Finding Money in the Clouds

Well, it’s Friday and a good time to piece together some news items for the week, things that by themselves may not be a revolution but that could be combined to signal something important.  An opening point is that Oracle’s Industry Connect event, which proves that Oracle does in fact see the communications industry as a vertical of growing importance.  Why?  We also saw Amazon and Google chest-butting on the price of basic IaaS services, bringing what seems likely to be a cut of a third or more in prices.  Why?  Dell suddenly gets into the data center switch and SDN business on a much more aggressive scale.  Why?

Let’s look at “cloud” as being the core of all of this.  Credit Suisse thinks that what we’re seeing with Amazon and Google price cuts is an indication of improved economy of scale, but I think they’re reading the wrong page of their economics text.  What they’re seeing is a lesson in optimized pricing.

The efficiency of a data center rises with scale because there’s more chance that you can hold utilization levels higher.  Pieces of this and that can be fit into a machine somewhere to make more of it billable.  You reach the point of adequate efficiency levels pretty quickly, so there’s really little change in “economy of scale” being represented here by either Amazon or Google.  However, to fill a slot in a data center you need both the slot and the “filling”.  Both Amazon and Google are going to cut their own revenues by cutting prices so they clearly expect to make up that loss in volume.  It’s not that we are running at better scale, folks, it’s that we can’t fill the slots as much as we want.  Otherwise lowering the price is dumb.  Amazon and Google think that there are cloud-ready applications that could be cost-justified at lower prices but not at the old levels.  They think that they’ll grab a lot of these other apps at the new price points.  They also think that they’ll make up for lower IaaS pricing with increased emphasis on platform services features that will augment basic IaaS.

The cloud is getting real, not by making IaaS the kind of revolution that low-insight articles on the topic suggest it is, but by gradually tuning applications to be more cloud-friendly.  As that happens, the features of the cloud that actually facilitate the shift (the platform services) become the key elements.  IaaS is cheap milk at a convenience store, a loss leader to get you to buy a Twinkie to have with it.

This means that “the cloud” in some form is going to create a new IT reservoir, not one that replaces the current data center.  Not all of the cloud will be incremental of course—SMBs in particular will be likely to shift spending rather than use the cloud to augment productivity.  Still, we are certainly going to see more server and software and data center growth driven by providers of cloud-based services than by traditional IT practices and budgets.  One place that’s very likely to come true in spades is in the communications industry.  Carriers have traditionally low internal rates of return so they can tolerate a price war on IaaS better than current competitors, and carriers also have the possibility of using network functions virtualization to offload functionality from appliances, reducing capital costs.  If they get what they really want from NFV, which is significant improvements in service agility and operations efficiency, they could realize even more gains and justify more deployment.

The data center is where all the real money is in both networking and IT, so it follows that what everyone is chasing is the new data center, which is the easiest to penetrate.  Where is the biggest opportunity for that new data center?  The cloud at a high level, but precisely where in the cloud?  The carrier cloud is the answer, because there aren’t enough Googles and Amazons to drive a huge business by themselves.  Operators will build the majority of incremental cloud data centers, and it could be a lot of data centers being built.

Our model, based on surveys of operators, says that in the US market alone a “basic” level of deployment of carrier cloud to host both services and NFV would require approximately 8,000 incremental data centers, and if the optimum level of NFV effectiveness could be realized the number could climb to over 30,000 data centers.  The midpoint model says that we could add over 100,000 servers from all of this.   Yes, most data centers would be small had have only a few servers—they’d be located at key central offices—but there would still be a lot of new money to be gained.  That’s why the communications vertical is important, why Amazon and Google need to grab more of the TAM now, and why Dell needs to be in the game in earnest.

HP is the poster child for cloud-to-come.  They have servers, software, cloud, network equipment, and all the good stuff.  They have an NFV story that is functionally as good or better than anything anyone else has productized at this point.  Oracle has software that could be combined with COTS to create a similarly good story, but they have to work harder on the software side and on what “platform services” are in order to win.  Even IBM has enormous assets in the software space that could be leveraged into a powerful cloud and NFV position and could address that server/data-center bonanza.  Dell has been a growing influence in servers, but it’s not been sparring one-on-one with HP in software, networking, or the cloud.  I think Dell’s announcement is a step in that direction, an attempt to catch the big boys before it’s too late.

Is Dell doing enough, though?  Are Amazon and Google doing what they need to do?  Is Oracle, even?  The fact is that NFV may be the most important thing in the cloud because it’s a source of demand that a network operator is in a unique position to own.  If operators build optimum NFV they’d have justified a boatload of data centers and an enormous resource pool they could then harness.  The might even have an operations framework uniquely capable of doing efficient provisioning and management of complex services.  Amazon and Google are not (despite Google’s fiber games) going to try to become network operators, so they can’t go to the NFV space.  Oracle, IBM, and even Dell need to have a real NFV strategy and not just a hope of selling infrastructure if they want to counter HP, and even Alcatel-Lucent and Cisco, both of whom have respectable NFV approaches they could leverage.  None of the NFV stories so far are great, and Dell’s announcement didn’t really move the functional ball for Dell in either SDN or NFV—they just announced hosting.  Does a hundred thousand servers, and all the associated platform software and network equipment, sound good to anyone out there?  If so, it’s time to get off your duff.

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