Following a fairly entertaining discussion going on re Cloud computing, (Tim O'Reilly via Nick Carr's blog)...... To set the argument into sequence, initially
Tim agrees with Larry by quoting Hugh:
A couple of months ago, Hugh Macleod created a bit of buzz with his blog post The Cloud's Best Kept Secret. Hugh's argument: that cloud computing will lead to a huge [and profitable] monopoly. Of course, a couple of weeks ago, Larry Ellison made the opposite point, arguing that salesforce.com is "barely profitable", and that no one will make much money in cloud computing.
The stage is set, and Tim writes that he thinks Larry is right, and Hugh is wrong (my thoughts on Hugh's post at the time
over here):
First, let's take a look at Hugh Macleod's argument: ...nobody seems to be talking about Power Laws. Nobody's saying that one day a single company may possibly emerge to dominate The Cloud, the way Google came to dominate Search, the way Microsoft came to dominate Software.
Monopoly issues aside, could you imagine such a company? We wouldn't be talking about a multi-billion dollar business like today's Microsoft or Google. We're talking about something that could feasibly dwarf them. We're potentially talking about a multi-trillion dollar company. Possibly the largest company to have ever existed.
Tim disagrees with Hugh's analysis, as he feels Hugh is not distinguishing between economies of scale and network effects (ie confusing Moore's with Metcalfe's economics). (I have another view by the way, which is that you can have a monopoly
and low profits, but more of that later) Anyway, on with the show...
The problem with this analysis is that it doesn't take into account what causes power laws in online activity. Understanding the dynamics of increasing returns on the web is the essence of what I called Web 2.0. Ultimately, on the network, applications win if they get better the more people use them. As I pointed out back in 2005, Google, Amazon, ebay, craigslist, wikipedia, and all other other Web 2.0 superstar applications have this in common.
Cloud computing, at least in the sense that Hugh seems to be using the term, as a synonym for the infrastructure level of the cloud as best exemplified by Amazon S3 and EC2, doesn't have this kind of dynamic. (More on different types of cloud computing later.)
Of course, it is true that the bigger players will have economies of scale in the cost of equipment, and especially in the cost of power, that are not available to smaller players. But there are quite a few big players -- Google, Microsoft, Amazon -- to name a few, that are already at that scale, with or without a cloud computing play. What's more, economies of scale are not the same as increasing returns from user network effects. They may be characteristic of a commoditizing marketplace that does not actually give outsize economic leverage to the winners.
So far, so good - now enter the irascible Nick Carr stage left, arguing that Tim in turn is confusing Network Effects with Good Olde Grabbing the Commons (and good olde cross subsidy too, I'd argue):
Let's stop here, and take a look at the big kahuna on the Net, Google, which O'Reilly lists as the first example of a business that has grown to dominance thanks to the network effect. Is the network effect really the main engine fueling Google's dominance of the search market? I would argue that it certainly is not. And in fact, if you look back at that 2005 O'Reilly article, What Is Web 2.0?, you'll find that O'Reilly makes a very different point about Google's success. Here's what he says, in a section of the article titled "Harnessing Collective Intelligence":
Google's breakthrough in search, which quickly made it the undisputed search market leader, was PageRank, a method of using the link structure of the web rather than just the characteristics of documents to provide better search results.
This has nothing to do with the network effect as O'Reilly defines it. What Google did was to successfully mine the "intelligence" that lies throughout the public web (not just within its own particular network or user group). The intelligence embedded in a link is equally valuable to Google whether the person who wrote the link is a Google user or not. In his new post, in other words, O'Reilly is confusing "harnessing collective intelligence" with "getting better the more people use them."
Yes, I hear you cry - but what about the Original Question? How many Clouds will there be, and will they make any money? One accumulated Cumulus or a whole Stratos of them?
My take - I think there are 3 separate questions here, and I think there is a danger they get conflated - viz:
(i) Will the Cloud/Grid/Hosting industry be composed of many or very few (one?) players
(ii) Will the Cloud etc be profitable?
(iii) Will value be captured by this layer, or will it move to the "Web 2.0" applications layer.
Taking these in turn:
Will Cloud / Grid be Many or Few companies?
I agree with Nick here - Sez he (expurgated by me):
Indeed, this new industry seems particularly well suited to a concentration of market power. Here are some of the reasons why:
1. Capital intensity - presents a big barrier to entry.
2. Scale advantages.
3. Diversity factor. One of the big advantages that accrue to utilities is their ability to make demand flatter and more predictable
4. Expertise advantages. Brilliant computer scientists and engineers are scarce.
5. Brand and marketing advantages. They still matter - a lot - and they probably matter most of all when it comes to the purchasing decisions of large, conservative companies.
6. Lock-in. Don't assume that "open" systems are attractive to mainstream buyers simply because of their openness.
These conditions all argue for a small number of players, but not necessarily for one. Telecoms and Web Hosting are similar example where a number of major players exist.
Will the Cloud be massively profitable?
Just because there is a concentration of market power does not imply there will be super-profits, and I'd argue this industry has the nature of a utility - a bit like Telecoms or Hosting - where in the early competition phase any surplus is competed away by the players trying to increase utilisation and win business from each other (especially if Google and Microsoft are involved, as they will cross subsidise the business).
Thus I would argue that there will initially be potentially good margins, but they will be rapidly competed away.
Will the "Web 2.0" Application Layer take up the surplus?
Tim is apparently in furious agreement that the industry will consolidate into a few large players, and low margin ones at that - but thinks that it will not be low margin at the software layer, for the reason he notes - the "The Law of Conservation of Attractive Profits"
A lot of my thinking about web 2.0 grew directly out of my thinking about open source. My argument in The Open Source Paradigm Shift was that what we learned from the history of the IBM personal computer -- a commodity platform built from off-the-shelf parts -- was that it drained value out of the hardware ecosystem, turning it into a low-margin business. But profits didn't go away. Instead, through something that Clayton Christensen calls "the law of conservation of attractive profits," value migrated elsewhere, from hardware to software, from IBM to Microsoft. Christensen:
When attractive profits disappear at one stage in the value chain because a product becomes modular and commoditized, the opportunity to earn attractive profits with proprietary products will usually emerge at an adjacent stage.
I believe strongly that open source and open internet standards are doing the same to traditional software. And value is migrating to a new kind of layer, which we now call Web 2.0, which consists of applications driven not just by software but by network-effects databases driven by explicit or implicit user contribution.
I think that while Tim is correct about where value is draining away from, it not clear to me that it will be accrued where he thinks it will. One point I'd make is that above analysis seems not to recall the main Microsoft advantage - monopoly ownership of the assets, vigorously enforced. Thus I would argue that unless Open Source has some form of ability to "corrall" the assets, value will leak away from this layer as well, just as it did from IBM.
To be fair to Tim, he defines a number of types of Cloud (my expurgation again):
1. Utility computing. Amazon's success in providing virtual machine instances, storage, and computation at pay-as-you-go utility pricing was the breakthrough in this category, and now everyone wants to play. Developers, not end-users, are the target of this kind of cloud computing.
This is the layer at which I don't presently see any strong network effect benefits (yet).
2. Platform as a Service. One step up from pure utility computing are platforms like Google AppEngine and Salesforce's force.com, which hide machine instances behind higher-level APIs. Porting an application from one of these platforms to another is more like porting from Mac to Windows than from one Linux distribution to another.
The key question at this level remains: are there advantages to developers in one of these platforms from other developers being on the same platform?
3. Cloud-based end-user applications. Any web application is a cloud application in the sense that it resides in the cloud. Google, Amazon, Facebook, twitter, flickr, and virtually every other Web 2.0 application is a cloud application in this sense. However, it seems to me that people use the term "cloud" more specifically in describing web applications that were formerly delivered locally on a PC, like spreadsheets, word processing, databases, and even email.
Point 1 is really describing utility level services. Point 2 describes more of a walled garden play, an approach to gain surplus by restricting user transfer options (aka good old proprietary plays). Point 3 reminds me of the dotcom world of ASP's (Application Service Providers), which I was involved with at the time and since. The issue is that anything easy to do (eg Office lookalike apps) has fairly low value (Open Office being free to user), and anything hard to do comes at a price that makes more traditional ways look more competitive. And the real value lies with the more sophisticated applications.
I return to my points at the time of Hugh's post - this is a bigger issue than which Cloud you sit on:
The issue quite simply is this - in my business, I am committed. The infrastructure partner is only involved.
Now, I hear you argue, Outsourcing has done very well - and it has - but it is instructive to look at what is usually outsourced and by whom. By and large its non core, non customer facing applications (we have in fact done a number of pieces of work re-insourcing customer facing services). So Email, HR, Sales Analysis and Order Management etc are outsourced, but core workflow far less so. Also (whisper this who dares) outsourcing is often a piece of financial, not technical, engineering. Smaller companies do tend to outsource more critical services, but its driven by their economic necessity (lower resource levels, lower cost plus trying to get a jump ahead of large players) rather than choice in many cases.
In other words, I think small companies will adopt the Cloud first, but they have b*gger-all money compared to Corporates. This the area where Web 2.0 technologies of today will excel, but the surplus is mainly being handed to the customer.
Now, where I do think Web 2.0 is different is the way it deals with the connection between people and data usage, but (having worked for 15 years or so with Enterprise systems and 4 or so with Web 2.0 ones) it is not yet "Enterprise Grade". But it will come. Question is though, how will they extract value? Now Tim notes that:
So when Larry Ellison says that cloud computing and open source won't produce many hugely profitable companies, he's right, but only if you look at the pure software layer. This is a lot like saying that the PC wouldn't produce many hugely profitable companies, and looking only at hardware vendors! First Microsoft, and now Google give the lie to Ellison's analysis. The big winners are those who best grasp the rules of the new platform.
This may be true, but in my view there is a big gap still to be crossed before these Web 2.0 services are properly Enterprise 2.0 ready, or can extract high margins. The value in web 2.0 will be extracted by whoever is taking the risks. Right now, these are the enterprises who implement them. Thus, until the Cloud apps' Service Level Agreements have real terms, with real penalty clauses, they will be unable to extract large surpluses and will be relegated to lower value areas. Which is really Larry Ellison's point.
In fact, I suspect the Cloud winner, as with Outsourcing, will be the one with a better financial rather than service package.
An interesting discussion, nonetheless....no doubt this is not the end of it!
Update - indeed not and end to it - there is a
good post from Whimsley on the matter, this bit moves the discussion on:
What we need to do is not so much look at the sources of increasing returns to scale, which are many, but instead look for what factors might limit increasing returns and prevent the expected monopolies from forming. Any such factor will affect different digital industries in different ways. I'll just look at one factor to show what I mean.
According to the classical model of trade, industries should get very concentrated as each country focuses on its own area of comparative advantage. If Germany is good at making cars and Sweden is good at making bookcases then all the cars will be made in Germany and all the bookcases in Sweden - then they will trade cars for bookcases.
But in the real world both cars and bookcases are made in both Sweden and Germany and they each trade both cars and bookcases among themselves. Industry concentration is limited. How come?
One of the things Krugman used to explain this observation is the idea that as consumers we have a taste for variety. So MacDonald's may have economies of scale and sell a lot of burgers, but no one wants to eat MacDonald's all the time so there's a limit to how much of the restaurant industry MacDonald's can win over.
In addition to this point, most tech commentators forget about Transaction Costs (I did when I wrote this....) - they impact every system and they grow in a Metcalfeian way (ie exponentially). The issue being at some point the Metcalfe's law benefit tops out to you, but the Transaction costs keep on growing. Think Dunbar's number effect - a social net of several million people has transactions Cost of all those million links, but can only give the Benefit of 150 or so to any user. At some point the system is just too costly for the benefits it produces and finds its natural limit.
