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Will Alphabet Inc. Threaten Inc's Cloud Dominance?

By Leo Sun – Mar 29, 2016 at 5:15PM

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Can the search giant catch up to the cloud platform leader by nabbing new customers and slashing prices?

Alphabet's (GOOG 6.30%) (GOOGL 6.09%) Google owns the world's largest search engine, mobile operating system, and mobile web browser. But one market where it remains an underdog is cloud infrastructure, which is dominated by Amazon's (AMZN 4.46%) AWS.

According to Synergy Research Group, AWS controls 31% of the cloud infrastructure market, followed by Microsoft's (MSFT 6.16%) Azure at 9%, IBM's Bluemix at 7%, and Google's Cloud Platform at just 4%. Google tried to catch up by cutting prices on its cloud storage, on-demand computing, and analytics services in early 2014. Amazon and Microsoft matched those prices, but smaller second-tier players got flushed out of the market.

Source: Pixabay.

Nonetheless, Google hasn't given up on challenging Amazon, and recently lured both streaming music leader Spotify and Apple (AAPL 4.86%) away from AWS. While neither company will abandon AWS, the split indicates that Google is likely offering more compelling prices and features than Amazon. Netflix, Amazon's biggest cloud customer, also recently spoke at Google's cloud conference, fueling speculation that it might be open to using alternative providers. These moves all indicate that Google is gearing up for a protracted cloud infrastructure battle against Amazon. But can Google catch up after lagging behind the market leaders for such a long time?

How Google got left behind
Google's dismal cloud growth can mainly be attributed to its weak enterprise presence. Amazon secured a first mover's advantage among businesses by hosting companies' websites on its massive servers. By adding new online services to those sites, AWS became the "best in breed" solution for hosting and processing large amounts of online data. Microsoft's Azure arrived in 2010, four years after Amazon launched AWS, but it leveraged its leading position in desktop operating systems and productivity software to quickly tether enterprise customers to Azure.

Google, being neither a first mover nor an enterprise leader, tried to squeeze into the market by challenging Microsoft's SaaS (software as a service) platforms Office 365 and Dynamics CRM with Google Apps for Work. The idea was that if more businesses adopted Google Apps, it would be more likely that they would tether themselves to its IaaS/PaaS (infrastructure/platform as a service) solution, Google Compute Engine.

Google Apps for Work. Source: Google.

Unfortunately, Google Apps for Work still have less than half the market share of Office 365 among the large enterprises, which mainly use AWS and Azure. AWS and Azure also have more momentum, since many companies prefer to use the proven cloud platforms that their industry peers are using.

How Google is trying to catch up
Google is trying to catch up to Amazon and Microsoft with two main strategies -- better features and lower prices. Spotify chose to move its infrastructure from a primarily on-premise solution to Google Cloud instead of AWS because Google offered more tools to process large amounts of data. It's unclear if other companies share that opinion, but Amazon notably beefed up its cloud offerings with 722 new features and services last year.

Apple didn't make similar claims, but the way it splits its iCloud between Amazon, Microsoft, and Google resembles the way it splits its hardware production among multiple suppliers. That strategy prevents it from becoming too dependent on a single provider, and gives it more clout during price negotiations. It also indicates that Google, Amazon, and Microsoft will need to keep slashing prices to stay competitive. Amazon already reduced the price of its cloud services 51 times over the past decade.

Google is gaining high-profile customers, but the company has been cagey about how much revenue the deals will actually generate. According to sources cited by CRN, the Apple deal might generate between $400 million to $600 million in annual sales for Google. However, that's a pretty insignificant amount since Google already pays Apple about $1 billion per year to keep its search bar on iPhones. Many analysts also speculated that Google gave Spotify and Apple "sweetheart deals" in which the incoming revenue will be more than offset by the platform's operating expenses.

Should Amazon investors be concerned?
Google's willingness to take losses to gain market share against AWS and Azure is troubling, but Amazon and Microsoft investors shouldn't panic. Google's cloud partnership with Spotify might be about processing big data efficiently, but I suspect it has more to do with narrowing Spotify's losses. Google's partnership with Apple also isn't built to last, since Apple plans to fully migrate to its own data centers within the next few years.

However, Amazon investors should see if this ongoing pricing war weighs down AWS' operating profits, which are expected to be a core profit driver and offset the thin margins of its marketplace business. If that happens, Wall Street's expectations for Amazon to achieve 41% annual earnings growth over the next five years should be carefully reexamined.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Leo Sun owns shares of The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares),, Apple, and Netflix. The Motley Fool owns shares of Microsoft. The Motley Fool recommends Home Depot. 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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