Bloomberg News

Amazon Sees Further Price Drops in Cloud, Pressuring Microsoft

March 16, 2012

Amazon.com Inc. (AMZN), which dropped prices on its Internet-based cloud-computing service last week, said it will keep cutting when it can, putting pressure on competitors like Microsoft Corp. (MSFT) to keep its own prices low.

Customers of Amazon’s EC2 service, which lets clients run their programs on the online retailer’s server computers, saw price cuts of as much as 37 percent on March 5, and other Amazon cloud service prices were trimmed as well. Microsoft responded days later with reductions on its rival Azure services.

“We expect prices to be lower and lower over time, and load volumes to be higher and higher,” said Adam Selipsky, a vice president at Amazon Web Services. Amazon has lowered prices 19 times in the 6 years it has sold Amazon Web Services, which has gained customers as more companies seek to run and store applications in outside data centers instead of maintaining the servers themselves.

As they tussle over price, the resulting narrower profit margins may be tough to swallow for both companies. Microsoft is under pressure from investors concerned about its entry into markets where costs are higher than its traditional software business. Meanwhile, Amazon’s stock has slid about 25 percent from a record in October as expanded investments in areas such as cloud services and the Kindle Fire tablet halved margins in 2011.

“It’s another round of a race to the bottom, and this won’t be the last one,” said Colin Gillis, an analyst at BGC Partners in New York. “Amazon has made it pretty clear that they are interested in share over profits, at least for now.”

Margin Shock

Microsoft and Amazon are jousting to stay competitive on price for a reason: The market for so-called public cloud services will increase from $21.5 billion in 2010 to $72.9 billion in 2015, according to the most recent forecast from researcher IDC, released in June.

As a veteran of the retail business -- with its razor-thin margins -- Seattle-based Amazon is more adept at dealing with pricing pressure than Microsoft, analysts said.

Amazon’s margins are about 10 percent on cloud services, a higher rate than its retail businesses, estimates David Smith, an analyst at Gartner Inc. For Redmond, Washington-based Microsoft, whose operating margins are 60 percent or wider on Windows and Office software, the scantier cloud profits are a more difficult adjustment, he said.

Amazon’s overall operating margin -- an indicator of profitability that measures revenue minus operating expenses -- narrowed by more than half to 1.8 percent last year, according to data compiled by Bloomberg. Microsoft’s was little changed at 39 percent in fiscal 2011.

Passing On Savings

“Amazon is setting the price, and that’s the way it’s going to be for some time,” said Smith. While Selipsky said the company is trying to pass along its operational savings to customers, Gartner’s Smith said the reductions are more about pressuring rivals. “It’s in their best interest to cut because they force the others to lower prices.”

Pricing pressure is likely to persist as new companies enter the market. Hewlett-Packard Co. (HPQ) is now testing a competing service and plans to release it officially this spring, said Michael Thacker, a spokesman.

Google last week also trimmed the price of its cloud-based storage service. Amazon had cut the price on its competing service last month.

Meredith Lynch, a spokeswoman for Microsoft, declined to comment on the price competition.

The only way Amazon might lose pricing power is if an overseas provider with even lower costs enters the cloud- services market, or a company that operates in another industry with low margins, such as a website-registration company like Go Daddy Group Inc. (DADY), starts to offer the same services, said Smith.

“It’s a commodity business,” said BGC’s Gillis. “These are ubiquitous services where you win with massive scale, and the way that you achieve massive scale is to lower the price.”

To contact the reporter on this story: Dina Bass in Seattle at dbass2@bloomberg.net

To contact the editor responsible for this story: Tom Giles at tgiles5@bloomberg.net


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