The Great Margin Divide
Selling raw cloud storage is a business perfectly suited to an online retailer
Amazon reigns supreme selling raw cloud storage. The biggest technology infrastructure system companies in the world keep trying to replicate Amazon’s success, only to find themselves hoping Amazon will go back to selling books. The bad news for companies like EMC, HP, IBM, NetApp and Dell is that selling raw cloud is a game they are unlikely to win. The good news is, Amazon will have just as hard a time trying to sell sophisticated solutions to the corporate data center, so both types of businesses will thrive in the new cloud ecosystem if they can each keep their eye on what they do best.
What Amazon does best is sell at razor-thin margins. That is its business. It’s a mega distributor selling direct to consumers from the world’s largest catalogue. It’s retail. Amazon understands, better than anyone else in retail, that technology can be used to reduce costs, improve the customer experience, and drive every potential competitor out of business. Amazon is a lethal, margin-killing machine. The AWS cloud is a byproduct of Amazon’s own need for low-cost commodity storage and compute infrastructure. While Amazon has evolved into a force to be reckoned with in technology —its S3 storage and EC2 compute clouds are the envy and terror of every systems company out there—it is still a low-margin business and must operate as such. In a low- margin business, there is little room for development, marketing, sales or support costs. For Amazon, this means that the distribution of AWS happens mostly through runaway successes like Dropbox that use AWS as component rather than through its own offerings. And that is as it should be.
What Infrastructure system vendors do best is develop, distribute and support advanced solutions to complex problems in the corporate data center. To operate, these companies must and do have much higher gross margins. Their business consists of buying raw materials at a low price, adding serious engineering, and selling their wonder widgets at a high price. This is the business of enterprise storage. Buy hard drives low and assemble them into bigger, faster, better and significantly more expensive storage. The higher margins are supported by the value the company has added to the raw components. Higher margins sustain a capable distribution army of sales people and support engineers, as well as the entire reseller ecosystem that customers look to for advanced solutions. This is also as it should be.
But infrastructure system vendors continue to chase the wrong end of the business. These companies are worried that their product lines will soon come under attack by the new and biggest kid on the block. The introduction of the AWS Gateway sent shivers through an established industry that is still trying to find its footing in the new world order. IBM keeps announcing that they will do something big, eventually. EMC put its toe in the cloud with Atmos Online, only to retreat and hope that VMware can figure something out. Dell introduces new flavors of cloud initiatives with each new season.
HP recently announced that it would be launching its own OpenStack-based cloud. I predict more dignified retreats.
What these companies are forgetting is that there is a dramatic difference between the gross margins necessary to sustain an EMC and those that feed Amazon, and thus that Amazon is operating under margin constraints that they are not. Chasing cloud dreams is a colossal distraction for the established infrastructure vendors, one that keeps them from seeing the real opportunity created by the cloud. Unfortunately, the gross has never looked so green on the other side of the margin divide.
Margins, more than anything, drive the distribution choices available to a company. Business can thrive with either high or low margins, but because margins determine distribution, businesses that try to support both high and low margins in their portfolios face constant conflict and waste in distribution.
Take NetApp or EMC. Their margins are north of 60%. Those margins are used not only to support the engineering effort required to build enterprise storage but also to deploy a trained sales organization that understands their customers needs sometimes better than the customers themselves do. Every new product can immediately be leveraged by their sales organizations. IBM has increased its margins by systematically shedding its low-margin business: first its hard-drive business and then its PC business.
HP and Dell are in a complicated spot. Both companies ruled the once highly profitable PC business, but as that business has been commoditized they have found their margins shrinking. HP clearly wants more of its high-margin business and less of its low-margin business. In 2010, it paid more than $2 billion for 3PAR, and last year it toyed with the idea of shedding its PC unit. Dell also knows it’s in tough spot and has made big bets to acquire real technology through acquisitions like EqualLogic and Compellent; however, much of Dell’s DNA remains that of a hyper-efficient retailer. Sell low. Sell direct. With these new acquisitions, Dell must resist the instinct to cut out the middleman and reduce margins, or it will alienate the enterprise sales teams and reseller ecosystem it has just bought, and will soon find itself without a go-to-market strategy that works for these high-value-added solutions.
Meanwhile, Amazon thrives with its margins hovering at just over 20%. Much like Walmart and other efficient retailers, Amazon spends as little as possible in sales. These are businesses of scale, where all savings are passed on to the consumer. This makes Amazon ideal for selling the cloud as a component in other companies’ solutions.
Amazon’s cloud distribution channel is akin to the old OEM business model, with an ISV ecosystem (DropBox) and system vendors like Nasuni that use AWS as a component inside their offerings. Selling raw cloud is very similar to the hard-drive business. It is a business that requires scale and low margins. Hard-drive manufacturers survive at retail-like margins because they do not have to incur the sales or marketing expenses of distribution. They rely instead on their OEM relationships and some low-end, direct-to- consumer products similar to Amazon’s new AWS Gateway.
If any of the top brass at EMC, IBM, NetApp, Dell or HP currently recommended buying a hard-drive factory they’d be ushered out the door. Yet within these companies there are still plenty of high-ranking advocates for building clouds. It’s the wrong business for them. The margins necessary to leverage their existing sales organizations are simply not there.
Fortunately for them, the problems in corporate data centers are far from solved by raw cloud storage alone. Organizations have become global and need their data everywhere. Backup is broken. The massive quantities of data in every business is a management nightmare. These are tough problems that require real engineering and should be the sweet spot for the most advanced infrastructure companies in the world. The cloud is the new hard drive. Amazon has won selling raw cloud, and that is a good thing for all of us selling enterprise storage, because cloud is a business that cannot be leveraged through our sales organizations. It’s time to stop playing a retail game we can’t win and start building the next generation of storage systems, with the cloud as a component, to solve our customers’ problems.