Amazon opens up about AWS revenues

Amazon Web Services is a big business that is growing fast. Amazon has typically remained quiet on the subject of AWS financials, but has finally opened up about how the service is doing. columnist Bernard Golden looks at what AWS revenues really mean.

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Two weeks ago AWS announced its financial results and, for the first time, broke out AWS revenues. AWS, it said, achieved $4.6 billion in 2014, and will reach $6.2 billion in 2015, with a growth rate of 49 percent -- which is accelerating. Perhaps more surprising is that AWS is not a low-margin business -- it achieves around 17 percent operating margins, much higher than the overall Amazon business itself.

The importance of this announcement is that it reveals what has been intuitively obvious to most observers: AWS is a big business and growing fast. For the first time, the notoriously secretive Amazon has opened up about AWS financials and given everyone a look at how the service is doing. Of course there were a great number of articles (some linked to in this piece) discussing the revenue announcement implications. Most of them were in the vein of a horse race -- how far in the lead is AWS, how fast are the other horses, will AWS flag in the stretch run, etc.

None of them, however, evaluated what AWS’s numbers mean in terms of the IT industry and overall application of information technology in our society and economy -- and I think that’s where the real meaning of AWS’s revenues emerges.

AWS revenues today and in the future

In late 2014 I projected AWS revenues through 2020. In that piece I gathered estimates from a number of sources, including the much-lamented GigaOM and various investment banks; the consensus of those estimates was that 2014 would see around $5 billion and around $7 billion in 2015 (pretty close to AWS’s actual results).

I went on and extrapolated growth projections from Pacific Crest (it said AWS was growing at around 40 percent) and estimated that AWS would see $6 billion in 2014 and around $9 billion in 2015; obviously I was wrong on the high side. In that piece I noted that, by using the Pacific Crest growth numbers, AWS would, by 2020, achieve around double the consensus revenue numbers ($40 billion vs. consensus $20 billion).

However, while I was on the high side, it’s important to recognize that the numbers I estimated aren’t wrong -- just a few years early. And, given that AWS is growing approximately 25 percent faster than Pacific Crest estimated, it might be that my 2020 numbers will actually end up too low, not too high.

In the figure below I updated the revenue chart from my previous piece to include a third projection based on Amazon’s announced revenue and numbers and its statement that the service is growing at 49 percent. In this third set I have used 49 percent throughout the next five years even though Amazon said AWS’s growth is actually accelerating.

aws revenue graph

As one can see, this third line shows AWS revenues at around $46 billion in 2020, 15 percent higher than my previous estimate, and evidence of what the impact of a high growth rate can be. It’s surprising that in all of the commentary on the AWS revenue announcement, no one focused on the likely future numbers for the service, which, if the growth rate continues, become truly staggering pretty quickly.

Of course, this raises the question of the AWS growth rate. Naysayers will no doubt voice a belief that AWS’s growth is bound to level off soon. However, to state the obvious, AWS’s growth is based on two things: supply and demand. The next section of this piece will address the demand side, but one can look to AWS’s margins for a clue to the supply side.

The curious thing about these margins is that they’re so un-Amazon like -- they put paid to the oft-voiced incumbent vendor lament that AWS prices can be so low because Amazon is ‘subsidized’ by the capital markets, while they have to show profit.

As this Seattle PI piece describes, Amazon’s core business strategy is low prices, expressed via cost efficiency and low margins. This drives volume, which reduces costs, etc., etc. In other words, low margins are baked into the Amazon strategy (the one time Amazon strayed from this, with the Amazon Fire phone, it was unsuccessful and derided; I maintain that if Amazon had followed its core strategy and priced the phone at $99 initially, it would have achieved very different results).

So why has Amazon pursued a different margin strategy for AWS? I believe it’s because AWS is supply-constrained. Amazon is working flat-out just to keep up with current demand; increasing demand by dropping prices (and reducing margins) would be self-defeating, and pose a real business risk -- lack of capacity, which could alienate current or potential users.

The question of capacity is quite important, and rather controversial. One insightful commentator, Charles Fitzgerald, says that Amazon needs to spin AWS off so that the service can be free of the company’s seemingly unending new offerings (e.g, Echo, Amazon Business, Dash, which I wrote about here) that compete with it for capital, and can therefore grow even more rapidly. This is in part based on a topic that briefly became hot during the past quarter, Amazon’s use of capital leases, which appeared to negate the company’s ability to drive free cash flow in the face of negative profitability.

This concern about capital leases is misplaced. These leases reflect Amazon using every dollar it can access to invest in its business, which is what companies that view themselves as participating in a transformational shift offering unprecedented opportunity do. Three decades ago the cable industry was criticized for continually borrowing to fund marketing and mergers, rather than building profit margins and paying dividends -- and we all know how that turned out. Cable became one of the great businesses of the last decade able to finance (although not complete) $40 billion mergers.

Amazon believes it is the leader in what will, in retrospect, be seen as a seachange in the way we work and shop. It wants to invest as much as possible in that, so it manages for cash flow and is borrowing for even more firepower in its manic devotion to winning this battle.

Why does Amazon manage AWS differently than other business units?

So the conundrum about AWS margins is why they are high, not low as the Amazon business philosophy would dictate. Why is Amazon managing this business so differently than its others?

I believe that the biggest issue for AWS executives is keeping up with customer demand. Two years ago I estimated that Amazon needed to install $6.5 million in equipment each and every day of the year; I may have estimated too high a figure, but it’s clear that Amazon has to manage a tremendous engineering process to provision enough computing resources to meet demand. To state it bluntly: Growing a $6 billion computing infrastructure 49 percent annually is a herculean task.

Therefore, cutting prices (and margins) isn’t in AWS’s interest, given the scope of this task. When you’re working flat-out to keep up with demand, the last thing you want to do is create even more demand. A 49 percent growth rate shows that there is no shortage of demand -- and demand is where the really interesting implication of AWS’s revenues displays itself.

AWS demand shows IT is no commodity

A decade ago, Nick Carr achieved great fame with his book “Does IT Matter: Information Technology and the Corrosion of Competitive Advantage” (to save you the suspense, the answer is a resounding no). According to Carr, IT is nothing more than a commodity, undifferentiated function that should be directed toward low-cost, standardized offerings.

Carr’s perspective gained many adherents, and the outsourcing craze of the past decade reflects it. In effect, Carr believes that everything important about IT has already been created, and the remaining challenge is to squeeze cost out of it.

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