Life Is Getting Even Tougher for Rackspace

Google and Cisco just joined the army of price cutters in the IaaS market. With Amazon, Microsoft, and Oracle, they are aggressively competing in the market, so where does this leave Rackspace?

Mar 31, 2014 at 3:00PM

Life just got a bit harder for cloud computing services company Rackspace Hosting (NYSE:RAX). Google (NASDAQ:GOOGL) aggressively reduced prices across its range of cloud services recently, while deep-pocketed competitors like Amazon (NASDAQ:AMZN), Microsoft, and Oracle (NYSE:ORCL) are committed to offering infrastructure as a service, or IaaS, at highly competitive rates. In addition, Cisco Systems (NASDAQ:CSCO) is planning to invest heavily in offering IaaS. While much of this is known to investors, it's sometimes easy to lose site of the fundamental reasons why these companies are doing this and why competition is only going to get more intense.

Why companies are investing in IaaS
Simply put, it works. The companies that have transitioned to offering their services and applications on a software as a service, or SaaS, basis have seen a transformational improvement in their prospects. The three leading examples of this change are Adobe, Autodesk, and Intuit. Investing Fools already know how and why these companies are outperforming the markets.

It's not a coincidence. The evidence from these three companies is that offering SaaS-based solutions tends to improve the metrics that increase the lifetime value of a customer. In other words, retention ratios go up, marketing costs to keep or acquire a customer go down, and the opportunity to cross-sell solutions to customers is improved.

Of course, if it's working in terms of offering SaaS to customers, then companies will invest in more IaaS. Moreover, cloud-based infrastructure is also increasing operational efficiencies within companies. All told, corporate demand for IaaS is only going to increase in the future, and if companies need IaaS, they also need to run applications on platforms.

Move to the cloud or die
Inevitably, this means a company like Oracle is forced to invest heavily in offering IaaS because it needs to ensure that customers continue to use its applications and platforms. This isn't an optional extra for Oracle, it's an inevitable consequence of shifts in customer behavior. The company needs to respond to the challenges of pure cloud play companies like Workday and Salesforce.com.

As for Cisco Systems, it needs to offer IaaS to service providers and enterprise customers because, according to Cisco's president of development and sales, Rob Lloyd: "they want to rapidly deploy valuable enterprise-class cloud experiences for key customers – all while mitigating the risk of capital investment."

Cisco needs to do this because, if companies are shifting toward the cloud, it implies they are spending  less on the kind of hardware solutions that Cisco offers enterprises.

Turning to Google, its move to slash prices is seen as directly taking aim at Amazon Web Services' leading position in the market. If anyone thought that Amazon would take this lying down, then Amazon's announcement -- the day after Google outlined price cuts -- that it was cutting prices by 10%-65% should have served notice. According to a Reuters article, the cut marks the 42nd reduction since the company started.

What it means for the industry
Putting all of these factors together, it's clear that the these tech behemoths are committed to investing in offering IaaS. They are motivated by a combination of trying to penetrate new markets (Google), replace potential sales lost to customers (Cisco, Oracle), and offer other, higher-margin solutions to customers (Oracle, Microsoft, Cisco, Amazon, Google). Moreover, the success of companies shifting IT infrastructure and software offerings into the cloud will ensure rapid uptake of cloud computing in the future.

What it means to Rackspace investors
While all of this is great news for companies that want to invest in cloud-based infrastructure, it inevitably creates difficult market conditions for a company like Rackspace Hosting. Investing Fools have already seen how the company faces significant challenges in 2014, and the recent announcements by Cisco, Google, Amazon, and Oracle are only going to make things harder.

It's one thing to try to offer a differentiated service, but it's another thing to try to charge a premium for it when so many tech giants are aggressively cutting prices for IaaS.

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Lee Samaha owns shares of Cisco Systems. The Motley Fool recommends Amazon.com, Cisco Systems, Google, and Rackspace Hosting. The Motley Fool owns shares of Amazon.com, Google, and Oracle.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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