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Tuesday, April 6, 2010

A Brief Investment Perspective of the Cloud

We've written extensively here at Beyond the Arc about the confusion surrounding cloud computing. Like anything with enormous potential, cloud computing is fueled by marketing hype, uninformed dialogue, informed dialogue and overstated expectations.  We only need to look back at last weekend's launch of the iPad to see how this scenario builds to a volume so loud that fact no longer is easily discernible from fiction and product or service delivery becomes the only control a vendor has on the hype cycle.

Who, I wondered recently, cuts to the chase in an objective and measurable way?  Then it struck me that investment analysts might be as much a realist as anyone in the dialogue because, depending on how you look at it, the cloud is either just an evolution of computing as we know it or a sea change in the history of technology and of business. Either way, the implications for investors will be notable. 

One of the more informed articles I found was published recently by Morningstar, the global investment research company.  The article by Sonit Gogia, breaks the market into three commonly known segments:  infrastructure, platform and software as services and then tries to forecast value around each. Imprecise at this early stage, but worthy of consideration, Gogia's analysis suggests the following:

SaaS: Open Competition, Reduced Profitability
SaaS is the most mature of these segments and has proven its appeal, particularly with small and medium enterprises. It already is easy to foresee how changes in the economics of computing driven by the cloud can diminish the impact of enterprise software leaders like Microsoft, IBM, HP, SAP, Oracle and a few others in the same way that the shift from mainframe systems to client server computing in the 1990s threatened the business models of the mainframe market.  With Microsoft Office Web Apps scheduled for release in May, Microsoft already is playing catch up to Google Docs, which was used in 20% of the offices surveyed last year by IDC. While these same vendors are aggressively restructuring their business models toward the cloud, they are joined by many others in offering IT services simultaneously to many customers over the from remote data centers. While creating more choice for customers and weakening the lock-in model that ties some customers to costly, less-than-optimal solutions, SaaS isn't designed to be sticky in the same way long-term licenses and maintenance contracts are currently structured. Until a customer hits a critical mass of users, changing vendors is relatively cheap and easy.  As a result, however, Gongia believes SaaS will limit profitability and returns on capital compared to the levels investors are used to with traditional enterprise software vendors.

PaaS: Less Competition,Greater ROCI
PaaS vendors offer IT departments the ability to develop and deploy software applications in the cloud.  PaaS vendors offer software, servers, storage, networking equipment and management services. Unlike SaaS, the cost of entry is high to providers and the cost of changing vendors can be high to customers.  This is a young, emerging market, but Gogia believes the ultimate number of competitors will be few. IBM and Oracle will be entrants to a market already populated by Google's AppEngine, Microsoft Azure and's  Gongia believes these vendors will deepen the barriers to entry, and he forecasts high returns on invested capital for PaaS vendors.

IaaS: Fast Growth, Becoming Commoditized
IaaS vendors rent out processing power, storage, and bandwidth on-demand. This where Amazon Amazon Elastic Compute Cloud (Amazon EC2) and a few other companies have focused their offering to small businesses, medium businesses and departments of Fortune 500 companies. The appeal of IaaS is that customers can access and pay for computing capacity only when it is needed.  But, Gogia contends, it is destined to become a commodity -- hard to differentiate with low switching costs and, like most commodities, it eventually will migrate to price competition.

If the past repeats itself, as it is often does, computing after the cloud may not be all that different.  But the opportunity for established vendors to reposition themselves, for new companies to enter markets and for customers to gain greater control and flexibility at reduced costs may become  a reality.  Certainly, the opening act has been captivating, and it is exciting to anticipate what happens next.

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