Cloud Computing By Mikael Thakur

CL OUD COMPU TING

PREPARED BY: Abid Imam Karan Jaiswal Mikael Thakur

SCHULICH SCHOOL OF BUSINESS -YORK UNIVERSITY 4700 Keele Street, Toronto, Ontario, M3J 1P3 Masters of Business Program

1.0 AMAZON.COM 1.1 Amazon Today Amazon today has evolved from the world's largest e-commerce company to a technology firm, shifting its function from a technology consumer to a technology provider. Through acquisitions and technology spending funded by meteoric market capitalization, the company has rapidly captured market share in various sectors. Amazon’s technical and business innovations and its commitment to serve consumers have earned it the reputation of being a market leader. The current strategy of Amazon is to develop and capture a substantial market of business-toconsumer electronic commerce. Amazon is recognized as the most innovative enterprise in B2C e-commerce and the companies name has become synonymous with e-tailing. It has proved itself to be technically very innovative - there is no doubting the online retailer’s ability to try out new ideas. Every few weeks a new feature appears on its website and every few quarters they announce the launch of a product that compliments their e-initiatives. Branding is a powerful and revenuegenerating asset for Amazon. The company currently has two brands— one with consumers for its low prices and one in the business world for technology expertise, its core competency, which it capitalizes on to support its consumer-facing brand. Amazon has invested millions of dollars in building up their core competencies, much of which went into IT. Now what Amazon is doing is leasing their core competency to other companies that capitalize mutual co-branding in terms of revenue growth for both parties. 1.1 Management Amazon is obsessed with finding innovative ways to satisfy its customers – regardless of what the competition is doing. Jeff Bezos has infused the firm with a sense of urgency and chaotic fluxi. The company has also ensured that every executive officer is tied to the company’s success by making stock-based compensation a large part of their overall compensation. This compensation model thus ensures long-term shareholder value. Amazon’s CEO is also strongly tied to the company’s success as he currently owns 24% of outstanding shares. Furthermore, he has requested to be compensated a modest salary that hovers between $81,000 and $150,000 USDii. The fact that a few of his subordinates make more in terms of dollar compensation speaks volumes of the way the firm is structured – that is, a meritocracy. The challenges facing the company is that since 1997 it is not able to convince the investment community that it is able to generate profits in the long run. Amazon has made a bet on becoming a provider of technology services generally known as cloud computing. The following document provides investors a succinct analysis of Amazon’s cloud computing offering and recommendations if they should pursue investing in the company. 2 | Page

2.0 CLOUD COMPUTING Cloud computing is a technology bound to disrupt not only the business models of existing software giants such as Microsoft but also disrupt the IT industry as a whole. The concept refers to the virtualization of the datacenter such that server machines are not thought of individually, but as a computing commodity in a greater pool of servers acting as one. Cloud computing, unlike traditional computing, is free from the confines of desktop-based hardware and software. Bare bones computer terminals run and store programs from a third-party server connected to the Web, (almost) eliminating the chance data loss through a computer crash. In cloud computing, the provider builds a virtualized infrastructure and you get to install and run your applications on it for a pay-as-you-go price that is directly proportional to the resources your applications use. The provider automatically scales your implementation up and down according to the resources you need at any given time. The main distinction from managed hosting is that some of the choices are made by the provider rather than the customer. They choose how to do the scaling and load balancing, for example, rather than allowing you to specify how it’s done. But you still take responsibility for higher-level application infrastructure such as performance tuning, user provisioning and access rights, framing APIs, and so on. Cloud computing opportunities are limitless as its scalability means wonders for a companies IT bottom line. 2.1TYPES OF CLOUD COMPUTING There are 3 types of cloud computing technology arenas: 1) Applications, 2) Platforms, and 3) Infrastructure. Applications are what almost everyone has already used in the form of electronic mail, wiki’s search, etc. Platforms are the newest entry where an application platform is offered to developers in the cloud. Developers write their application to a more or less open Figure 1: Cloud Computing Types and specification and then upload their code into the Company Associations cloud where the application is run magically somewhere, typically being able to scale up automatically as usage for the application grows. The service being sold is the machinery that funnels requests to an application and makes the application “tick”. Finally there is the infrastructure – the actual hardware required to store data. This is the most powerful type of cloud in that virtually any application and any configuration that is fit for the internet can be mapped to this type of service. Distinction between platform and infrastructure providers is currently vague – which is probably due to product development and migration into other types of cloud offerings by firms. Figure 1 illustrates various

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cloud types and companies associated to each. Note that only Google shares Amazon’s interests in both PaaS and IaaS (see Section 2.2).

2.2 DISRUPTIVE NATURE OF CLOUD COMPUTING The profusion of cheap storage, software that can run a single massive application across thousands of low-cost servers, and near-ubiquitous internet access across North America has created a virtual supercomputer that is accessible anywhere. For enterprises, the technology shift to cloud computing provides the benefits of a data center without the cost and hassle of maintaining one – thus disrupting the datacenter-warehousing business as well as certain IT professions. Alternative delivery models such as software as a service (SaaS), will change the way software and services are delivered, diminishing the importance of the traditional monolithic desktop-installed applications, which could seriously disrupt the shrink-wrapped software business (Microsoft et al) Cloud Computing is also widely expected to change the Figure 2: AWS Technology Lifecycle Positioning shape of the OS market and associated revenue because both enterprises and end users increasingly require more on-demand type infrastructure services rather than on-premises, self-owned or commodity-type solutions. Longer term, Gartner Research predicts that with the help of virtualization, companies will be better able to manage their resources, eventually requiring fewer software licenses; and that pre-deployed applications in virtual machines could replace the OS as an infrastructure while dramatically changing software distribution methods and resolving OS compatibility issuesiii. 2.3AMAZON’S CLOUD OFFERING After building a massive cloud for its own, internal applications, Amazon realized others could benefit while increasing ROI on their datacenters. In 2006, Amazon launched its Amazon Web Services (AWS) by providing their infrastructure and platform as a service. Their current position in the marketplace is that of a market leader, thriving in a ‘blue ocean’ primarily due to first mover advantage. However the industry is bound to become competitive – especially through niche providers. For functional specifications on AWS and pricing structure please see Appendix A. 2.4 STRATEGIC TECHNOLOGY ASSETS At a high-level, Amazon Web Services (AWS) specific to cloud computing are composed of five strategic technology assets: Elastic Computing (EC2), Amazon Simple Storage (S3), Simple Database (SimpleDB), Simple Queue Service (SQS), and

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DevPay. For a brief description of each Strategic Technology Assets (STA), please refer to Appendix B.

Each STA sits on a specific spot on the technology life cycle. Figure 2 illustrates each STA in the lifecycle Interestingly, for such a disruptive technology, only the EC2 component qualifies as pacing. EC2 development hardly poses a significant financial risk to the firm and the potential success is certainly much more clear than what is often characterized by emerging technologies . SimpleDB and SQS are key technologies as they both strongly influence competitive advantage today: SimpleDB was the first cloud computing offering for structured data storage allowing firms to migrate their company data to AWS and further promoting network effects due to the exponential growth of data as applications use existing data to create more (see Appendix E – Figure 2). SQS is a unique offering in that it allow partial migration of web applications as Greenfieldiv development may not currently be an option for many clients due to cost and time constraints. Currently no other cloud provider offers a communications bridge such as SQS. DevPay is also a key technology as it facilitates payments made to developers – promoting AWS adoption through ease of use. It certainly offers and supports a point of differentiation as it leverages Amazon’s reliable and robust payment receivable system. S3 is a base technology in that it is necessary to survive. S3 provides a means of online storage of virtual images used by EC2 instances, but alone does not offer any means of differentiation than other online storage solutions – which is extremely common. Based on the above analysis EC2 is the technology to bet on, as all other STAs are only relevant within its context. The certainty of it changing the basis of competition is solidifying as ambiguity surrounding cloud computing lessens and is worth looking at for a serious bet. Putting the STA’s together into what is known as AWS the following technology-based evaluation categorizes AWS’s benefits: Scalability: Grow and your deployment rapidly, as required, without huge capital costs or operational time. Flexibility: Add and remove resources on-the-fly to cope with peaks in requirements. Only pay for what you need.

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Reliability: Take advantage of a massive computing platform, without having to build and buy one’s own. Improve organization’s infrastructure SLA’s by using a highly redundant and resilient platform that has no single points of failure. Fast Setup: React to decisions or requirements quickly and deploy complex architectures rapidly.

3.0 INDUSTRY ANALYSIS An industry analysis of Amazon’s AWS offering denotes a favorable outlook on the firm’s current position. Quoting Merill Lynch research, cloud computing is seen as a “$160 billion addressable market opportunity”v. However this definition includes SaaS providers as well and thus should be taken as an optimistic upper limit for now within the context of PaaS, IaaS and Amazon. Marked by weak substitutes, weak buyer power and high barriers to entry, AWS and other PaaS providers are positioned for sustained business growth and customer lock-in. However moderate supplier power poses a threat that can be mitigated by sourcing their datacenters from multiple providers. Substitutes. Current substitutes to cloud computing or PaaS are the current prepackaged, shrink-wrapped software and hardware offerings. Although most consumers are used to the purchase of software and hardware, AWS’s business model and the pay-as-you-use billing system will eventually win-out due to the price-performance gains of the paradigm. Threat of Substitutes: Moderate (current), Low (future) Buyer Power. AWS’s proprietary coding requirements successfully creates a high switching cost for developers (buyers), meaning that in order for them to migrate their code out of AWS, they’ll have to re-develop from the ground up. Since Amazon’s core business is not dependant on AWS, buyer bargaining power is also quite low, regardless of their size. Buyer Power: Low Threat of New Entrants. Because the market is new, there will be many new entrants in the cloud-computing sphere. Relative to AWS, most will be niche players as they will tend not to control the resources necessary to overcome the barrier to entry required to become a leader (i.e.: revenue, R&D, brand image, etc.). However, there are a few of potential entrants that already possess many of the attributes required to become a leader in cloud computing, and all that stands in their way is the decision to invest. Institutions with large datacenters and good brand recognition can successfully follow a me-too/follower approach by delivering the same offerings as existing leaders or succeed in leapfrogging them by analyzing gaps in their offerings. Yahoo claims to be attempting the latter strategyvi although based on the firm’s slow entry into the market, it will probably achieve marginal success unless it targets different 6 | Page

market segments – segments unaffected by the switching costs associated with adopting GAE or AWS. Brand equity is expected to play a big role in the adoption cloud computing providers. Google currently significantly outpaces Amazon in this area: According to BrandFinance.com, Google’s brand ranks 15 across all global brands with a brand equity of approximately $24.5 Bn USD, while Amazon ranks 159th, with a brand equity of approximately $5.5 Bn USDvii. Once IBM is added into the mix, there is simply very little probability that a new entrant can come in as a non-niche PaaS. Economies of scale and initial capital requirements (i.e. datacenters) also create huge barriers to entry.

Figure 3 Cloud Computing Competitive PaaS - IaaS Positioning. L = Leader; F = Follower; N = Niche; R = Rationalizer

Threat of new entrants: Low Supplier Power: Amazon is unfortunately dependant on few providers; but in the same time it is likely to be one of the larger customers for datacenter items. More importantly many server suppliers can forward integrate, meaning that they can create datacenters of their own and with added effort, integrate their servers into a cloud computing offering. Hewlett-Packard (HP) comes to mind while other server manufacturers such as IBM and Sun have already entered. Supplier Power: Moderate Rivalry: In term of relative price performance of substitutes, cloud computing providers are at an advantage. Major players currently have little to no significant overlap in their offerings (see Figure 3 for competitive positioning and Appendix F for competitive space occupied). Figure 1 Cloud Computing Competitive PaaS - IaaS Google is considered as Amazon’s Positioning. L = Leader; F = Follower; N = Niche; R closes threat to competitive = Rationalizer

leadership even though their current offerings are non-overlapping. Google is a leader in SaaS, but they are competitively close to Amazon because they’re seen as an imminent threat if they decide to convert their vast datacenters to a IaaS offering while providing a rich suite of SaaS products. In fact, as of April 2008 Google has released to the media, their intentions of opening up their datacenters to the publicviii.

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4.0 STRATEGY 4.1 Innovation Strategy Existing modes of behaviour are very powerful. Despite its lead market share, Amazon continues to maintain its entrepreneurial spirit by encouraging internal seedling ventures and nurturing them by removing the usual hurdle ratesix. This may be due to the company’s short history and the fact that it is still headed by its founder. It is also important to mention that the firm also leverages its size and buying power by engaging in a number of acquisitions. The nature of these acquisitions is not to internalize new ideas that result in new, Amazon-branded and modified products, but to increase market diversification and growth. Thus Amazon’s innovation strategy is primarily a factor of internal ideas and funding. With shorter market cycles – especially in high-technology, acquisitions are essential to drive innovation. The lack of incorporation of external ideas is thus seen as a threat to Amazon’s ability to maintain its relevance and to essentially ‘keep up’ (see Appendix C to view a comparison between Amazon’s and Google’s Innovation Strategy). Google on the other hand has been able to churn out products from both internal and external ideas. Where Amazon’s acquisitions and strategic alliances allow the firm to increase market share by delivering the same types of products, Googles endeavors to deliver new product that innovatively aggregate data. Figure 4 AWS Business Strategy

At a high-level, Amazon straddles two generic business strategies: differentiator and low cost provider. The two tactics underline more strategies of being market in order to gain critical mass through network effects and finally to a standard in terms of a PaaS provider (Figure 4).

product specific first-tobecome

The First-to-Market and Low-Cost provider strategies promote early adoption of the AWS platform. Proprietary software module calls are used for AWS and this promotes buyer lock-in (switching costs) once adopted. As more and more developers adopt and port applications onto EC2, the more interoperable applications become across other services and applications – not to mention the

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lowering of usage cost through economies of scale. This is how AWS can potentially become a standard as network effects achieve critical mass of members. There is a risk, however, of becoming ‘stuck’ between strategies as very few firms can simultaneously and successfully engage in multiple Porter-strategies. Whether Amazon will be successful in the juggling act remains to be seen, although the firm has already demonstrated results through the consistent lowering of usage costs and growth in member increase (see Appendix D). 4.2 Creating Value: One-stop shop for web-based businesses Amazon is creating value through the virtualization of business infrastructure. As previously mentioned, a number of STA’s have been used to create what is known as Amazon Web Services (AWS): EC2, SimpleDB, SQS, S3, and DevPay. EC2 uses emerging technologies to provide the framework or platform to be leveraged by all subsequent AWS offerings. It essentially adds value by providing a link into Amazon’s computing capacity. S3 uses basic technologies to provide an online storage space for users. Alone there is very little value to be had (i.e.: “…just another online drive in which I can store all my MP3s”), however once S3 is combined with EC2, synergies are created allowing EC2 users to store their virtual environments. DevPay is a window into Amazon’s trusted billing and account management infrastructure. The online service is categorized as a key technology as it eases developers’ burden of collecting payments for their applications built on AWS. This thus promotes developer membership and the benefits to be gained by network effects. SQS is a key technology as it serves to integrate applications in and outside AWS. One of the initial drawbacks with AWS was that it required “Greenfield” development – meaning that it required applications to be re-developed. With SQS, developers may incrementally develop add-ons to their existing, non-AWS applications. This lowers the switching costs associated with adopting a new technology and ultimately furthers AWS adoption. 4.3 Delivering Value (To Developers) - Do more development, waste less time According to Moore’s Model, Amazon is engaged in the “bowling alley” phase: It is targeting developers by providing the tools to develop and integrate their applications into low-cost, scalable infrastructure while removing activities relegated to creating and maintaining hardware environments. 4.4 Capturing Value

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Amazon is setup to capture maximum value from its AWS offering in terms of immediate profitability. Medium to long-term value capture is becoming more and more certain as developers and companies increasingly start adopting AWS. 4.4.1 Immediate Profitability Revenue capture is especially easy for Amazon as all transactions are online and integrated into their existing payment system. EC2 adoption almost necessitates branching off into AWS’s other products, therefore synergies created by AWS’s products – especially for “Greenfield” applications furthers the firm’s revenue generation. 4.4.2 Road to Standardization AWS is setup to gain heavily through network effects (see Appendix E for a detailed explanation). As more and more users signup, abandoning the platform becomes costlier - as the low pricing due to economies of scale, the proprietary coding standard and general migration costs nullify almost any business objectives to switch providers (from Amazon). In fact, leading cloud services like Amazon may resist a standard for fear of losing their proprietary lock on early customers. A more standardized cloud computing market could also hurt cloud computing leaders by removing competitive advantages and leveling the playing field, says Nick Carr, blogger and author of the cloud computing-focused book, The Big Switch. "Right now, Amazon and Google can compete based on their reliability or other factors," says Carr. "But the long-run danger for standard utility computing service is that it becomes a commodity and your only way to compete is on price." Therefore standardization may not be the best strategic path to follow. 4.4.3 Amazon’s Ecology According to Ecology As A Strategy by Levien and Iansitix and within the broader context of cloud computing stretching across Amazon.com’s corporate boundaries, AWS fulfills the criteria of a keystone advantage player: connecting network participants with one another, by making the products created by third parties more efficient, and by providing a point of reference helping participants to new and uncertain conditions. Connecting Network Participants with One Another. Amazon is already adept at doing this through its current e-commerce business by connecting buyers and sellers whether they are businesses or individuals. AWS is simply an extension to Amazon’s overall virtual marketplace offering – connecting buyers who are seeking the use of particular online applications with application suppliers. Increasing Efficiency of Third Party Product Creation. Asides of the learning curve associated with AWS’s proprietary coding requirements, the AWS offering does save significant time in regards to deployment (on-demand infrastructure) and in regards 10 | P a g e

to costs (developers: no up-front infrastructure fee, usage-based-pay; buyers: no license fee, online access versus shrink-wrapped media). The biggest underlying win is the continued drop in infrastructure fees due to increasing network effects. Providing a Point of Reference. Amazon’s strong brand commands a sense of trust to those who are reticent about migrating their infrastructure to AWS and to those who are skeptical of using applications as an online service. Amazon’s reliable datacenter would also promote the adoption of business models that exploit the benefits of cloud computing. Finally, AWS also promotes the creation of niche players, such as consulting services that facilitate the migration of infrastructure onto Amazon’s cloud. The numbers of offshoot businesses are endless and strengthen the overall ecology by promoting ecological robustness and productivity through the creation of inter-dependant businesses and the efficiency of each dependant business due to the aforementioned reasons, respectively. Some examples of newly created niche firms are RightScale, Hyperic and Soasta, who not only depend on AWS availability but also on its shortcomings (where their offerings bridge identified gaps in AWS). Further synergies are created through other offerings such as mini-laptops that are used primarily for internet access (i.e.: Asus' EEE PCs, HP mini-note, Apple Mac Air, etc…). These laptops have very little hard drive space thus depending on SaaS provider to access rich applications such as photo editing and word processing tools. SaaS providers in turn will need PaaS and/or IaaS providers for their applications to reside on – thus strengthening AWS's ecology. 4.4.4 Strategy Evaluation Amazon’s AWS strategy is vetted against the following definition of technology strategy: to maximize the contribution of technology and to acquire, sustain and defend competitive advantage. The definition is broken down into components and each component into criterions: Maximize Contribution of Technology to Acquire Competitive Advantage  Amazon has successfully used the first-(significant)-to-market strategy to acquire an advantage over others players in the cloud computing arena by:  Getting the initial pool of early adopters (developers, businesses) interested in cloud computing.  Getting a jump on network effects due to usage and cycle of data processing and generation (see Appendix E).  Through EC2, Amazon has maximized the contribution of its existing datacenter resulting in a significant advantage over smaller players as datacenter size acts as an effective hurdle or barrier to entry in providing a cloud computing service with acceptable SLAs. 11 | P a g e

Rating: Very Good Maximize Contribution of Technology to Sustain Competitive Advantage  Although Amazon’s management espouses constant innovation, actual R&D expenditure to sales paints a different picture: According to Appendix D’s R&D to Sales Ratio, Amazon spends about 5% - not bad but not great – especially when compared to Google current investing about 14%.  Consistent platform extensions such as S3, SimpleDB and others have added value to Amazon’s AWS offerings through sustaining innovations that promote overall strategy of network effects and reaching gorilla status.  Proprietary API increases switching costs once AWS is adopted.  Amazon has increased and sustained barriers to entry through economies of scale. Rating: Excellent Maximize Contribution of Technology to Defend Competitive Advantage  Amazon’s revenue is not cloud computing dependant, income from retail businesses can be used to support/enhance/defend AWS. ˜

Amazon has and approved patent since 2004 for an online marketplace for the consumption of third party web servicesxi. Its effectiveness remains to be seen.

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Exposure to heterogeneous rules regarding data ownership and security. For example Amazon may lose out to China-based cloud computing offerings as data is highly controlled in the Chinese market

Rating: Low-to-moderate Overall, Amazon’s technology strategy is setup to acquire and sustain competitive advantage. The ambiguity surrounding cloud computing definitions renders it difficult to create effective patents. As time progresses and the ambiguity lessens, a rush for patents is expected.

5.0BUSINESS STRATEGY FOR THE FUTURE Amazon’s current growth strategy for its web services division is to increase market penetration through platform extensions. For example, Amazon’s Simple DB service allows the running of queries on structured data via applications on EC2 – thus Simple DB is an extension to EC2 allowing current developers developing on EC2 an enhanced coding environment. For Amazon to remain competitive as an infrastructure provider it must adopt the current ‘green’ trend. As servers become more numerous, powerful and densely packed, more energy is needed to keep the data centres at room temperature. Often just as much power is needed for cooling 12 | P a g e

as for computing. In order sustain a comparative advantage and pass down cost savings to end-customers, servers will be located in remote areas where cost of energy is substantially cheaper and the environment much cooler e.g. Iceland or Siberia. Being LEED certified will also be a future trend and possibly a compliance requirement. Infrastructure is bound to become a commodity like electricity, with prices/rates that will eventually decrease towards the cost of production as competition increases. As Amazon has established a first mover advantage and is experienced in the low margin retail industry, being a commodity-based business may actually be beneficial. Amazon may need to invest more in capital spending, especially on servers. Google is said to operate a global network of about three dozen data centers with, according to some estimates, more than one million servers. Microsoft is also investing billions of dollars and adding up to 20,000 servers. 5.1 Future of the Segment Industry consolidation is inevitable with cloud computing space dominated by those companies who have invested in infrastructure early and/or acquired it. Technology industry usually turns out to be a game of duopoly with two main players emerging. Google and Amazon will be the likely industry leaders on the Internet with other players relegated to the status of niche providers.

6.0ISSUES AWS has unique attributes that require risk assessment in areas such as data integrity, recovery and privacy, and an evaluation of legal issues in areas such as ediscovery, regulatory compliance and auditing. There are drawbacks to keeping all of one’s data in the cloud, of course, and one of the main ones is that one can be cut off from it at crucial times- either because of no internet coverage/access or because the cloud you're using is unavailable (crash). Currently Amazon does not provide 100% uptime (rather a 99.999%) nor provides a service level agreement (SLA) for its customers. Also there is no cloud computing standard or security models and this is beneficial for Amazon since most of the risk and blame, if something goes wrong, will fall directly on the shoulders of IT(CIO’s etc.) and not on the cloud computing service providers. A risk that Amazon AWS is exposed to will be legal ramifications of lost data and downtime. In order for Amazon.com to execute its business strategy (Moore’s bowling alley strategy), it must enter new segments targeting big business. Challenges posed by moving past the bowling-alley phase include:

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Today, cloud data storage locations are ambiguous while The European Union has strict limits on what citizen-data can be stored, where and for how long.

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Many compliance regulations require that data not be intermixed with other data, such as on shared servers or databases.

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Industries such as banking and health require data to be stored in their home country to be compliant with industry and regional specific regulations such as Sarbanes Oxley and HIPAA.

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Patriot Act – USA’s radical Patriot Act has been around for several years, and stories of servers being seized without justification almost as long.

6.1 SARBANES OXLEY Companies benefit by using AWS by giving up some control over the data in exchange for cost economies, however companies have a particular concern about cloud computing, namely its impact on Sarbanes-Oxley (SOX) regulatory requirements. The SOX act was enacted to prevent scandals from happening again. The legislation establishes new or enhanced standards for all U.S. public company boards, management, and public accounting firms. The SOX act holds signing officers responsible for the fairness and completeness of their company's financial statements. They are also held responsible for the state of the company's internal controls, and must report any deficiencies. An internal control is a process designed to reasonably assure that objectives can be met in the following categories: financial reporting reliability, operational effectiveness and efficiency, and compliance with applicable laws and regulations. Hosted archiving is perfect for SOX compliance requirements. SOX is an onerous IT burden, and the right cloud computing solution can solve the requirement. Compliance has been one of the dominant themes in the post-Enron age of corporate IT. SOX, while an issue is not going to be a real issue as long as Amazon really wants to segment out to get into the enterprise market. Being a public company, Amazon already has most of the SOX controls in place and can implement appropriate separation in terms of data, encryption to pass any audit. To build a trustworthy reputation among enterprise customers, Amazon will need to undergo audits to obtain SAS 70-1 and SAS 70-2 certification, internal policy. 6.2 INTELLECTUAL PROPERTY Intellectual property (IP) is a huge gap for Amazon. Relative to their e-commerce competitors, Amazon has one of the fewest patents. However, this is likely to change as the firm becomes a technology provider. Currently Amazon holds a single patent in regards to AWS. The patent was established in 2005 for a web services marketplacexii. There have been no cases of infringement to date, perhaps indicating a poor patent coverage or out of court settlements/cross patent agreements. 14 | P a g e

7.0FINANCIAL SYNOPSIS

If the Internet is to be dominated by huge computing clouds, the performance and profitability of the largest clouds is an important issue, and Amazon is likely to provide the best early case study of how to monetize a huge utility computing operation. Amazon has the first mover advantage, and their early investment in research and development has started to pay off. Amazon AWS provided a profit of $111 million in the first quarter of 2008, and if you take the growth of developers as a metric, AWS will continue to drive profits for Amazon (see Figure 5). Even with Google launching their cloud computing offering, Google App Engine, AWS will only benefit from the future media frenzy behind that (since they'll both be mentioned in tandem). In 10 years, Amazon’s Web services business is going to be sizeable. And it’s not a stretch to predict that Amazon’s cloud computing effort will be the profit margin savior of the company. Today, Amazon’s retailing business bankrolls these fliers into cloud computing services. In a decade, Amazon’s cloud will subsidize the retailing business. It will take some time before they have enough scale to have a meaningful impact that becomes visible, given the scale of our other businesses. So with a $10 billion business, even though these businesses are doing very well, it's going to take some number of years before they become meaningful. This customer set is developers. A lot of them are start-up companies.

8.0CONCLUSION WHAT TO BET, HOW MUCH TO BET, WHEN TO BET

Figure 5: AWS Developer Growth

What to bet on: We recommend betting on the cloud computing industry, specificially the IaaS players as this represents a paradigm shift in the IT industry. The shift would affect companies in a number of sub-industries including software companies, internet service providers and hardware manufacturers. Companies in each of these industries will face significant change if cloud computing is to be the next step for the industry. AWS is simply a single offering in the IaaS space we recommend diversifying the major players (AWS, GAE) and smaller, promising niche players such as 3Tera and Saleforce.com. When to bet: Referring to Appendix H, it is clear that we have missed the upswing period for an investment on AWS. The ideal time would have been 2 nd quarter 2006 when the stock was near its all time low and when the company officially launched its AWS service. Since then the stock has appreciated and is now hovering near its all time high. However, to be prudent we recommend to take a ‘hold’ position as a IaaS storm is brewing above Amazon’s current blue ocean - which is bound to look bloody. 15 | P a g e

How much to bet: Investors are concerned with the present value of future cash flows, and since the NPV on their web services asset is kept secret, we can make an analysis based on year over year developer growth which is (See Figure 5). In terms of investing in Amazon purely as a blue-chip cloud infrastructure play, we recommend a diversified approach with a mix of 70:30 Amazon, Google play. Nonblue chip investments should be balanced across the major niche players such as 3Tera and Akamai. If the company’s cloud computing strategy is not successful, investors can fall back on Amazon’s successful retail business. Instead of building ‘cute’ applications and ladling them out to the masses — the Google and Microsoft model — Amazon is delivering silicon power to the people, which is the real disruption. It’s clearly evident that Amazon is in a league of its own in terms of infrastructure and its AWS unit was profitable as of the first quarter 2008, however Google has opened its cloud as of April 2008 and will eventually take market share if not through acquisitions/in-house development then through the strength of its brand. However, since Amazon is sustained by its complimentary assets and its successful e-retail business, we recommend that an investment be more heavily weighted on their company. We continue to believe that the transition to "cloud computing" is a disruptive trend that will increasingly put legacy PC and enterprise businesses like Microsoft (MSFT) and Oracle (ORCL) behind the eight ball.

8.0 Future Proposals for AWS The following are some of the recommendations we suggest investors to bring up during an Amazon annual meeting and/or open conference call regarding their cloud computing offering: 1. Lower Structured Data Storage Costs There are current inconsistencies in Amazon’s low-cost strategy. Structured data storage is simply too pricey to appeal to storage-heavy implementations. If Amazon is to benefit from network effects due to data growth (Appendix E – Figure 2), it needs to remove the data cost barriers. In the end, the more data, the higher the switching costs, the more likelihood of attaining a sustained bigplayer status. A good analogy would be to exist in a blue ocean (blue ocean strategy) among a handful of whales. 2. Spin off AWS unit Amazon needs to clearly identify their AWS strategy instead of straddling multiple ones for the sake of simplification and focus. It also needs to be mindful of the brand image that is inherited from its e-commerce business – whether it is a hindering or an enabling factor. As Amazon.com continues to grow as a technology infrastructure provider, we predict that the e-commerce business will diminish the AWS brand which is why we recommend spinning off and rebranding AWS as a wholly owned subsidiary of Amazon.com. 16 | P a g e

3. Consolidate – M&A In order to compete with technology giants who acquire to sustain growth (and innovation), we recommend Amazon to follow suit. Amazon should acquire niche players specifically in the cloud computing sphere as well as establishing data centres internationally in order to increase robustness of their offering and network topology.

APPENDIX APPENDIX A: AMAZON’S AWS PRICING STRUCTURE 17 | P a g e

Machine Utilization - $0.14 per Amazon SimpleDB Machine Hour consumed Amazon SimpleDB measures the machine utilization of each request and charges based on the amount of machine capacity used to complete the particular request (QUERY, GET, PUT, etc.), normalized to the hourly capacity of a circa 2007 1.7 GHz Xeon processor. Data Transfer $0.100 $0.170 $0.130 $0.110 $0.100

per per per per per

GB GB GB GB GB

-

all data transfer in first 10 TB / month data transfer out next 40 TB / month data transfer out next 100 TB / month data transfer out data transfer out / month over 150 TB

Data transfer "in" and "out" refers to transfer into and out of Amazon SimpleDB. Data transferred between Amazon SimpleDB and other Amazon Web Services is free of charge (i.e., $0.00 per GB). Structured Data Storage - $1.50 per GB-month Amazon SimpleDB measures the size of your billable data by adding the raw byte size of the data you upload + 45 bytes of overhead for each item, attribute name and attribute-value pair. Amazon SimpleDB is designed to store relatively small amounts of data and is optimized for fast data access and flexibility in how that data is expressed. In order to minimize your costs across AWS services, large objects or files should be stored in Amazon S3, while the pointers and the meta-data associated with those files can be stored in Amazon SimpleDB. This will allow you to quickly search for and access your files, while minimizing overall storage costs. See below for detailed descriptions on calculating your own structured data storage requirements and for a more detailed explanation of how storage in Amazon SimpleDB and storage in Amazon S3 differ. Source: Amazon.com – AWS Service Offering

COST COMPARISON TABLE: AMAZON & GOOGLE Cost/GB

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Cost/hour

Cost/month

Cost/ 1TB

($)

($)

($)

($)

AMAZON Instance Standard Instances Small

0.1

72

Large

0.4

288

Extra-Large

0.8

576

0.2

144

0.8

576

High CPU Instances Medium Large Structured Storage

1.5

1500

0.1

100

0.17

170

Data Transfer In-bound data Out-bound data (<10TB)

GOOGLE CPU Core Hour Storage

0.12

86.4

0.18

180

In-bound data

0.11

110

Out-bound data

0.13

130

Data Transfer

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APPENDIX B: AMAZON’S AWS STA DESCRIPTION Amazon Elastic Compute Cloud (EC2). Web Service that provides resizable compute capacity in the cloud. Scalability is achieved within minutes both, by the user and the application. Amazon Simple Storage Service (S3). Storage for the internet, that can be used to store and retrieve any amount of data, at any time, from anywhere on the web. Amazon SimpleDB . A web service for running queries on structured data and works hand-in-hand with EC2 and S3 in order to store, process and query data sets. Mitigates large-scale, upfront database investments. Amazon DevPay. Online billing and account management service that makes it easy for developers to get paid for applications they build on AWS. Unlike the first three offerings, DevPay is not an infrastructure service, but strongly supports their adoption by developers.

APPENDIX C: AMAZON’S INNOVATION STRATEGY

APPENDIX D: AWS DEVELOPER GROWTH

2006 Q1 Developers 160,000 2008 Q1 Developers 330,000

Current growth rate since launch: 51.5%

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APPENDIX E: NETWORK EFFECTS Figure 1: Network Effects due to User-sign up

Essentially as the number of AWS users increase, usage costs go down due to economies of scale. As prices go down, the willing to pay increases as the new price-point appeals to a broader audience. And finally once the willingness to pay hurdle rate has been satisfied, more users sign up. Figure 2: Network Effects due to data

The above figure is more relevant to data-heavy users such as large market research firms.

APPENDIX F: PAAS, IAAS ANALYSIS Segment

Description

Platform as a service (PaaS)

Many of the companies that started out providing on demand application services have developed platform services as well. The platform segment of cloud computing refers to products that are used to deploy applications. Platforms serve as an interface for users to access applications provided by partners or in some cases the customers.

Infrastructure as a service (IaaS)

The final segment in cloud computing, known as infrastructure, is very much the backbone of the entire concept. Infrastructure vendors provide the physical storage space and processing capabilities that allow for the all the services described above. The products in this segment are slightly more varied than those in the other areas of cloud computing but include ones such as managed hosting, and development environments (such as Google gears) that allow users to build applications. Cloud storage, such as Amazon's S3, is also considered to be part of the infrastructure segment

Key Player •

Google (GOOG) - Apps Engine

•

Amazon.com (AMZN) - EC2

•

Microsoft (MSFT) - Windows Live

•

Salesforce.com (CRM) - Force.com

•

NetSuite (N) - Suiteflex

•

Mosso - Mosso, a division of Rackspace

•

Google (GOOG) - Managed hosting, development environment

•

International Business Machines (IBM) - Managed hosting

•

Terremark Worldwide (TMRK) Managed hosting

•

Amazon.com (AMZN) - Cloud storage

APPENDIX G: AMAZON (AMZN) HISTORICAL PERFORMANCE

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APPENDIX H: CLOUD COMPUTING INDUSTRY OVERVIEW

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REFERENCES

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i

Spann, S. E-Commerce – Amazon – Corporate Culture. September 2004. Website: http://wiki.mediaculture.org.au/index.php/Amazon_-_Corporate_Culture, accessed July 9, 2008 ii

Amazon 2007 Proxy

iii

Plummer C.D. et al. Gartner's Top Predictions for IT Organizations and Users, 2008 and Beyond: Going Green and SelfHealing. Gartner Research. January 2008. iv

Greenfold development is when you have to recode the application from the ground up due to a lack of portability.

v

‘Hamilton, D., ‘Cloud computing’ seen as next wave for technology investors. June 4, 2008 Financial Post. Website: http://www.financialpost.com/money/story.html?id=562877. Accessed July 15, 2008. vi

Farber, D. Yahoo Looking to Unleash Its Cloud Computing Infrastructure. June 26, 2008. Website: http://news.cnet.com/8301-10784_3-9978409-7.html?hhTest=1. Accessed July 10, 2008 vii

Brand Finance 250, The Annual Report on the World’s Most Valuable Brands. January 2007. Website: www.brandfinance.com viii

Google unlocks its data centers. April 08, 2008. Website: http://www.roughtype.com/archives/2008/04/google_unlocks.php. Accessed July 15, 2008 ix

Amazon 2008 Proxy

x

Iansiti R. and Levien R. Strategy as Ecology. March 2004, Harvard Business Review.

xi

Online Business Toolkit, Accessed July 12 http://news.zdnet.co.uk/internet/0,1000000097,39211251,00.htm

xii

Kawamoto D., July 29, 2005. Amazon Web services marketplace patent published. Website: http://news.zdnet.co.uk/internet/0,1000000097,39211251,00.htm Understanding the Cloud Computing/SaaS/PaaS markets: a Map of the Players in the Industry, Accessed July 1st: http://dev2dev.bea.com/blog/plaird/archive/2008/05/understanding_t.html Amazon Web Services, Accessed on June 15th http://www.amazon.com/SimpleDB-AWS-Service-Pricing/b?ie=UTF8&node=342335011 Data excerpted from: DataMonitor: Business Information Center, Amazon.com Inc. June 2007. Website: www.datamonitor.com. Accessed June 2nd, 2008 DataMonitor: Business Information Center, Google Inc. June 2007. Website: www.datamonitor.com. Accessed July 7th, 2008 James Hamilton Blog, perspectives : Accessed July 2nd http://perspectives.mvdirona.com/2008/05/21/CloudComputingGrowthRate.aspx