Amazon: Profitable AWS Is A Serious Threat To Cloud Contenders

| About: Amazon.com, Inc. (AMZN)

Summary

All eyes were on the AWS breakout for Amazon's Q1 report.

Contrary to expectations, the segment turned a handsome profit, helping offset overall losses.

Disclosing the details of its cloud operations will likely prompt its competitors to do the same, and its profitability may force them to reconsider their own pricing models.

In my previous article on Amazon (NASDAQ:AMZN), I discussed the notion that AWS might not yet be profitable. With the release of Amazon's Q1 report, it became clear that this is far from the truth. Not only is the segment growing revenue rapidly, but it is actually turning a decent profit. This is in spite of Amazon's aggressive approach to pricing and its relatively slim margins. This is a serious problem from other companies in the cloud space, and may force them to also break out the specifics of their cloud divisions as well as lower their prices.

Calling out the competition

Breaking out the AWS numbers is a thinly-veiled challenge to competitors to do the same, most of which maintain a rather murky way of disclosing their cloud revenue growth rates, let alone actual profits. For example, Microsoft (NASDAQ:MSFT) lumps all of its cloud offerings together, making comparisons between its own Azure infrastructure service and competing products such as AWS difficult. Some analysts maintain that Azure is actually far smaller than the overall cloud numbers would suggest. IBM (NYSE:IBM) has a similarly opaque way of describing its cloud business, also lumping its "as-a-service" offerings together.

There are good reasons why most companies don't provide detailed insight into their cloud operations. It is still a fairly immature business, and this method allows them to maintain the veil of secrecy that surrounds the burgeoning cloud industry as well as spin the numbers in a way that makes them look good. Amazon breaking out the cloud numbers is likely to force competitors to do the same, and not all will come out looking as strong.

The second threat to competitors is the fact that despite its low pricing, AWS is profitable. Its competitors were presumably hoping that its aggressive pricing approach would result in losses, thereby validating their own pricing models. At 16.9%, AWS' EBIT margin is lower than most companies that sell cloud infrastructure. Cisco (NASDAQ:CSCO) for instance works with an EBIT margin of 28%. According to a JP Morgan report, Cisco's prices may have to come down if the company hopes to remain competitive with Amazon's offerings, which would in turn put pressure on its bottom line.

Should this be the case, it would likely cause a ripple effect through the industry, leading to lower prices overall, in turn pressuring margins and the bottom lines of competing cloud infrastructure vendors.

Conclusion

While investors and analysts were pleasantly surprised by the specifics of Amazon's cloud segment, its competitors were in all likelihood quite horrified. The disclosure of the financial details of the business means that they will in all likelihood be expected to do the same, which limits their ability to put a positive spin on their own cloud numbers. Additionally, the fact that Amazon's cutthroat approach to pricing is actually paying off in terms of the bottom line means that its competitors may have to reevaluate their own pricing models to remain competitive.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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