Amazon’s profit engine is slowing down as rival cloud players are growing fast. My interviews with two upstarts — Wasabi Technologies and Sushi Cloud — suggest that AWS is overcharging as slowing economic growth pressures customers to reduce their costs.
AWS’s profitability depends on how well it can lock customers in, sell them more services, and make it expensive for them to leave. Fortunately for customers, upstarts are offering excellent point solutions for specific services — such as storage and compute — at prices low enough to more than offset AWS’s high switching costs.
AWS could grow faster were it to lower its prices enough to neutralize the effectiveness of that strategy. However, unless it reduces costs along with its prices, AWS profits will decline.
After forecasting that its growth could slow considerably below its record-low 15.8%, AWS seems to be losing ground to Microsoft’s Azure Cloud which raised growth guidance above analyst expectations.
While analysts remain modestly bullish on Amazon, I do not see how AWS can recover to the 40% growth rate it previously enjoyed.
(I have no financial interest in the securities mentioned).
Amazon’s First Quarter Results
Before getting into what ails AWS, Amazon reported strong results for the first quarter — with growth in advertising leading the way — sending its stock price up 10% on April 27.
Amazon beat expectations for revenue and profit growth. For the March 2023-ending quarter, Amazon’s sales increased 9% to $127.4 billion — more than Wall Street projected and its $3.2 billion in profit was “almost 50% higher than analysts expected,” reported the Wall Street Journal.
Aggressive cost cutting — global head count dropped 10% to roughly 1.46 million employees — contributed to Amazon’s eye-popping first quarter profits. The company will slash 9,000 corporate jobs by the end of April after parting ways with 18,000 workers.
Amazon cut people at AWS, advertising, streaming platform Twitch, its health-focused Halo unit, and its fitness tracker unit. In March the company paused construction on HQ2 — its Washington, D.C. corporate real estate project, noted the Journal.
Growth varied across Amazon’s business units:
- Advertising revenue grew by 21% to $9.5 billion — a slight slowdown from last year’s 23% increase.
- AWS revenue increased 15.8% to $21.3 billion — marking a steady decline from the 40% growth it enjoyed in the fourth quarter of 2021, the Journal reported.
- Amazon’s online store revenues have been decreasing and its results for the first quarter — $106 billion in revenue worldwide — were “roughly flat” as its U.S. market share growth in e-commerce and Prime “stalled after years of high growth,” according to the Journal. Its global e-commerce business reported a $300 million operating loss.
Amazon acknowledged challenges while remaining optimistic about the future. CEO Andy Jassy said AWS faces “short-term headwinds” as companies cut cloud spending due to recession fears.
Yet Amazon is investing in growth opportunities. These include its international, chip development, advertising, groceries, healthcare, satellite-internet business Project Kuiper, and generative AI for corporate customers, according to a recent shareholder letter.
AWS’s Performance And Prospects
With Jassy — AWS’s longtime head — now approaching his second year as Amazon CEO, investors should be concerned about what the cloud unit’s declining performance and prospects says about his leadership and that of AWS CEO Adam Selipsky.
How so? In the first quarter, AWS revenue grew at its slowest rate ever, its operating profit of $5.1 billion landed 4% short of expectations, and its growth for the second quarter could be much slower, the Journal noted. At 24%, AWS’s operating margin was the lowest it has been since 2017, CNBC reported.
Amazon stock fell after CFO, Brian Olsavsky, told investors that the AWS growth rate in April is tracking five percentage points below its first quarter growth rate. Were that slowdown to continue, AWS could grow at 10.8% in the second quarter — well below the 13% Wall Street projects for the second quarter, the Journal wrote.
The 3% drop in Amazon’s stock price following Olsavsky’s comment makes sense. That’s because although AWS represents a mere 16% of Amazon’s sales — with its retail unit losing money for the last six quarters — cloud services account for all of its operating profit, noted the Journal.
AWS is responding by cutting costs and locking customers into longer-term contracts at lower prices. Selipsky issued an April 26 memo explaining that it was cutting costs with the aim of “identifying and putting resources behind [its] top priorities — those things that matter most to customers and that will move the needle for our business.”
Amazon says it is helping AWS customers to “optimize their spending.” On April 27, Olsavsky told analysts that “Amazon has been renegotiating contracts with customers that will lock them in to longer-term commitments, and noted that $270 million in severance reserves took a chunk of profit away as AWS was hit in Amazon’s 9,000 layoffs,” MarketWatch reported.
AWS Losing Market Share To Microsoft
Although AWS’s largest rivals saw growth slow down in the first quarter, their growth was much faster than AWS’s. This suggests AWS is losing market share.
Large rivals growing much faster than AWS
AWS large cloud services rivals — Microsoft and Google
GOOG
Azure cloud — abetted by its generative AI technology — appears to be growing faster than AWS. Unlike AWS, Microsoft projected better-than-expected cloud growth for the current quarter, the Journal noted.
Upstarts tapping customer resistance to AWS cloud lock-in
Upstarts are capitalizing on the dissatisfaction of cloud customers who feel locked in to AWS. Microsoft and Google — forcing them to overpay for hundreds of different cloud services some of which are not best of breed.
One such upstart — Boston-based Wasabi Technologies — closed a $250 million round of funding last September at a $1.1 billion valuation. Wasabi — which offers a cloud storage service — said it has won “tens of thousands of customers.”
Companies buy from Wasabi because it “enables organizations to store and instantly access an unlimited amount of data at 1/5th the price of the competition with no complex tiers or unpredictable egress fees,” CEO David Friend told me.
Cloud services providers charge their customers egress fees to transfer their data out. French cloud management platform supplier Holori calculated that AWS charges $4,300 to transfer out 50 terabytes — second only to Alibaba Cloud’s $6,150 egress charge. AWS’s price is 1.25 times more than Google’s fee and 1.27 times what Microsoft levies.
One happy Wasabi customer — Cloudflyer, a Pasadena, Calif.-based cloud to cloud data transfer service operator — seeks to avoid such egress fees. As CEO Patrick Kennedy said, “Wasabi has quickly become the defacto safe haven for AWS and Microsoft Azure customers seeking to lower their growing cloud storage costs and do away with their expensive egress fees.”
Companies have been seeking to liberate themselves from being locked in to a single cloud provider.
David Boland, Wasabi Vice President Cloud Strategy, told me on April 27, “The hyper scalers like AWS have hundreds of different cloud services, they can’t be the best at all of them. By focusing 100% of our attention on cloud storage, Wasabi can develop better technology, have a better understanding of the needs of our channel partners, technology alliance partners and end-users.”
By unbundling their cloud services, customers can get better quality at a lower price. Specifically, customers can choose the best of each service — e.g., cloud storage, compute, and content delivery.
Boland says such best of breed vendors — Wasabi for storage, “Sushi Cloud for compute, Signiant for file acceleration, and Stackpath for content delivery” are allying to provide customers with alternatives to AWS’s “walled garden” approach.
Sushi Cloud shares Wasabi’s view. As Shauna O’Flaherty, Sushi Cloud Co-Founder, Chief Operating Officer, told me April 27, “Oh to have the luxury of being a monopolist! AWS has massive hidden fees — for example, Carnegie Mellon unintentionally left a machine running overnight and got an unexpected bill for $15,000 — and confusing billing practices associated with using their compute services.”
Sushi Cloud offers such customers considerable advantages — most notably, lower prices, faster computing times, quicker deployment times and more predictable cloud compute budgeting.
“Sushi Cloud is 80% cheaper because we are not forcing customers to use tools they do not need or do not want. We are a faster solution because we give customers ‘bare metal’ rather than slower hypervisors and virtual machines. MIT’s media lab used to pay AWS $50,000 to train a large language model. We charge them $10,000,” said O’Flaherty.
AWS says it helps customers manage costs
AWS says there are four reasons customers choose its cloud service. An AWS spokesperson told me April 26, “AWS makes it easier for organizations to lower their overall infrastructure costs, and be flexible in scaling their resources up and down depending on what they use, and what they need.”
The spokesperson also noted that AWS:
- Innovates to improve performance while maximizing customer savings.
- Provides management tools to monitor and optimize cloud costs.
- Helps organizations become more agile in delivering new products faster—with fewer resources.
FINRA, a U.S. brokerage firm regulator, has saved money by using AWS compared to what it paid for its private data center back in 2013. According to FINRA CIO Steve Randich, “Based on our calculations, the infrastructure cost savings, specifically around hardware and private data center infrastructure is 40% cheaper in AWS than it would be in a private data center.”
This customer case study strikes me as outdated. After all, the issue now is not whether companies should move from in-house computing to the cloud. Instead, cloud customers are seeking to liberate themselves from lock-in by the large cloud providers so they can get better performance on key computing services at a lower price.
Can Amazon Stock Go Up?
Analysts are modestly bullish about Amazon stock. CNNMoney reports that the 44 analysts offering 12-month price forecasts for Amazon set a median target of $134.50 — a 28% increase from its April 28 price of about $105.
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I think AWS will struggle to restore the 40% growth it enjoyed before the Fed started raising interest rates. With customers seeking to lower their cloud computing costs, unless AWS gives up its walled garden strategy, it will keep losing market share.
Investors hoping that Amazon can resume the nearly 28% average annual growth rate it enjoyed during Jeff Bezos’ final decade as CEO could be in for a long wait.
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