Investing in Cloud Computing for Dummies

If you ask 10 technology experts to define cloud computing, you might get 10 different answers. If you don't know what it is, how can you expect to invest well? Well, here's your flash-card answer: Cloud computing is the computer as a utility.

While they lack monopoly power, the best cloud-computing providers, like utilities, leverage superior scale and per-use payment plans to offer resources at lower costs than what most companies could get on their own. Like utilities, no cloud service could exist without the necessary inputs -- in this case, hardware suppliers. At the other end of the chain, cloud users are restricted only by the limits of computers themselves, allowing for incredibly diverse opportunities.

I've put together a primer on the cloud that I hope will demystify an industry that often seems more buzzword than legitimate business model. Make no mistake -- it is legitimate, and there is great potential for those willing to dig deep. If you're curious about how to find and analyze cloud companies without needing a computer science degree, read on.

The computer utility defined                                                                                      
Utility computing was once offered only in long-term contracts with little flexibility, closer to the cable company than the electric company. Intel (Nasdaq: INTC  ) found little success with this model, but Amazon.com's (Nasdaq: AMZN  ) Elastic Compute Cloud, or EC2, later won the day by allowing users to pay only for what they used.

Many top cloud providers now offer per-use payments, though service-focused companies such as salesforce.com (NYSE: CRM  ) may still use contracts. Contracts can work when pre-developed software is needed, ensuring ongoing support and regular updates. Pay-per-use usually is better for companies that have specialized needs and already have the people in place for high-level software work.

Component players
Intel is dominant in server processing and also competes in a crowded solid-state-drive market. I've repeatedly pointed out Intel's deep commitment to R&D, but that's only one aspect of the chipmaker's superior scale. Any search for the best cloud component investment should begin with Intel, but it doesn't have to end there. Other heavyweight hardware manufacturers also excel in this sector, as might be expected.

That doesn't mean that small companies can't succeed, but it's not easy. The entry barriers to profitably manufacturing computer hardware are quite high. It can be exciting to get in on the ground floor of a next-gen tech manufacturer, but without a deep understanding of what makes its technology better, such investments can be more like gambling.

Cloud providers
Cloud-computing providers thrive off scale, which is not easy to reach. Very large data centers -- the only real source of cloud capacity -- may cost hundreds of millions of dollars to build, equip, and maintain. If a company doesn't have deep pockets, it probably won't get far as a cloud provider.

An average data center might have 1,000 servers, but massive operations usually have at least 50,000. Microsoft (Nasdaq: MSFT  ) once spent half a billion dollars on one 300,000-server facility. A manager claims the operation costs Microsoft an eighth what most average data centers would spend per server over the long run. Scale allows these computing power plants to rent capacity at costs lower than those borne by smaller users while still netting a nice profit for themselves.


Sources: UC Berkeley RAD Lab, Microsoft Research, author's calculations.

The provider spectrum
But while most utilities are the same to consumers, cloud providers fall on a spectrum between infrastructure and platform -- not including storage, which is a separate but equally viable cloud model. Since storage is such a straightforward option, it's often part of the package when users need utility computing. Some cloud companies are storage-centric, but few are public.

Amazon's EC2 is all about infrastructure, and users can treat it like a big block of empty servers they might otherwise have in their own offices. Anything that can be done on physical servers can be done on Amazon's servers, with all the techie grunt work that entails.

Microsoft's Azure cloud, on the other hand, runs on the Windows operating system and provides pre-built applications, a midrange between pure infrastructure and pure platform. This restricts what programmers can do but provides greater support. Salesforce's Force.com is pure platform, offering limited modification options but excellent support.

Whether offering infrastructure, platform, something in between, or storage, it always pays to out-scale the competition. If a company commands enough resources, its profits are almost as guaranteed as those earned by utility companies -- provided users take advantage of those resources in significant numbers.

Software, services, and you
The final tier of cloud computing may be the most difficult to target for investment. It's certainly the broadest category. Most call it software as a service, just as infrastructure and platform options are dubbed services in the cloud. This tier is the only one most of us would ordinarily encounter.

The software that runs in the cloud ranges from Salesforce's myriad business apps to Netflix's online presence (now hosted by Amazon). Google (Nasdaq: GOOG  ) is an app provider through and through, with a full array of cloud-hosted business solutions that compete with Microsoft's Office suite. The only real difference between software as a service and regular old software is the delivery method. Many investment considerations are the same in both cases.

Foolish final thoughts
There's a lot of ground to cover in cloud computing. I could never get to it all in one go. You can find out a lot more, though, in The Motley Fool's free report on the future of cloud computing. If you really want to discover what an incredible opportunity this is, our video report will give you a lot more information -- and some great tips -- on investing the cloud phenomenon. Thousands have discovered the cloud's potential through this revealing video, so join them now and get your copy of this free report.

Fool contributor Alex Planes holds no financial position in any company mentioned here. Add him on Google+ or follow him on Twitter for more news and insights. The Motley Fool owns shares of Amazon.com, Microsoft, Intel, and Google. Motley Fool newsletter services have recommended buying shares of Microsoft, Intel, Google, salesforce.com, Netflix, and Amazon.com, creating a bull call spread position in Microsoft, and shorting salesforce.com. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has adisclosure policy.


Read/Post Comments (7) | Recommend This Article (31)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 07, 2012, at 9:42 PM, roguesisland wrote:

    How does EMC fit into this article? I was under the impression that data storage was essential to "the cloud".

    Curiously missing from this article.

  • Report this Comment On February 07, 2012, at 11:49 PM, TMFBiggles wrote:

    @ roguesisland -

    Due to space constraints, I had to keep the list of companies small. EMC is discussed in the linked article on utility cloud providers due to its size and success in cloud storage. This piece was meant as an overview for those less familiar with cloud computing, and a gateway to more research on the reader's part.

    - Alex

  • Report this Comment On February 08, 2012, at 6:34 AM, steveat wrote:

    As a Cloud Analyst myself, Amazon has built their own technology which is different from the others. Not all clouds are the same, however, many have the same attributes like scalability, flexibility.

    To describe what cloud is, is not very difficult. It's the same technology (nothing new), just arranged in a different way. I digress.

    If you want companies to look for, check out Citrix that has an IaaS solution and also VMWare. I believe VMWare will be the clear winner in the next 5 years. I have a funny feeling Amazon won't be able to keep up as their are too many NON-Interoperable pieces to their pie whereas, VMWare's ESX/ESXi virtualization technology can handle up to 80 different operating systems, not to mention they support the OVF format which is a far cry from the less than interoperable AMI (Amazon Machine Image)

    ALSO!!! Keep in mind that when you build a cloud infrastructure, it doesn't mean you are redundant! Your entire network needs to be upgrade. This means you need to upgrade the network (switches, routers etc)...thus, companies like Cisco/Juniper/F5/Extreme etc will all see a winfall!

    As far as storage is concerned, you need to pay attention to Intel purchasing "Infiniband" which is a storage protocol like ATAoE/iSCSI/NFS/FCoE. Infiniband is the wave of the future. That technology is hitting I think up to 60 Mps where a norma hosting provider using iSCSI hovers between 1 mps and 10 mps. The only other protocol that can come close would be fiber channel over ethernet (FCoE).

    Keep an eye on (I havent checked if these companies are public, but Aberdeen/Nexsan/nexenta/Fusion IO. These companies, along with EMC will receive significant success for at least the next 5 years.

    To the Author: If you want to pick my brain on anything else cloud computing, you can do so.

  • Report this Comment On February 08, 2012, at 11:37 AM, sccaldwell wrote:

    I agree with roguesisland...omitting EMC is a major oversight. As the leader in enterprise-level storage (Clariion, Celerra, Symmetrix, etc), leadership in virtualization (via majority ownership of VMWare), and the leadership in enterprise backup solutions (Data Domain, Avamar, Networker, etc), no article on cloud computing is complete w/o at least mentioning EMC.

    Also, the suggestion Intel will gain from cloud computing is wrong, IMHO. Sure, they'll sell a lot of components for all of those cloud servers....but on the flip side, they'll *lose* a lot of sales of servers for the companies that are now hosting in the cloud instead of hosting their own.

  • Report this Comment On February 08, 2012, at 12:00 PM, dummy537 wrote:

    "Intel will gain from Cloud computing" is probably true not because what the author mentioned in terms of general enterprise cloud story but from Smartphone infrastarcture that Telcos and Application vendor need to build. Imagine tons of server investment that Telco have to consider in next few years due to Smarphone growth? Essentially Smarphone backend is all about Cloud.

  • Report this Comment On February 08, 2012, at 12:02 PM, ET114 wrote:

    The really, really simple answer to "the cloud": it's the Internet... be it EMC, NetApp, Amazon, Google, IBM, SAP or whomever; it's all about executing, updating and storing stuff at massive data center/service bureau locations over the internet or some other secure private pipe... that's it...

  • Report this Comment On February 08, 2012, at 10:03 PM, optimist911 wrote:

    We had all this in the 60's, back when it was known as IBM's VM/CMS.

    Somehow people have forgotten all about it and believe they've invented a brand new paradigm.

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