Amazon Web Services: Seeing Through the Clouds

How Amazon abstracts the data center and makes billions of dollars in the process.

We’re all familiar with Amazon. It’s where we can buy practically anything that UPS can ship to us. They’re the largest global online e-commerce business and yet there is a bigger business underneath the hood that fewer of us know about. Amazon’s web services business is so profitable that it generates 8% of Amazon’s total revenues but over 50% of its operating income.

The business model.

AWS sells IT infrastructure to businesses of all sizes through the “cloud.” Customers only pay for what they use. The business was launched in 2006 and is now at an ~$8 billion revenue run-rate, almost doubling year-over-year. Today, it serves over one million customers in more than 190 countries. As the biggest online retailer with tremendous IT demands, the idea emerged as Amazon realized it had built world-class expertise in managing traffic and that as a single-tenant user, its own infrastructure wasn’t being used efficiently. In this way, Amazon’s investment in building AWS, a new business model, is the result of how efficiently it ran the operating processes of its retail operations. This new business comes with its own business and operating models and yet it serves to improve its existing retail model as the cost to serve its customers and manage its infrastructure improve as AWS proliferates. Furthermore, AWS’s superior profitability helps underwrite other projects under the greater Amazon umbrella that serve to bring additional value to its customer base.

What is being disrupted?

Why should customers use AWS? Normally, IT departments would spend significant resources building up their infrastructure around storage, compute, and databases on their own premises. As companies grew, teams needed to procure more storage, more computing power, and more physical real estate to accommodate increasing demand on their servers. Once purchased, these components need to be integrated and configured correctly. On an ongoing basis, application demand would have to be balanced and capacity handled efficiently. This takes tremendous time and diverts resources from execution of the core business. The transition to the cloud is at its early stages but many large enterprises have gone all-in with the cloud.

How the clouds align.

AWS removes many of these burdens by deploying huge number of servers (a server farm) and having multiple customers run their applications on top of that shared infrastructure. This is referred to as a multi-tenant environment. The fundamental idea here is that shared infrastructure lends itself to the “elastic” distribution of different companies’ needs and the subsequent removal of bottlenecks in computing demand. For instance, when an online news site breaks important news and sees unprecedented levels of traffic, Amazon helps virtually spin up more instances to support the demand on its servers to prevent the site from breaking down. This protects the brand of that company but also enormous amounts of advertising dollars. Thus, infrastructure capacity can be managed at a fraction of the cost and at higher utilization rates. Amazon can better utilize its server farms and pass on some of the savings to its customers who pay only for the infrastructure they use at any given time. This all equates to cheaper, faster, more flexible IT environments. As companies worry less and spend less on infrastructure needs — the plumbing behind many of the applications we use everyday — the more they can allocate resources to building those applications. And if you’re wondering who to blame for the countless technology startups that have propped up, you can blame Amazon.

The operating model: how Amazon’s clouds make it rain. 

The total cost of ownership for IT infrastructure is dramatically reduced by leveraging Amazon’s cloud. The elegance of the operating model is that as it scales, the business’s value proposition improves. When more and more companies transition and run their applications on AWS’s infrastructure, AWS is better able to execute its processes. This dynamic reduces costs further since workloads can be distributed across a more diversified network which then drives savings to the end-user. The business model then becomes more attractive particularly against its higher-priced competitors, which then spurs further growth. Growing AWS profits also helps the company fund service projects that improve the value and services of AWS. See here for a graphical representation of AWS’s growing stack, which last year released an enormous 530 new features. Beyond the basic building blocks of storage and compute, a company can now use Amazon’s load balancers to even out traffic or they can use Amazon’s content delivery network to speed up service to its customers. Business intelligence tools are being rolled out too. As additional services roll out, here too, customers pay on an activity-based pricing model thus ensuring that Amazon can both continue profiting and bring value to its customer.

Amazon Web Services is in the business of selling the building blocks of IT. The brilliance of the model comes down to just how effectively its operating processes as discussed above are designed to continually improve and protect the value proposition of its business model.

(Sincere apologies for the cirrusly bad puns.)

Sources:
1. Company 10-Q (Q3, 2015)
2. Multiple pages; https://aws.amazon.com
3. Columbus, Louis. “Building Powerful Web Applications in the AWS Cloud.” March 2011.
4. Multiple videos; https://www.youtube.com/user/AmazonWebServices
5. Amazon. “AWS Pricing Overview.” June 2015. Web.
6. Meyer, Robinson. “The Unbelievable Power of Amazon’s Cloud.” The Atlantic. Atlantic Media Company, 23 April 2015. Web.

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1 thought on “Amazon Web Services: Seeing Through the Clouds

  1. Slightly misleading saying that AWS is half of Amazon’s operating income considering how unprofitable the company is — 178M on 89B?

    Anyways, this is a really interesting read. Just further underscores Amazon’s power today — not just the world’s largest retailer but also essentially powering the internet. The competitive issues here are super interesting. I know that Netflix (primary competitor to Amazon’s video offering) runs on AWS. I wonder how many retailers/other companies that Amazon competes with do the same?

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