Amazon Web Services Strategic Analysis: Capstone
Analysis conducted for the Business Strategy Specialization: Final Project course offered by UVA Darden School of Business on Coursera.
Executive Summary
During the past several weeks we have diligently analyzed Amazon Web Services’ (AWS) competitive position.
AWS is the first mover of the global cloud computing industry and stands as the largest provider of on-demand computer system resources with expected revenues of $46.1bn in 2020. The total industry value is estimated to be $260bn in 2020 with conservative expectations of 13.9% CAGR through 2027. High industry margins result from a phenomenon called “vendor lock” which creates high power for suppliers by making it difficult for users to change service providers and increases industry attractiveness.
However, the industry landscape is changing. Other Big Tech firms such as Google and Microsoft have made major investments in cloud computing, and Microsoft annual revenues now nearly equal those of AWS. While still relatively small, Google has taken an alternative path and has specialized their offering in AI, machine learning, and big data analytics. Most recently, Snowflake has disrupted the industry model of “vendor lock” by introducing multi-cloud services to the market.
The introduction of deep pocketed competitors with equally brilliant roots in tech as well as disruption to the industry has resulted in a major strategic challenge for AWS: for the first time they are faced with slowing revenue growth and the question of how to re-energize the competitiveness of the cloud computing business.
As the second largest company by market cap, Amazon has myriad strategic options and we examined four of them: expanding operations in global markets, better leveraging the complementary assets of Amazon.com, investing in innovation and the creation of new markets, and divesture of AWS as an independent business.
It is our conclusion that AWS will be best served to invest their resources to innovate new use cases for cloud technology and corner specialized parts of the market. Product specialization will deflect the direct pressure of competition and allow multiple players to exist in a dynamic market while maintaining higher profit margins.
The recommended solution fits well for AWS to streamline internal know-how and leverage the complementary expertise of other Amazon business units in developing new solutions relating to e-commerce, warehousing, logistics, and transportation. The Internet of Things (IoT) is central to all of these fields and may provide a strong option for orienting our initial direction.
Furthermore, this solution aligns well with Amazon’s values and encourages AWS to double down on the corporate culture of customer-centric entrepreneurship and long-term thinking. While investing in their vision for the future, AWS will be granted a large amount of strategic flexibility to avoid upfront costs, make evidence-based investments, have numerous options to exit.
Finally, central to executing this vision is the recruitment of the best technical talent in emerging fields which should be achievable due to AWS strong brand, high salaries relative to the market, and existing HR operation.
For these reasons we believe investing in the creation of new markets is the soundest strategic path for AWS to meet the strategic challenges ahead and enhance their competitive position.
A: INTRODUCTION
The global cloud computing industry measured up at $260bn in 2020 with an expectation to add another $100bn in just the next two years (Statista.com n.d.). In the midst of global economic uncertainty, no other industry can confidently boast to have the same prospects for growth.
Broadly speaking, cloud computing is defined as the on-demand availability of computer system resources, especially data storage (cloud storage) and computing power, without direct active management by the user (Wikipedia n.d.). Since development, the industry has grown to include a vast portfolio of software engineering, data analytics, and other services to support organization’s maximization of value from their virtualized IT infrastructure.
Leading this market is none other than AWS, Amazon Web Services. In the mid-2000’s, Amazon was developing their own IT infrastructure to support their burgeoning e-commerce platform. Companies reached out to learn from their model, and Jeff Bezos keenly perceived an unfilled market opportunity. Amazon began leasing their IT infrastructure to other companies in 2006, and AWS was born (Medium.com n.d.). In 2020, AWS is expected to bring in $46.1bn in sales for the second largest company in the world by market cap, and it is widely seen as a major driver of Amazon’s profitability and increasing stock price.
Amazon’s guiding principles are clearly summarized in the opening of their 2019 10-K SEC filing:
“We seek to be Earth’s most customer-centric company. We are guided by four principles: customer obsession rather than competitor focus, passion for invention, commitment to operational excellence, and long-term thinking. (SEC.gov n.d.)”
In this report, I will analyze the competitive environment in which AWS operates and identify several key strategic issues facing the company as it strives to maintain its valuable competitive position.
B: COMPETITIVE ANALYSIS
The notion of cloud computing has existed since the early 1990’s, yet it was not until Amazon began to rollout infrastructure and data warehousing solutions that the industry became widely adopted. A peculiar and rare occurrence in today’s business environment, during the early years AWS grew the market relatively unchallenged by major competitors. Microsoft Azure, the industry’s clear number two in terms of sales, did not have a first release until 2010, giving AWS a 4-year head start. Although Google Cloud was released in 2008, cloud computing services were not yet a strategic focal point for the organization. Naturally, being the first mover provided advantages to Amazon can be evidenced by a comparison of incoming revenues and growth rates found in industry documents filed with the SEC:
While these numbers show clear revenue leadership by AWS, they also communicate that the cloud computing industry is still very much in the growth phase of the industry life cycle. This notion is supported by data cited in our introduction that the industry is expected to add $100bn in value, or a 37% increase, in the next two years alone.
Typically, the technology industry is governed by several key principles including high switching costs and a relentless pace of innovation. The implication is two-fold; 1) achieving “vendor locking” can provide handsome profits for companies, and this phenomenon is commonly seen by the high valuations of SaaS products and 2) the technology industry tends to be extremely competitive with fierce rivalry among firms.
Indeed, Amazon grew to its massive size by serving companies with the foundational, core products of cloud computing: virtualization of data storage and computing power (ZDNET n.d.). There was an obvious value for customers to migrate IT systems onto Amazon servers, huge cost savings for companies that no longer needed to invest in IT infrastructure or IT departments, but the cost is equally high for these companies that are now “locked in” to extract themselves from AWS. This factor, combined with the simple notion that early cloud computing solutions were merely an extension of the massive IT operations built to to service technology company’s own software products, led to the introduction of competing firms such as Microsoft and Google. While high capital investment is required to enter the industry, this was not seen as a major barrier to entry by internet technology companies because the invested hardware has a terminal value that can be salvaged through re-sale in the future.
So, in the early days, the two principles of high switching costs and industry rivalry did govern. But as the industry continues to mature, the implications of these principles and the next phase of the industry lifecycle is beginning to emerge.
First, due to changing customer demands, there is a space for disruptors to enter the market. The company that will likely have the most seismic shift on the market is Snowflake. As companies began to require more flexibility and desire to avoid vendor lock grew larger, the concept of a multi-cloud solution became more popular (Aptitive.com n.d.). Companies using two or more cloud service providers faced the challenge that data and information stored in the systems of two competing organizations was not easy to combine. Snowflake introduced a Data Platform architecture that allows organizations to collate data that is stored in the cloud of two different providers, say AWS and Google Cloud, in one place. The marked a huge change from the past and has greatly changed the competitive dynamics of the industry via shift of power from suppliers to buyers. In just the past two years, AWS has seen major corporations like Target or DropBox invest to migrate portions of their IT infrastructure off of AWS and onto other systems (Wired.com n.d.).
Buyers now have the flexibility to pick-and-choose providers based on specific use cases or technologies, and consequently there has been a boom in the number of specialized products and services offered by these companies.
This has created a source of competitive advantage for companies like Microsoft, Google, and IBM which have leaned on their history of software and IT expertise to rapidly innovate and expand market share.
Google Cloud has worked to integrate with a number of other Google services such as the Google Maps API, G-Suite Workspace, or Artificial Intelligence and Machine Learning products such as image recognition or NLP technologies, all relevant to companies interested in performing big data analytics (Google Cloud n.d.).
Microsoft is able to lean into their fleet of Enterprise Business Process tools such as Office 365 or Microsoft teams, and they have gone one step further to introduce a new go-to-market strategy; bundling Azure services with Office 365 subscriptions to create and more attractive value proposition for corporate customers (Microsoft.com n.d.).
IBM has adopted a slightly different strategy and acquired Red Hat, a provider of Linux-based operating system solutions for enterprises and virtualized IT systems, for $34bn in 2018, strengthening their ability to target a specific niche of the industry value chain.
These developments present an existential threat to Amazon’s market position, and these industry trends are reflected by the less attractive growth rate of AWS (29%, declining YoY) compared to other providers such as Microsoft (48%, declining YoY), Google Cloud (44%, growing YoY), or Snowflake (133%, growing YoY).
C: STRATEGIC ISSUES
The analysis of cloud computing industry revealed that the industry is dynamic, competitive, and still growing. Amazon’s position in this market is still that of a market leader, but their competitive position is under increasing amounts of pressure from rival firms exposing them to several strategic challenges:
1) AWS’s customers seek greater flexibility when choosing cloud computing solutions and are turning to the multi-cloud in greater numbers. The early landscape of the cloud computing market was disrupted, and incumbent firms will be forced to innovate or lose market share.
2) Unlike its major competitors who specialize in business productivity, software and/or hardware services, AWS heritage lies in e-commerce. AWS must deal with the challenge of diversifying the products and solutions offered as it transitions from being a cloud computing service driven by IaaS to one that offers a more comprehensive selection of services.
D: MAJOR STRATEGIC ISSUE
These strategic issues can be incorporated under the expanse of a larger, major strategic issue:
- AWS is facing stagnating growth rates and does not appear to be the dynamic powerhouse of its early days. It’s first mover advantage has been weakened as the market has matured, and the unit will face increasing pressure from stakeholders to maintain its premier position atop the market.
E: STRATEGIC PATHS
When considering how AWS should confront the major issue of stagnating growth rates in a maturing market, it is important to consider their responsibility as a firm. Amazon’s guiding principles speak to the organization’s values, but a mission statement on the EU website offers more insight to its value proposition:
“We believe this mission is important…because digital empowerment for customers and businesses improves living standards for people up and down the country and drives our economic competitiveness and productivity in a global economy. We will continue to push at the boundaries of how technology — digital infrastructure and services — can improve the customer experience and help make the economies of the countries where we operate more competitive on the global stage. (AboutAmazon n.d.)”
Amazon, and by extension AWS, have a clear mission to develop the overall competitiveness and commercial sustainability of the people and organizations they serve, and this mission helps to determine how they might respond to strategic issues.
That being said, AWS is confronted with several strategic choices. Should AWS compete to merely survive and continue capturing existing rents, or should it grow the business? What are the inherent risks or benefits that come with competition and growth?
Amazon was the first mover and originator of the modern-day cloud computing industry. One could argue, however, that AWS is further outside of the Amazon.com core business of e-commerce and logistics than cloud computing is for major rivals such as Microsoft Azure, Google Cloud, or IBM. As competition intensifies and the industry evolves, AWS may face risks from overextension into new areas. Yet again, not competing would threaten their first mover advantage and potentially cost AWS the battle for industry standard. Facing fierce rivalry in a dynamic market, it is almost certain that should AWS not fight, both market share and profits will be forfeited at an accelerated rate.
So, in order to consider how AWS can best fight, we must evaluate their current market position. Incumbent firms are sometimes worse positioned compared to pure innovators due to their core rigidities. Indeed, in the face of an industry disruption from the likes of Snowflake, does AWS respond by following the trend and potentially cannibalizing existing profits or sit tight and continue to harvest profits from existing operations? There is certainly a case to be made that AWS has the best positions to compete through leveraging their industry expertise, knowledge of the customer, and access to capital. In this line of thinking, how might AWS influence the rules of the game to best suit their own capabilities and deflect exogenous pressures?
The global cloud computing industry is dynamic, features fierce rivalry, and remains in a growth stage. Yet the profitability of the industry is extremely high and given the evolving landscape and high attractiveness of the market, there are many strategic options for AWS to compete, grow, and prosper.
- Grow in global markets:
The dominant market for cloud computing is the US. The size of the US market is far greater than elsewhere. However, the cloud computing industry is nascent and still growing in important markets like Europe or Southeast Asia. Presently on 26% of EU firms utilize cloud services and the total market size is projected to reach $75bn by 2026 (EuroStat n.d.). In SE Asia, there is a developed ecosystem of technology companies and markets such as Indonesia, Malaysia, or Thailand are driving global growth. While AWS competes with Microsoft and Google in Europe, in Asia there are other competitors to be reckoned with such as Alibaba, holder of 7.7% of the global cloud computing market (IDC n.d.).
- Innovate / create new markets:
This strategic option is a bit trickier since relying on innovation is inherently risky. But the world is going through an “information revolution” and new use cases for cloud computing are still emerging. This implies that as long as AWS is willing to continue fighting, there are opportunities to grow the business in areas like 5G, edge computing services to support machine learning and artificial intelligence, or the Internet of Things (IoT) which aligns nicely with Amazon’s current expertise in supply chain and warehousing.
- Better leverage complementary assets:
In a more radical move, Amazon could bundle e-commerce, logistics, supply chain, and warehousing services to offer end-to-end cloud e-commerce services product in the way that Microsoft has begun to bundle Azure with Office 365. While this potentially introduces a threat to Amazon’s core e-commerce business and many businesses might be skeptical of relying on the largest e-commerce company in the world, Amazon certainly has the subject matter expertise to offer a credible solution. Furthermore, this route has the potential to lock customers into subscription services which establish stable, long-term revenue streams and create immense value for shareholders.
- Divest AWS:
Divesture of AWS has been a subject of conversation for several years now, and this option presents real benefits and risks. Ironically, there is value to be created by spinning-off AWS and distancing the cloud services unit from Amazon.com. The main argument is that many customers are wary to do business with the world’s largest e-commerce retailer or host sensitive data on the AWS platform (CNBC n.d.). Secondly a divesture would allow investors to place their money in a pure cloud computing company, whereas neither Azure and Google Cloud are independent, resulting in a huge capital raise for AWS to fuel its ongoing competition.
F: OUR RECOMMENDATION
The viable strategic paths presented in Part 2 of our analysis are hypotheses, and this invites us to make an investigation of the underlying assumptions that encourage us to determine these options as ‘viable’. For each option we will look at four types of assumptions which, in turn, will expose trends or uncertainties that underly our options. Once exposed, we are able to plan for certain scenarios and evaluate the robustness of each option against different scenarios. Below we give a superficial look at some critical assumptions or trends that support the viability of the presented options,
- Grow in global markets:
- Assumptions about global market demand, the expected size of global markets, and the relative opportunity cost compared with to the US market
- Assumptions that foreign governments will welcome international firms in the face of rising techno-nationalism
2. Innovate / create new markets
- Innovation is achievable, AWS R&D will be able to develop products attractive to the market, and AWS will beat the competition to invent these products
- AWS will win the war for top engineering and technical talent
3. Better leverage existing and complementary assets from Amazon
- Amazon portfolio of services would be attractive to customers as a bundle
- The positive impact of bundling services outweighs any negative effect from cannibalization of buyers, otherwise
- Amazon company culture will enable teams to work across silos and effectively support each other
4. Divest AWS
- Capital markets would be interested in owning a stake in an independent AWS
- The divesture would not have a material negative impact on either AWS or Amazon regular operations
The above assumptions expose a number of general uncertainties that AWS and the cloud computing industry at large are facing. These include:
- What will be the major use cases of cloud computing in the future and how big will demand be?
- How will foreign governments regulate the cloud computing industry and data storage?
- Can AWS secure the top echelon of cloud engineering talent?
- How will firms respond to the transition to multi-cloud solutions?
Our strategic paths were tested for robustness across each of these uncertainties and it was determined that the path of “Innovate / create new markets” is the most robust option. Namely, this strategic option provides an amount of flexibility and aggressiveness that bodes well for Amazons future competitiveness. There are a number of inherent risks and costs with choosing this path, which were explored via payoff matrices and real-options analysis.
In assessing the potential payouts of this path, we assume a symmetric game for simplicity:
In the context of a developing and growing market, we can see that AWS stands to benefit in the majority of situations. If AWS and competitor firms uphold the status quo and do not move, the market will continue to grow, and all existing firms will benefit. There is a clear advantage to innovating when a competitor does not, as that will allow firms to capture a larger share of a growing market. But most firms will not tolerate a drop in market share and some firm will act to meet the needs of a growing market, so it is apparent that the dominant strategy for both firms is to innovate and keep fighting. Although the payouts when both firms innovate are higher than when they do not, they are less attractive than when just one firm innovates. So that begs the question, how can we change the dominant strategy to better fit the advantage of AWS, and it turns out if AWS and competitor firms can come to some sort of agreement about how companies specialize and corner parts of the market, the result may be that all firms operations may be more sustainable and positions more competitive. We imagine the payouts may shift to be:
Specialization is a niche market strategy, so topline payouts will be smaller than attacking the mass market. However, if AWS and competitors, say Microsoft, both specialize, they should not directly compete which enables firms to save costs and reap attractive profits. This strategy bodes well for AWS as they do have considerable differentiation compared to Microsoft and Google, the two leading competitors of public cloud services. Microsoft excels in business productivity, Google excels in marketing and advertising, and Amazon excels in e-commerce and logistics. If Amazon were to lean into their current expertise in e-commerce, warehousing, logistics, and transportation, one could argue they have a significant and differentiated position to make a play in edge computing of artificial intelligence and the Internet of Things.
It will be critical that AWS continues to recruit top engineers and product managers that can understand the needs of their customers, brainstorm creative solutions, and then engineer those products. Amazon strives to be the “most customer-centric” company on Earth, and they have a great track record of delivering value to their customers, so this challenge looks to be par for the course. Similarly, the Amazon talent recruitment network is well developed, recruiting from top engineering schools and offering some of the highest salaries in the market for a given position.
Now, it is unlikely that AWS would elect to specialize in edge computing for AI and IoT in such a limited number of industries from its current position of market dominance. In all reality, AWS would benefit from continuing to develop products to service the mass market while experimenting with innovation of new use cases until it is clear where they have a distinct advantage in an attractive market. This entrepreneurial mindset will provide them great flexibility and a number of different “gates” at which they are able to abandon or exit an investment project.
Still, there will be some upfront costs required as Amazon will need to invest in acquiring customers with which they will innovate new solutions together, invest in recruitment of the top engineers, and invest in research and development of new technologies.
The biggest uncertainty AWS will face on this path will be the question of which part of the market will develop into the most attractive and will AWS be the company that is able to corner it.
PROJECT REFERENCES
1. https://www.statista.com/statistics/273818/global-revenue-generated-with-cloud-computing-since-2009/
2. https://en.wikipedia.org/wiki/Cloud_computing
4. Amazon 10-K, 2020 Q3, SEC.gov
5. Microsoft 10-Q, 2020 Q3, SEC.gov
6. Google 10-Q, 2020 Q3, SEC.gov
7. Snowflake S-1, SEC.gov
8. https://aptitive.com/blog/what-is-snowflake-and-how-is-it-different/
9. https://cloud.google.com/vpc/docs/private-access-options#pga
10. https://docs.microsoft.com/en-us/microsoft-365/enterprise/azure-integration?view=o365-worldwide
11. https://www.zdnet.com/article/what-makes-google-cloud-platform-unique-compared-to-azure-and-amazon/
12. https://www.wired.com/2016/03/epic-story-dropboxs-exodus-amazon-cloud-empire/
13. https://adtmag.com/articles/2018/02/01/accenture-developer-report.aspx
14. https://www.aboutamazon.co.uk/uk-investment/our-mission
16. https://www.idc.com/getdoc.jsp?containerId=prAP46702820
18. https://aws.amazon.com/ecommerce-applications/
19. https://aws.amazon.com/cpg/supply-chain/
20. https://www.cnbc.com/2020/07/24/former-amazon-senior-engineer-calls-for-aws-spinoff.html
21. https://www.mindinventory.com/blog/cloud-computing-challenges/
23.https://media.bain.com/Images/BAIN_BRIEF_The_Changing_Faces_of_the_Cloud.pdf
24. https://www.racknap.com/blog/top-challenges-of-cloud-service-providers/
ADDENDUMS:
