating income margin last year -- a figure that excludes stock compensation and some other costs -- was 2.7 percent. In other words, out of each $100 in sales Amazon racked up last year, its operations cleared $2.68 in profit, even before accounting for expenses like taxes and interest.
But at AWS, segment operating margin was 24 percent in 2015, and revenue rose 70 percent from the year before.
The relatively fat profits give Amazon investors warm and fuzzy feelings. But they are also a potential vulnerability that can be exploited by two big rivals -- Microsoft and more recently Google (again) -- that are trying to unseat AWS.
Amazon's plump margins provide an opening for Google to poach business by undercutting AWS on cloud costs, and it may be happening already. A wave of headlines recently has documented Google doing what technology sellers always do when they're trying to make a splash in a new market -- hunting for big-name customers to boast about.
No one has said what marquee names like Apple, Spotify and Home Depot are paying to get on Google's cloud, but it's easy to imagine they're receiving big price breaks in exchange for giving Google bragging rights.
If this breaks out into widespread price wars, it could bruise AWS, just as an earlier one did. Between October 2013 and June 2014, the average monthly cost for basic data storage on AWS dropped by more than 50 percent, according to an RBC Capital Markets analysis, during a flurry of escalating cloud price cuts at AWS, Microsoft and Google.
Revenue growth backtracked at AWS, and segment operating margin dipped to about 8 percent in the spring and summer of 2014. The cloud competition has cooled a bit since then, price reductions have been more gradual, and AWS revenue growth and segment operating profit margins have perked back up.
A big unknown this time about the threat of Google's cloud operation is whether the company is truly committed. The same question applies for almost any business outside of the company's advertising-dependent operations like search and YouTube.
Repeatedly over the years, Google has emphasized business-technology products including a version of Gmail and Google Docs for companies. But Google's interest seemed to wane, and it never posed a serious challenge to rivals like Microsoft. In the cloud business, Google seemed to be on the cusp of challenging Amazon two years ago, but its effort fizzled and Google remains far behind AWS.
Google's AWS rival, now called Google Cloud Platform, had sales of less than $500 million last year, Morgan Stanley estimates, or about 6 percent of AWS's 2015 sales. It has to be particularly painful for the boys in Mountain View to be so far behind Amazon, given that Google operates the world's most advanced computing networks.
This time, there are signs of Google's commitment. The company last fall hired VMware founder Diane Greene, a well-respected technologist, to run the cloud operation. Google said this week that it planned to increase the number of geographic zones for its cloud customers to 16 from four.
Tackling exactly those commitment concerns, Greene said at a conference on Wednesday, "We're serious about this business."
She cited as evidence Google's $9.9 billion in capital spending last year on items like data centers. Much of that spending is to run Google's own Web services, but if the company plans to quadruple the cloud regions for its cloud customers, it is sure to drive up that capital spending tab.
To be sure, even a long cloud war with Google and Microsoft may not be a bad thing for Amazon. For three decades, the company has shown it can live happily in a profit desert. (See the first sentence of this piece.)
While Bezos may not care if he has to get into the muck with Google and Microsoft over prices, his investors should. The investment narrative on Amazon holds that AWS will help usher in a magical new era of profitable Amazon. If AWS's profit profile dims, the already shaky investment narrative does, too.
RBC arrives at its valuation by applying AWS's estimated 2017 sales to typical price-to-revenue multiples for fast-growing software firms.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
To contact the author of this story:
Shira Ovide in New York at email@example.com
To contact the editor responsible for this story:
Daniel Niemi at firstname.lastname@example.org