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Amazon Web Services Is No

While there is a wide range of opinions on the long-term ceiling for's (NASDAQ: AMZN  ) retail business, the company's cloud-computing arm is an even bigger wildcard. Amazon Web Services allows other companies to rent computing power from Amazon rather than buying and operating their own servers.

This business has been growing very rapidly. Last year, revenue in Amazon's "other" segment in North America -- which primarily consists of AWS sales -- reached $3.7 billion: up from less than $1 billion in 2010. The rapid growth of Amazon Web Services has led some analysts to value this oft-overlooked part of Amazon's business at $50 billion or more.

To justify these estimates, analysts typically point to other "cloud-computing" companies like (NYSE: CRM  ) , which has a $34 billion market cap despite generating just over $4 billion in revenue last year. But Amazon Web Services is nothing like Salesforce. It is a much more capital-intensive business than Salesforce and has minimal pricing power.

Another round of price cuts
Amazon Web Services (like Salesforce) is the clear leader in its field. In fact, AWS dominates the "infrastructure-as-a-service" market. According to Gartner (NYSE: IT  ) it is more than five times the size of the next 14 competitors combined! Normally, this kind of market share lead should translate to significant pricing power.

But AWS is under pressure -- or at least feels under pressure -- from various Big Tech firms that are trying to break into this market, including Google (NASDAQ: GOOGL  ) and Microsoft (NASDAQ: MSFT  ) . Neither company's IaaS offerings are close to AWS in market share, but Google and Microsoft both have unique competitive advantages in cloud computing. Google has its popular Google Drive service, various productivity apps, and Compute Engine, while Microsoft has its Office 365 cloud-based productivity suite as well as Azure.

In any case, Amazon has been ultrasensitive to the prospect of being underpriced by other IaaS providers. Since Google launched its AWS competitor in 2012, the two companies have periodically engaged in price-cutting battles.

This past week, Google cut its "App Engine" prices yet again. It didn't take long for Amazon to shoot back with price cuts of its own that range from 36%-65%, effective April 1. AWS senior vice president Andy Jassy made light of the price cuts, noting that AWS has reduced prices 42 times in its relatively brief history.

Jassy is essentially trying to make a virtue of a clear weakness. If AWS needs to respond in kind to every competitor's price cuts, it will have two negative impacts on the business. First, it will cause revenue growth to slow dramatically -- if prices fall 50%, AWS would need to double its volume just to keep revenue flat. Second, it will ensure that AWS remains a perpetually low-margin business.

A black hole of CapEx
The commoditized nature of Amazon's product stands in stark contrast to Salesforce's business. But an even bigger difference between the two companies is the capital intensity of their respective businesses.

Unlike AWS, which primarily sells infrastructure as a service, Salesforce offers software as a service. While Salesforce has to devote a significant amount of money to R&D -- over $600 million last year -- the vast majority of its costs relate to selling, general, and administrative expenses.

SG&A has been rising rapidly recently, but over time Salesforce should be able to leverage those expenses significantly. This potential for margin growth can justify Salesforce's high valuation even though it has consistently lost money on a GAAP basis and has a narrow profit margin on a non-GAAP basis (which excludes acquisition-related costs and stock compensation costs).

By contrast, as AWS grows, it needs more and more computing power and storage to rent out to its clients. This has driven a massive jump in Amazon's capital expenditures recently. From 2005 to 2009, Amazon's annual CapEx rose from $204 million to $373 million, which was significantly slower than the rate of revenue growth.

By 2013, CapEx had skyrocketed to $3.44 billion: up nine-fold in just four years. Some of that growth is related to new distribution centers for the retail business, but a large portion can be attributed to AWS.

For Salesforce, strong revenue growth brings the promise of margin expansion as the marginal cost of adding customers is fairly low. That's not true for Amazon Web Services. As it gains more business, it must plow billions and billions of dollars into things like servers, storage, and networking gear to support that growth.

Foolish bottom line
Amazon Web Services should be a solid contributor to Amazon's overall business in the long run. But just because it's involved in "cloud computing" doesn't make it similar to companies like Salesforce.

Despite its dominant market share, AWS competes tooth and nail with competitors like Google and Microsoft. Moreover, it needs to spend an ever-increasing amount on adding computing power in order to support its growth. This makes it a fundamentally low-margin, weak-cash-flow business: not one worth a gaudy multiple like Salesforce.

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Read/Post Comments (8) | Recommend This Article (4)

Comments from our Foolish Readers

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 March 30, 2014, at 5:26 PM, thevishalhere wrote:

    yes but if a better software shows up on internet Salesforge cant recover, the fall also will be superfast, unlike amazon

  • Report this Comment On March 30, 2014, at 6:51 PM, zippero wrote:

    Google's capex rose 124% last year to $7.4 billion from $3.3 billion due to its suicidal desire to compete on price with Amazon in cloud services. As a result, Google's free cash flow in 2013 fell for the first time in its history from $13.3 bil. to $11.3, and its $11.3 bil. in free cash flow undershot its $12.9 net income last year, which was the first time this has ever happened in Google's history. $7.4 bil. in capex is 60% of Google's 2013 net income. Essentially, Google is pouring all its monopoly, high-margin profits from its asset-light core advertising business into the capital-intensive money-pit of low-margin commodity cloud computing that is cursed by price wars with AMZN and everyone else.

  • Report this Comment On March 31, 2014, at 9:39 AM, BillOhne wrote:

    I'm not quite sure this actually is accurate. runs all it's Software as a service on Infrastructure. It also sells access to that infrastructure via its service and "Salesforce One" brand (which encompasses other services like Heroku). All of this requires CapEx. Salesforce wants to be THE platform on which SaaS runs, theirs and their partner's. That will mean a lot of CapEx to expand their data centers and build new ones. The Salesforce model is IaaS + SaaS. That may have greater revenue potential, but the CapEx costs will grow for Salesforce as they try to expand their IaaS capacity to support the thousands of non-Salesforce apps that run on their platform. I don't think this article gets to the heart of both business models. BOTH rely on leveraged Infrastructure and selling that infrastructure.

  • Report this Comment On March 31, 2014, at 11:00 AM, strattitarius wrote:

    I do agree salesforce and aws are not the same. Salesforce's main product is their CRM software. AWS's main product is infrastructure.

    CRM software should have higher margins... but I am not sure the marginal cost of a new customer is greatly lower at Salesforce than AWS. When you produce a finished software product, you have to meet the needs of customers in ways you never planned when you first wrote the software.

    AWS works at a much lower level. AWS gives developers and software providers the tools to build a large scale, web based application with little regard to what they actually do with it. AWS has to make sure the tools meet the needs of software providers. Salesforce has to make sure their CRM meets the needs of sales companies. Bill says Salesforce is getting into the "cloud" but I don't know and for this comment that's not important.

    Also, exactly what is "cloud computing"? Because as a software developer, I find AWS to be exactly what the true definition would be. is a website that runs software that you interface with though a browser. But it's still just software with a data, application, and presentation layer. It may be in the "cloud" to a user, but it is not the "cloud" to Salesforce. Just like the company I work for will let you order on our website, but that isn't the "cloud". However, if we developed a website and utilized S3, Computer, and other services from AWS, then it would be in the "cloud", but none of our customers would know or care. I, as the developer, would care, but the user doesn't care.

    Salesforce's definition of the cloud is what I coined "Application Service Providers" back when I wrote my thesis on this subject. They are not much different than if you bought an ERP or CRM from some vendor 10 years ago and they installed it locally for your company. But now we have fast internet and can install it at their location and maintain it for you. It's vendor managed inventory.

  • Report this Comment On March 31, 2014, at 12:00 PM, TMFGemHunter wrote:

    @Bill: Most of the value-added on Salesforce is the software, not the infrastructure. There's definitely some gray area, but it's very different than the pure infrastructure play of AWS.

    While Amazon doesn't break out AWS CapEx from the rest of the company, I think it's pretty safe to ballpark it at $1-$2 billion annually based on the overall rise in Amazon's CapEx since 2009. That's several times higher than Salesforce's CapEx, for slightly less revenue.

    @strattitarius: I agree that it's not very clear what "cloud computing" means and that was part of my point here. People are lumping all kinds of different businesses with vastly different margin structures, CapEx requirements, etc. and arguing that they should get the same high multiple of sales because they are "cloud computing" companies.


  • Report this Comment On March 31, 2014, at 2:43 PM, 45ACPbullseye wrote:

    Hi Adam, I enjoy your articles! I have been trying to get my mind around the different types of "cloud-centric" solutions, albeit approaching this from yet another angle -- data center REITs.

    This is a way for companies to reduce cap-ex, maintain flexibility to grow (or shrink), while reducing the costs for redundancy and security. Many companies are trying to figure out how to balance the need of data center computing vs. cloud applications. REITs such as QTS can provide a co-located hybrid solution.

    How do you see this piece fitting into the mix with the AWS, GOOG, and MSFT offerings?

    Best, Bill

  • Report this Comment On April 01, 2014, at 3:56 PM, TMFGemHunter wrote:

    Hey Bill,

    Thanks. I definitely think that data-center REITs are an interesting idea, but they're just not in my wheelhouse. I don't want to speculate wildly in an area I'm not all that familiar with.



  • Report this Comment On April 01, 2014, at 6:14 PM, 45ACPbullseye wrote:

    @Adam, you have hit the nail right on the head. It is difficult to find folks who are comfy with both IT and equity REITs. Any suggestions re: a fellow Fool who might be able to shed some light on this? Best, Bill

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Adam Levine-Weinberg

Adam Levine-Weinberg is a senior Industrials/Consumer Goods specialist with The Motley Fool. He is an avid stock-market watcher and a value investor at heart. He primarily covers airline, auto, retail, and tech stocks. Follow him on Twitter for the latest news and commentary on the airline industry!

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