Snap (NYSE:SNAP) is probably Google's biggest cloud customer. Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL) announced that it brings in over $1 billion in revenue per quarter from Google Cloud. Snap paid it about 10% of that in the fourth quarter. It spent $131 million between Google Cloud and Amazon.com's (NASDAQ:AMZN) Amazon Web Services.
That's quite different from other large social media and digital advertising platforms such as Facebook (NASDAQ:FB), which use their own servers to host their platform. The idea is the upfront costs are worth the long-term financial gain. After all, Snap has committed to spending $3 billion with Google and Amazon through 2021, which is nothing to sneeze at.
But Snap CEO Evan Spiegel says there are advantages to outsourcing its hosting. "For us, obviously, there are tremendous cost advantages there," he said at a recent investors' conference. "But there are also a lot of advantages in terms of the amount of time, attention, and engineering excellence we can devote to other things outside of keeping our servers running. So, I think, if we look at the history of the company and our ability to execute really really quickly, that's where the cloud played a really important role."
The ability to execute quickly is essential for Snap to stay ahead of the competition.
Snap's competitive advantage
In Snap's S-1 filing with the SEC ahead of its IPO last year, management noted, "In a world where anyone can distribute products instantly and provide them for free, the best way to compete is by innovating to create the most engaging products."
In other words, Snap relies on its ability to engineer new forms of communication and distribution and get them in front of as many users as quickly as possible. To that end, Google and Amazon are tremendously useful, especially for new product features like Discover, Snap Maps, or context cards that require significant increases in computing power and data consumption.
Snap can simply click a button and it has all the computing power it wants. No need to stand up thousands of servers across the globe like Facebook.
Facebook, comparatively, is consistently warning investors that it will invest a ton of cash in capital expenditures. CFO Dave Wehner just warned analysts during its fourth quarter earnings call that Facebook will more than double its capital expenditures in 2018 to somewhere between $14 billion and $15 billion.
But it still ain't cheap
Thanks to offloading a ton of work and capital expenses to Google and Amazon, Snap can get by without as much cash up front and without as much overhead for hiring systems administrators for its servers.
But Snap has to pay a premium for that flexibility. Snap paid $131 million to Google and Amazon in the fourth quarter, and that number will continue to climb as Snapchat adds more users and features.
Instead of an upfront capital expenditure that Snap can amortize over time, Snap's contracts with Google and Amazon show up in cost of goods sold every quarter. While Snap's revenue surpassed its hosting costs this year, it's still a major drag on gross margin. Even in the seasonally strong fourth quarter, hosting expenses totaled 46% of revenue. That percentage ought to climb in the first half of this year.
When Spiegel says there's an "obvious" cost advantage working with Google and Amazon, I'm not convinced. Perhaps in the near term there are significant advantages, but if Snapchat continues growing, the $3 billion in hosting agreements could quickly become a liability instead of an advantage.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Adam Levy owns shares of Alphabet (C shares), Amazon, and Facebook. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, and Facebook. The Motley Fool has the following options: short March 2018 $200 calls on Facebook and long March 2018 $170 puts on Facebook. The Motley Fool has a disclosure policy.