Amazon (AMZN) and Google (GOOG) seem to be at war over cloud storage prices as both the companies aggressively cut prices last week. Google made the first move cutting prices of its standard Google Cloud Storage by 20% and then followed it up with another 10% cut after Amazon followed up by reducing the prices of its S3 cloud storage services by about 25%.
As a large number of businesses look for ways to securely store immense quantities of data and save on the IT infrastructure costs simultaneously, we expect the price cuts to bring in more clients to the sector and result in revenue growth for the companies. Also, the price cuts would translate into thinning margins unless the companies find ways to bring down the costs. With Amazon having substantial experience in operating low-very low margin businesses, we expect the company to further cut down its prices to maintain a price advantage and rely on volumes to drive growth.
Meanwhile competitors such as Rackspace (RAX) are aiming to retain their cloud customers through aggressive pricing combined with exceptional service. The other major players in the cloud storage space include Microsoft (MSFT), IBM (IBM) and HP (HPQ).
Prices to continue declining
Amazon is running the cloud operation in much the same way it runs its retail business. Ultimately Amazon S3 is just selling a commodity in storage space. It has already lowered the prices for Amazon S3 several times since its 2006 launch.   With prices expected to be the only competitive driver as the services across the companies would be very similar over a period of time, we expect a further decline in prices as companies vie to stay competitive. This will translate into smaller margins.
Amazon with its background in retail which is also a price conscious market should be comfortable with the business model. Also, as the company was one of the first to enter the market, it already has the infrastructure and presence to use economies of scale to drive down prices while reducing costs. Its competitors who have a much smaller presence will find it harder to do so. Lower prices would bring in more traffic, generating more demand for infrastructure further repeating the cycle.
Besides lowering prices, the company is also attracting new users through free usage under AWS Free Usage Tier. Upon sign-up, new AWS customers receive 5 GB of Amazon S3 standard storage, 20,000 Get Requests, 2,000 Put Requests, and 15GB of data transfer out each month for one year. We expect the company to keep growing its revenues as growth in userbase will outstrip the decline in prices.
Enterprise business could pick up
The only blemish on an otherwise enviable track record has been Amazon’s inability to attract large enterprises to its cloud offerings. The company recently launched a long term data storage service Amazon Glacier, updated its EC2 application and entered into a partnership with private cloud company Eucalyptus which will allow companies to create hybrid clouds which span their own data center and Amazon’s. We believe that the ability to spread their data over their own and Amazon’s data center will attract enterprises to Amazon and the company can drive up revenue growth by cross selling its portfolio of SaaS and IaaS services.
Cutting costs through proprietary servers
Amazon is looking to mitigate the pressure on its cloud computing margins with custom servers. It has tied up with Asian manufacturers like Quanta and Foxconn, which became famous for manufacturing Apple‘s (AAPL) iPhone and iPad, to manufacture its own servers. It sources its chips directly from Intel (INTC) and in doing so has followed in the footsteps of Facebook (FB), Google, Microsoft and others going around middle men such as HP and Dell (DELL). The move away from standard machines towards cheaper gear will free up cash and should help the company expand its operations more quickly. (How Amazon Followed Google Into the World of Secret Servers, Wired, November 2012)
Given the enormous scale of its cloud based services, we expect the company to improve its bottom line cutting hardware costs and drive down the cost of the internet services it offers. The presence of multiple big resourceful companies in the market should result in the price decline outpacing the margin improvement through proprietary servers over the forecast period.
We have a $218 estimate for Amazon which is 12% below the current market price.
Disclosure: No positions