Amazon (AMZN +1.04%) struck gold with its cloud computing arm, Amazon Web Services. AWS accounts for around one-third of global cloud infrastructure spending, and it's far more profitable than the company's e-commerce business. Through the first nine months of 2022, AWS generated $58.7 billion of revenue and $17.6 billion of operating income, good for a segment operating margin of 30%.
How does AWS generate such incredible profits? One reason is that customers don't pay much attention to their cloud computing bills. Flexera estimates that roughly 32% of all cloud spending from organizations is completely wasted. That waste comes from idle resources, resources that organizations have lost track of, and the over-provisioning of resources.
On top of waste, many companies likely have room to optimize their cloud computing spending. A start-up trying to get to market quickly during a period of booming demand, for example, isn't going to spend much time worrying about cloud computing costs. That start-up might write inefficient code that uses more resources or bandwidth than would otherwise be necessary for the sake of expediency, or it might use expensive services that it can get up and running quickly.
This waste and inefficiency don't matter much when companies are more focused on growth than on costs. But the environment has shifted. Sky-high inflation and recession fears are taking their toll on companies' results, and cost-cutting is now the order of the day. Reducing cloud computing expense is low-hanging fruit.
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Key Data Points
The cloud bonanza could be coming to an end
Demand for cloud infrastructure is slowing as companies grapple with the current economic environment. The cloud offers a lot of benefits, and it should be a growth market for many years to come. But that doesn't mean that the excessive profits generated by the market leader will necessarily persist.
Amazon is seeing customers take a hard look at cloud costs, and in some cases, they're moving data to cheaper storage tiers and moving workloads to cheaper instances. As companies go through their cloud spending with a fine-tooth comb, they're likely to find that they're spending substantially more than they really need to be spending.
On top of this whittling of existing workloads, enterprise customers may start to slow down or pause the digital transformation initiatives that have been all the rage over the past few years. Moving workloads from on-premises data centers to the cloud gains flexibility and a more modern IT stack, but it's certainly not a cost-cutting measure. Cloud computing can be expensive, especially compared to running workloads in data centers that already exist.
Some companies are ditching the cloud altogether, which could turn into a trend as slashing costs becomes the primary focus. A notable example is upstart email provider HEY, which announced last October that it was done with cloud computing. HEY co-founder David Heinemeier Hansson argued that the company had reached a large enough size to justify owning and operating its own infrastructure, and that he'd never heard of any organization being able to downsize their operations team simply by moving to the cloud.
As all of this is happening, energy costs are much higher than they were before the pandemic. AWS uses a lot of electricity, and the company is facing this particular cost headwind for the first time in its history.
Margins may have peaked
Amazon was a first mover in the cloud infrastructure market -- one that enabled rapid innovation from start-ups and eventually drew in enterprises looking to modernize. In the long run, demand for cloud infrastructure should grow at a healthy pace.
But there's a lot more competition now than there was in the past. Microsoft Azure is catching up fast in terms of market share; Alphabet's Google Cloud is growing quickly; and a host of smaller cloud providers like DigitalOcean are going after customers looking for simpler platforms.
AWS's fat profit margins are those competitors' opportunities, to paraphrase Amazon founder Jeff Bezos. As demand for cloud infrastructure cools amid a tough economy, Amazon's most profitable business is likely to face some serious headwinds.
