Will Rackspace's Unorthodox Approach Pay Off In Cloud Infrastructure

Rackspace has significantly lagged its peers in cloud infrastructure, but as the company makes changes and builds awareness for its services, can it compete with the likes of Amazon and Google?

Jul 21, 2014 at 6:30PM

Rackspace Holding (NYSE:RAX) is working hard to convince investors and its customers that it has an edge in the cloud infrastructure, or infrastructure as a service (laaS), business over the likes of Amazon.com (NASDAQ:AMZN) and Google (NASDAQ:MSFT). However, as buyout hopes fall apart, whether or not Rackspace is successful in laaS has never been more important for shareholders.

The state of cloud services
During Rackspace's last quarter, its cloud segment accounted for nearly 30% of total revenue. With growth of 34% year-over-year it has been the most significant fundamental driver for the company. However, with just $121.4 million in a cloud industry that created $3.5 billion in the first quarter, Rackspace's cloud business is still somewhat insignificant.

The current market leader, Amazon, generated more than $1 billion in first quarter revenue from cloud services, including growth in excess of 60 %. This means that Rackspace is lagging the industry leader in both market share and growth. With that said, Amazon is undoubtedly the king of cloud, with the business valued at $50 billion by Evercore . Yet, with the cloud industry generating $12.5 billion in trailing 12-month sales and growth of 50% annually, Amazon's peers have made major attempts to steal its market share.

This includes Google, who in March made price cuts of 30% in its cloud application platform and cuts from 68% to 85% in cloud storage services . While it earned less than $250 million during the last quarter from cloud services, Google's recent price cuts have made the company more competitive in an industry that is growing rapidly.

Albeit, Amazon must have felt threatened, as the company followed Google's footsteps with price cuts in excess of 30% for its own services . Essentially, this price cutting war has become a trademark of the cloud industry.

Rackspace tries and defends its unorthodox approach
Meanwhile, Rackspace has refused to follow suit with price cuts, and insists that added features make its services are worth significantly higher prices. In a recent article entitled Is A Rackspace Holding Acquisition Good For CenturyLink Shareholders an illustration of Rackspace's premium pricing in comparison to Amazon was shown: Rackspace charges $0.68 per hour for a 15GB cloud server versus $0.28 for Amazon.

This particular illustration apparently struck a chord with Rackspace President Taylor Rhodes, who wrote a blog in response to the comparison. Rhodes said that Rackspace customers get 24×7 access to cloud engineers, including specialists in a host of complex technologies such as data stores and digital marketing platforms. He added that Rackspace customers get architecture guidance, a security audit, and system monitoring and alerts — just to name a few value adds for a $0.40 premium to Amazon's cloud server per hour.

Then, on Tuesday Rackspace went one step further in distinguishing itself from cheaper peers by breaking its laaS offerings into two tiers: Managed Infrastructure and Managed Operations , with the latter being more personalized in offering all of the services that Rhodes mentioned in his blog. Furthermore, Rackspace is hoping to attract developers by providing a bundle of cloud services for free to all clients for 12 months.

Does Rackspace have a point?
Albeit, does Rackspace have a strategy that can make it relevant in an industry that has seen aggressive discounting among all of its leaders. To answer that question, we must agree that Rackspace's services are equivalent to its peers.

The Register's Jack Clark recently called Amazon's m3.xlarge server the (roughly) equivalent of Rackspace's "Performance" cloud server, and this includes sold state drive storage, or SSD, for both services. Moreover, Clark notes that Google's n1-standard-4 is also the near equivalent, although lacking SSD storage, and also sells for $0.28 per hour. Hence, the storage itself is equivalent, which means Rackspace's big bet is that developers will pay for the additional services.

Yet, with Amazon's Web Services as a whole growing at near double the 34% clip of Rackspace's cloud segment, it proves that clients have preferred the cheaper options in this space. While Rhodes makes good points in his blog, cloud servers are the sought service, everything else is a luxury, including architecture guidance and security audits.

Now, Rackspace's decision to offer a bundle of free cloud services to its clients is an interesting decision, one that developers might find appealing. However, Amazon already offers free services for its developers with the company's success coming mainly from its enormous presence with developers.

Not to mention, at Google's recent I/O conference it unveiled a number of debugging, monitoring, and tracing applications for developers, many of which are free. Hence, Rackspace's 12-month free bundle is a big step in the right direction, but not a breakthrough by any means.

Foolish Thoughts
With all things considered, Rackspace has made some changes, but its premium pricing strategy remains, and history serves as proof that developers and clients are more worried about the cloud services rather than additional features that may be more costly. Therefore, Rackspace has tried hard to find a fundamental difference between it and its peers' cloud business, but in reality, the biggest difference is price, and for this reason Rackspace will continue to be held back.

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Brian Nichols has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, Google (A shares), Google (C shares), and Rackspace Hosting. The Motley Fool owns shares of Amazon.com, Google (A shares), Google (C shares), and Microsoft. 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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