AWS: Amazon’s Profitability Crutch


IT infrastructure is one of the most expensive components of most modern businesses that handle large amounts of data. Take the world of e-commerce, for instance: with hundreds of thousands of transactions and millions of data items to be collected, organized, stored and retrieved on a daily basis, the cost of infrastructure is often a hugely prohibitive for new entrants.

But when companies take a big liability and turn it into their most profitable asset, you can’t help but admire what they’ve done.

I’m talking about Amazon. The barely-profitable retailer has been bleeding money for the longest time, and IT infrastructure was one of its biggest expense items. But when two of their employees suggested how the company could actually make money off the infrastructure surplus they had, management made the right choice.

Today, Amazon Web Services is the market leader in Cloud Infrastructure-as-a-Service (IaaS) with nearly $8 billion in sales, and a 23% operating margin that would put many profitable companies to shame.

Amazon Segment-wise Revenues and Margins – Q1 2016

While Amazon’s retail and international retail segments are struggling with operating margins in the low single digits, AWS has zipped past them in less than a decade to boast of margins that are more often above the 20% level than not.

In terms of hard numbers, Amazon’s North American business brings in $63.5 billion in sales but only $2.75 billion in operating profits; AWS, on the other hand, brings in an operating income of $1.86 billion from just $7.88 billion in revenue.

This past quarter, AWS is already bringing in the bulk of the operating income for the company, and this is a trend that’s only going to deepen.

How Did AWS Get To This Size?

The success of AWS was not an overnight one although that’s exactly what it looks like. The division was a mere idea on paper in 2003, but one year later it made its appearance first as Simple Queue Service, the forerunner to the EC2 (Elastic Compute Cloud.)

Until 2014, Amazon did not report AWS numbers independently. Even as early as 2012, revenues were estimated at $1.5 billion, but that figure was breached only in April 2015 when Amazon reported the first quarter (1Q 2015) of profitability at AWS – $265 million in operating income from a revenue of $1.57 billion.

How Amazon Web Service Revenues Have Grown

See how far they’ve grown since they starting standalone reporting for AWS.

This is Amazon’s success story, and this is what competitors will need to match if they want a crack at pole position. So, now let’s see exactly what form that competition has taken.

The Competitor Landscape

From major technology companies like Microsoft and IBM, to smaller players like Rackspace and CSC, to non-US companies like Alibaba with their Alicloud, Amazon has a tremendous string of competition behind it.

In terms of market share, however,  Amazon is the clear leader by a wide margin.

One of the biggest advantage is that Amazon has had, and has maintained, is its pricing power. Even with impressive margins higher than 20% Amazon has been able to reduce its price of cloud services more than 50 times since the service was launched.

This is important because it allows Amazon to continue in its price fight and not significantly lose out on margins.

Even the bigger players such as IBM and Microsoft are relatively recent entrants in the Cloud IaaS arena. Microsoft, for example, only made its intent for cloud known after Satya Nadella took over. Since then, however, they have been a force to reckon with, using their hugely popular Office 365 for the cloud service – Azure – to piggyback on. Clients in the SMB market are being offered free cloud credits along with their subscription to Microsoft’s Office suite in the cloud.

The resulting uptake has been impressive, and Microsoft now seems to be one of two serious contenders for the cloud infra space.

The other is IBM. Until their SoftLayer acquisition, IBM’s presence has been more distinctly felt in the hybrid cloud space with Enterprise customers. Of late, however, IBM has become more aggressive and lithe based on CEO Ginni Rometty’s strategic imperatives on cloud, analytics and big data.

Today, the cloud infra landscape shows three clear silhouettes: AWS, Microsoft and IBM. Google is now trying to muscle its way into the picture on sheer strength of global presence, but has yet been unable to make the kind of impact it should have for a technology company of its reach and cash power.

The Future of AWS

AWS has already become more profitable than Amazon’s retail business, and I see them going far beyond them in the next five years.

Several questions will crop up at that point, such as “will AWS be spun off as an independent business?”, “Can Amazon’s retail business survive without the profitability of AWS” and so on.

Jeff Bezos and the board have already given them a greater measure of autonomy by appointing a new CEO, but I think a spin off will hurt Amazon more than benefit it. It’s still a core part of their retail infrastructure across the globe, and that’s not going to change for the foreseeable future.