Is Amazon really a low-margin cloud business?

A startup competitor to Amazon Web Service's cloud computing platform is accusing the company of engaging in a "fake price war" and inflating the prices of its services.

The issue stems from comments made at AWS's first-ever user conference last year in which AWS Senior Vice President Andy Jassy said the organization operates by the same tenets that guide its parent organization, Amazon.com the online retailer: High volume of sales, low margin of profit.

No one questions that AWS is a high-volume business, but low-margin? Andreas Gauger, Founder and CMO of ProfitBricks, and a veteran of the hosting industry, announced in a blog post a price cut in ProfitBricks' services and in doing so accused the industry's biggest players of misleading customers about their pricing. "Unlike the big players, we do not talk about a fake price war and fake low margins," he wrote. "We just act."

[MORE CLOUD:Why Netflix is one of the most important cloud computing companies]

The issue reflects a broader battle-royale among cloud computing companies that has evolved during the past year over pricing. AWS has cut prices on some portion of its cloud computing platform 37 times in seven years since announcing the service; in most cases the price drops apply to a small subset of AWS services though, Gauger points out.

AWS competitors have begun responding to AWS price cuts with reductions in the cost of their services as well. Microsoft and Google have each been known to drop prices directly after an AWS reduction, for example. Microsoft even went so far as to announce that it will match any AWS price drop moving forward on "core" services such as cloud compute, network and storage. Earlier this year it took Google a mere few hours to cut its prices after Amazon announced a reduction.

Startups and smaller competitors are getting into the cloud pricing game too. European IaaS providers CloudSigma announced a price drop recently, although CloudSigma claims it was fueled by efficiencies the company has created in its system and wasn't done in response to AWS.

ProfitBricks, a 1-year-old startup, is doing the same. The difference with ProfitBricks is that company executives are calling out Amazon this time.

"I don't see a price war or a race to the bottom," Gauger said in an interview. "It's all a nicely-played PR stunt." After running the ProfitBricks IaaS for a year, Gauger said the company's costs have gone down much faster than the 50% price cut the company announced this week. "Cloud computing prices are inflated," he says. Based on his experience running a cloud company, he estimates that AWS gross margins could be more than 50% (meaning the difference between revenue and cost of producing the product before taxes and other costs are incurred) on some products. He says ProfitBricks had healthy margins, and Amazon has even greater scale, which leads to even cheaper costs and likely even higher margins.

ProfitBricks cut its prices this week by about half: dedicated, single-tenant, single-CPU core servers dropped from $0.05 per hour to $0.025 per hour. It's difficult to do an apples-to-apples comparison of ProfitBricks and AWS prices, but AWS's smallest instance size comes with 1.7GB of memory and 160GB of instant storage for $0.06 per hour.

Amazon Web Services would not comment publicly about its business strategy, or respond to claims about it not actually being a low-margin business. But, the company proudly touts its price cuts and Jassy explained last year at the re:Invent conference a virtuous cycle in which the price cuts lead to higher volume of use by customers, which in turn lead to greater economies of scale for the company and allows it to continue to reduce prices. "High margin businesses have been around forever and in lots of industries and they're obviously a viable and successful business model. It's just not ours," Jassy said.

So what's really going on here between these disputing Amazon and ProfitBricks claims? Is AWS really a low-margin business? "No," says Carl Brooks and IaaS-watcher for the 451 Research Group. "It is a high volume, high margin business, at least on the base cost." Running a virtual server should cost around $0.01/$0.02/hr., which would include a profit margin; some in the market, like Digital Ocean, offer dedicated servers for as little as $0.007/hour for a 512MB server, or $5 a month.

Analyst firm Technology Business Research estimates that Amazon and Microsoft have healthy operating margins of around 14% to 15% (meaning the amount of revenue left over after paying all costs, including production, taxes and wages). That's much higher than Amazon.com the retailer's margins, notes Jillian Mirandi, who tracks the financials of cloud computing companies. "IaaS providers we believe are able to operate at higher margins as they have more of a 'build once sell a lot' business model" compared to SaaS providers and other non-cloud businesses, she notes. Those margins could be adversely impacted as AWS builds out its headcount in areas like enterprise sales, and continues to add features and tools, she adds.

Some other analysts are buying into ProfitBricks' claims too. After being briefed by the company, Ben Kepes, a blogger, consultant and investor, questions why Amazon virtual machine instance price reductions have not gone down at the same pace as compute performance increases and Moore's Law. "Moore's Law expected price economies really haven't been borne out in actuality," he writes about Amazon pricing.

The real answer is that Amazon does not release the financial details of its cloud computing division, so no one outside of the company really knows for sure what the margins are and how they've changed. But, if there wasn't a price war before, there sure is now.

Network World senior writer Brandon Butler covers cloud computing and social collaboration. He can be reached at BButler@nww.com and found on Twitter at @BButlerNWW.

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