COVID-19: A 'cloud-20' response is accelerating major vendors' opportunity
May 6 2020
by William Fellows, Melanie Posey
COVID-19 appears to be wiping out cloud concerns, if the businesses of the major hyperscalers are anything to go by. Most have reported quarterly earnings over the last few days and while the COVID-19 impact was (with the exception of Alibaba) really felt only from March onwards, it's nevertheless a directional growth guide at a time when no one really knows what lies ahead. A better picture of cloud spending under COVID-19 conditions will be seen in Q2 2020 but we expect that over the longer term, an increased demand for cloud-based resources and a greater emphasis on IT transformation is likely. In particular, Microsoft and Amazon mentioned strength in their cloud businesses on their respective earnings calls.
The 451 Take
Cloud suppliers have had to shift priorities because customer demand has shifted, especially among industries that have been hurt most by COVID-19. Some future growth in the cloud has been pulled into the present by COVID-19, but it seems likely that accelerated use of cloud will continue while current conditions persist (no vaccine, social distancing) and onward into the future. The end may be coming into view with the easing of lockdown measures, and while we don't know much about what the future holds, we do know that no one is continuing as before and that cloud appears to be a winner. We expect larger providers in particular will benefit from a 'flight to safety,' where customers will look for providers that will be in a position to withstand the downturn (see figure below). Cloud sits strategically at the top of the list of IT technologies viewed as most transformative, and any work in progress is prone to acceleration, not retrenchment, among those for which the short-term negatives of COVID-19 can and will be absorbed. The C-suite points to cloud as a weapon it will bring to the fight against variables such as uncertainty and rapidly changing market conditions. This viewpoint was born prior to COVID-19 – which brings all those variables in spades.
COVID-19 as the accelerator for transformation
Our vendor checks suggest they are experiencing three key phases of COVID-19 response from their customers. The first is that most (although not all) new projects stopped (phase 1) while companies identified what to do to keep their businesses running (what to accelerate). Once stable (phase 2) and running, they then assessed which projects need to continue to go forward (phase 3). It seems that old systems have been much less able to adapt to meet these requirements. All of this goes hand-in-hand with squeezing out costs as much as possible and heightened concern about the increased number of bad actors.
We suspect that if even 50% of cloud projects underway do continue in some form, and even taking into account customers that go bust, cloud providers will more than make up any downside with additional sales to and increased usage volume from existing customers accelerating projects and the onboarding of net new customers.
Moreover, we expect COVID-19 will likely expedite the evacuation of datacenters and large-scale capex (equipment, real estate) takeout as long-term business disruptions and changes to working practices become permanent 'new normal' conditions.
In addition to the accelerated enterprise conversion to cloud, working from home, schooling and lockdown video streaming have caused cloud-based traffic to jump. Even when there is a 'return to work,' the split-team approaches required by social distancing will mean 50% of employees are at home at any time.
We expect consumer and SMB activity to change in favor of public cloud because struggling consumers will opt to consume more home streaming services, with SMBs likely opting for a more pronounced cloud/online presence.
Cloud services and cloud-native vendors we have spoken to report there is considerably more interest in how to use cloud and cloud-native approaches than during pre-COVID-19. After all, no company's board will advocate 'keep doing the same' and decide to sidestep the inevitable IT modernization/digital transformation reckoning. The COVID-19-inspired rush to cloud is not just about infrastructure; accelerated cloud migration is also about applications. Many applications need to be refactored (i.e., broken down into smaller functional components and rebuilt as new cloud-native services) before they can be re-platformed and deployed in the cloud.
Enterprises not far down the path of transformation will be concerned that they are behind, especially on hearing the experience of Microsoft, whose CEO Sataya Nadella stated on its Q3 earning call that, "as COVID-19 impacts every aspect of our work and life, we have seen two years' worth of digital transformation in two months." We've heard from many vendors that the current pandemic is an accelerator for transformation.
To accelerate its global ambition and take advantage of the upsurge in cloud usage driven by the conditions of COVID-19, Alibaba is doubling down on its cloud datacenter and related technology investments, planning to invest $28bn over three years. It currently operates 10 datacenters in China and 11 elsewhere. Its 10-year-old public cloud business grew 62% in its December 2019 quarter to some $1.5bn – about 7% of Alibaba's total revenue – although it remains unprofitable. The planned investments amount to roughly half of Alibaba's entire $55bn 2019 revenue and the annual outlay described in the plan is about double what it is spending on datacenter investments in its current year. It reckons to handle up to 70% of China's peak internet traffic.
Amazon's Q1 2020 net income declined 30% to $2.5bn compared with $3.6bn a year ago on revenue that grew 26% to $75.5bn compared with $59.7bn. Within this, AWS sales grew 33% to break the $10bn barrier at $10.2bn of which $3.1bn is operating income – representing 77% of Amazon's total operating income. AWS now accounts for 13.5% of Amazon's total revenue. The 33% growth compares to 41% growth a year ago – and while there hasn't been a quarterly rise in AWS growth since Q1 2018, it's still a huge increase – its quarter was bigger than Oracle's last. AWS has outlined how it will cater to increased demand and has held spot pricing steady over the course of the pandemic; a sign, according to 451 Research, that the cloud leader is handling capacity challenges well. In addition, AWS recently applied for the fast-track approval of new datacenter construction. Amazon is having to set aside all its anticipated $4.0bn Q2 profit to cover the costs of measures it is taking related to COVID-19 in its operations. However, with the digital economy and indeed our digital lives only set to grow during the pandemic, Amazon's continuing growth trajectory will show how it is benefiting.
Within Alphabet's $33.7bn Q1, Google Cloud revenue climbed 52% to $2.8bn, roughly the same growth as 2019. The company said there was no real impact to its business from COVID-19 across the board until late March, when the Google Cloud business (including Google Cloud Platform and G suite) accelerated sharply. However, its advertising business was negatively affected – while search usage has gone up, advertising spending has fallen. Given this and the unchartered waters ahead, the company said it is stopping facilities construction while capex spending on datacenters and cloud will be roughly the same as 2019 (we suspect datacenters likely accounted for most of its $25bn capex spending last year). Instead, Google will focus on better optimization and efficiency in its datacenters, which will have a long-tail benefit for customers. Other service providers are sure to emulate Google's approach – a likely boon to makers of datacenter infrastructure management and best execution venue software.
IBM's Q1 net income declined 26% to $1.18bn on revenue that declined 3.4% to $17.62bn. Revenue in its cloud and cognitive software segment was up 5% Y/Y to $5.24bn, driven by 32% growth in cloud and data platforms, which was led by Red Hat, where revenue grew 18% Y/Y to $1.07bn.
Microsoft reported net income of $10.8bn on revenue of $35bn. Revenue from its Intelligent Cloud business was up 27% at $12.3bn. Within that, it said Azure revenue growth was 57% (Microsoft doesn't break out Azure revenue), while overall revenue attached to the cloud was up 39%. Any strains on service levels or capacity related to supply chain issues appear to have been resolved.
Cloud services and license support grew 4% to reach $6.93bn in Oracle's third quarter through February 2020. Net income fell to $2.57bn from $2.75bn on total revenue, which increased 2% to $9.8bn. Oracle doesn't foresee much impact from COVID-19 on its Q4 business – it said much of its subscription revenue is already contracted.
451 Research Market Monitor, IaaS Cloud Computing
Given the uncertain economic environment, 451 Research has augmented its market forecast with a scenario analysis that incorporates alternative economic and market-specific assumptions (mild, moderate, severe) and provides a range of potential outcomes for the market – COVID-19 Impact: Infrastructure-as-a-Service Market Scenario.
2019 Infrastructure-as-a-Service Market Share
451 Research - COVID-19 Impact: Infrastructure-as-a-Service Market Scenario Analysis