Cloud Data Center Build-Out Race Good for Customers, Bad for Profits

NEWS ANALYSIS: Enterprises that want to move their IT infrastructure to the cloud are sure to benefit from the data center build-out race that Google, IBM, Amazon, Microsoft and others are engaged in, but where will the profits come from?

How much is your company spending on infrastructure this year? What would you do with $2.35 billion in infrastructure spending in just one quarter? The $2.35 billion is the infrastructure spending Google provided in its most recent quarterly report.

While Google, like its peers, does not break down capital expenditures in a granular fashion, the company is betting on data center capacity for future needs. As Google CFO Patrick Pichette said in the company’s recent earnings call, "in the case of data center construction, we have found that the option value of having more capacity on standby and available to us to grow versus not having it is actually a real strategy issue for the company."

Because if Google "had a spike in demand that was really pronounced and sustained for a couple of quarters and we did not have the capacity, it would be a real issue strategically for us, relative to the quite low cost of having the infrastructure in place," Pichette said.

Setting aside the notion for a moment that the whole purpose of cloud computing is for customers not to have to build up capacity in advance of computing needs, but to have the capacity spin up on demand, the big cloud vendors are clearly in a big data center build-out race.

IBM is in the midst of building 15 new data centers at a cost of $1.2 billion. Microsoft just broke ground for a nearly $2 billion data center in Des Moines, Iowa. Amazon Web Services is reportedly considering building data centers in international regions, including Germany, to both increase capacity and to address customers' concerns regarding foreign access to their data, including the U.S. National Security Agency.

Throw in $1 billion from Cisco, investments from Hewlett-Packard, Rackspace, VMware and internal OpenStack-like deployments and 2014 is shaping up to be the year of the great data center build-out.

The question is whether there will be sufficient customers to make those billions of data center investment dollars worthwhile. Amazon Web Services is the largest enterprise cloud service provider at an estimated $3.2 billion in 2013. Other vendors might claim bigger cloud revenue but they tend to throw in hardware sales, service revenues and nearly everything else they can into the cloud bucket.

While $3 billion or $4 billion seems like a good business on the revenue side, the recent price wars that have broken out between Amazon, Google and Microsoft means the margins derived from those revenues are going to tighten. High volume, low margin is not a new game for Amazon, but it is a new undertaking for traditional software vendors.

Although the future of enterprise computing may see cloud applications as the default place to create and run enterprise applications, the vendor side of the cloud business will become increasingly costly. Anyone that has run a data center knows that costs don’t stop once the data center is complete. Computer upgrades, maintenance of cooling systems and hardware and software updates means a consistent cycle of re-investment.

For the user, the increased vendor competition for the enterprise cloud dollar would seem like a good thing. Although it is actually quite tricky to change from one cloud vendor to another once you have made an infrastructure decision, you can always use the alternative vendor’s cloud pricing to drive your pricing negotiations.

It is difficult to see how there will not be some vendor fallout from the big data center infrastructure race. Even those vendors with billions in the bank will at some point have to think about whether it might be better to put those billions to work elsewhere rather than in businesses where the competition continually gets more intense while the profits gets ever narrower.

Eric Lundquist is a technology analyst at Ziff Brothers Investments, a private investment firm. Lundquist, who was editor-in-chief at eWEEK (previously PC WEEK) from 1996-2008 authored this article for eWEEK to share his thoughts on technology, products and services. No investment advice is offered in this article. All duties are disclaimed. Lundquist works separately for a private investment firm which may at any time invest in companies whose products are discussed in this article and no disclosure of securities transactions will be made.