Is “Cloud Dominance” the Same as Cloud Monopoly?

Is “dominance” the same as “monopolistic”? That’s a question that many regulators are wrestling with, and sometimes they’re also wrestling with lobbying and nationalism. In the UK, Ofcom (the UK regulator) has been looking at public cloud services, and recently referred Amazon and Microsoft to the investigatory body in the UK (the US equivalent of the FTC). One question this raises is whether the public cloud market, which depends on economy of scale, can be efficient if there aren’t only a small number of competitors. Another question is how a competitive market in the space could be promoted.

Cloud services are very much like network services in that they depend on earning revenue from an “infrastructure” that has to be deployed and operating before even selling services is possible. Telcos back fifty years ago used to draw a graph to illustrate this challenge. On Day One, the operator starts deploying infrastructure, and that process continues for a period of time before credible scope is reached. During that period, the graph falls negative because cash flow is negative. At some point, service sales kick in and investment falls off, and the curve flattens and then ascends, finally crossing the zero axis that represents neutral cash flow. It then continues into the profit phase. The negative part of the chart is called “first cost”, the outflow needed until the service begins to pay back in the net.

In the public cloud space, the “first cost” problem is exacerbated when there are established competitors in place while a new one is trying to gain traction. These competitors, having established customers and having paid their first costs already, are in a stronger position. They also have more infrastructure in most cases, which means at least somewhat better overall economy of scale. They have real estate and facilities established where markets demand they be located for efficient operation, too, and they understand both the operation of their gear and the marketing and sale of their services.

The “secondary” cloud providers that the referenced article cite are all players who had a viable non-cloud business and hoped to exploit their customer base with cloud services, which facilitates their entry into the market. However, none of these secondary players have really gained much market share. Amazon, Microsoft, and Google dominate the cloud.

Many market theorists would say that’s OK. The “optimum” number of competitors in a space has been calculated in many ways by many researchers, and the result usually turns out to be “Three!” Well, that’s how many major cloud players we have. So what’s Ofcom and the UK griping about? I think there is a touch of nationalism involved, which isn’t anything heinous, just perhaps unrealistic. The US tends to be a more risk-tolerant market for startup investments and also for the expansion of established players into new businesses. All three of our cloud giants exploited their own need for distributed hosting resources to get started in the public cloud space. It’s inevitable that where taking risks is better tolerated, more risks pay off.

The UK can’t turn back the clock. Could regulators there decide to somehow move against Amazon, Google, and Microsoft, or the biggest two of the three, which is what the current initiative seems to contemplate? Do they threaten to stop the big cloud providers from operating in their country? Do they force them to wholesale their services, or constrain the number of customers they sell to, or the number of new customers they accept? The challenge here is that any of these measures would almost surely fail, and would also almost surely hurt cloud users. Would they then encourage new players to step in? What happens when those players become “dominant”?

It seems to me that the smart move here would hearken back to the telco days of old. We had a unified set of telco services worldwide, with many different “competitors” in play. How did that come about, and seemingly work? I think the answer lies in three words, “Interconnect”, “Federation” and “Settlement.”

Regulators required that telcos “interconnect” their networks to provide services across them all. In many jurisdictions, they also required telcos to “federate”, meaning to offer their services to competitors who wanted a single point of contact but needed service coverage where no single provider could offer it. Finally, they required “settlement” among providers for services where one operator collected for a pan-provider service, so the other operator was compensated for the resources they contributed.

Could cloud providers have these same three requirements imposed? In theory, yes, though the legal basis for it might vary from country to country and in some cases might be linked to a consent decree imposed by the authority assigned to regulate monopolistic practices. In practice, the process could be a game-changer worldwide because it might eliminate a lot of problems users face today, like the challenges of supporting multi-cloud.

Could this help “competition”? Almost certainly, if one were to define “competition” as the entry of new giant competitors (like telcos and cable companies) who’ve stayed out of the public cloud services market up to now. All the second-tier cloud providers, as I’ve noted above, jumped into the cloud space by exploiting incumbent relationships and products. That means that it’s possible to start a specialized, targeted, cloud business. The problem is that you can’t achieve full geographic scale. Suppose that the big guys had to offer you services at a wholesale rate, which was retail less avoidable sales/marketing. That would allow smaller providers to leverage resource of the major players to build credibility. They could still eventually offer their own resources in those areas where they’d initially wholesaled, but only when the opportunities moved them enough on that first-cost “S” curve.

To make this work, though, you’d need to define a set of services that were subject to federated wholesale and standardize interfaces for them. Do regulators have the skill to do that, or even the authority? Perhaps most important, do they have the time? We can’t enter into another of those years-long “Where does your lap go when you stand up?” study adventures all to common in the standards world. If we could get through the process quickly, meaning if the UK and perhaps the EU are really prepared to push, we could in fact add competitors to public clouds. Would that help anything other than nationalistic pride? Not according to the data that says that three competitors is optimum, and we have more than that already. And for all the nationalistic pride at stake here, there’s no indication of major cloud investments by new players to enter the competitive fray.

That still leaves our first question, though. If enterprise cloud users have the option of using a set of “federated cloud” services brokered by a smaller player, versus a single unified service of a major player, would they pick the former? Not according to what enterprises tell me. These days in particular, with global economic stresses impacting almost every industry, enterprises want cloud providers that have the financial mass and technical credibility needed to stay the course. And would the smaller players, even if they then tried to selectively build out their own resources where wholesaling indicated opportunities existed, ever achieve reasonable economies in real estate, capital equipment, and operations?

Remember the CLEC craze of the 1970s, when regulators mandated telcos share access assets with others? I firmly believe that the requirement reduced and delayed competition in the access space, creating in its place a kind of retail arbitrage of wholesale relationships. It wasted a decade. We could do that again in the cloud, and waste another decade.