The first report of this came in late September, when marketing software service SEOMoz reported huge price spikes on the spot market. A sudden spike in the price of “m2.2xlarge” servers (normally $.44/hour) drove the price briefly up to $999/hour, causing a site-wise outage. While this was bad news for SEOMoz, it was probably worse news for the unlucky customers who ended up paying $999 for one hour of compute time!

Will you pay $999 per hour for a server?

Why would anyone bid such a high price? It’s hard to say for sure, but the unlucky winner of the auction probably did not expect to pay $999 per hour for a server. On the Amazon marketplace, your bid represents the maximum amount that you are willing to pay: you usually end up paying much less than your bid. Many buyers seem to have assumed that the price would never rise above the fixed-price “on-demand” rate charged by Amazon.

Unfortunately, it seems like a large number of people were using that flawed strategy. And when something changed in the spot market (perhaps a reduction in the number of machines available to rent, due to increased demand) the unrealistically high bids that customers made went into effect. Amazon has since posted a video describing the different strategies buyers on the spot market use. Litmus, one of the companies mentioned in the video, describes their strategy as “bidding high for convenience.” The $999 bidder who cornered the spot market on large servers was probably using an extreme version of this strategy.

My company (SlideShare) was also effected by the recent price spikes on the spot market. Several times in October and November, all of our EC2 servers disappeared at once because of a price spike (this had never happened before). Fortunately, the software code that manages SlideShare’s cloud servers responded automatically by renting new machines at the “on-demand” rate, so we didn’t experience any actual downtime, only degraded service. But after this happened to us several times, we have changed the mix of machines that we use so that only half of them are from the spot market, and the rest are on-demand.

Spikes are a recent problem

Looking through the pricing history for various classes of machines, it’s clear that these spikes are new, and that they are happening across almost all instance types, at least for servers that are on the East Coast of the United Sates. For example, “small” servers on AWS both spiked as high as $100 an hour twice in November, when the on-demand price for those servers is $.085/hr. “m1.large” machines also spiked as high as $40 an hour. Almost every class of servers has hit spikes of more than 10 times their retail price in last few months. What is going on?

It’s hard to say why the spot market is suddenly showing more price spikes. A drop in supply (from Amazon requisitioning machines for its own purposes or for renting in the on-demand market) or a spike in demand (from the Christmas e-commerce rush) could be to blame. It’s important to remember that the AWS spot market is not a typical market, with many buyers and sellers doing business over a neutral exchange. One seller is servicing many buyers, and is also operating the exchange.

Amazon benefits from customer anxiety about getting access to spot servers: they sell on-demand instances for a higher price, and pre-paid reserved instances for better cash flow. So it’s unrealistic to expect Amazon to do anything to “fix” these price spikes. From Amazon’s perspective, they are a feature, not a bug.

How to deal with EC2 spot price spikes

For customers of the AWS spot market, there are some best practices to be learned from these recent price spikes:

• Never EVER bid more than you are willing to pay for a server on the spot market. This is the most important lesson. Don’t even bother doing “convenience bidding” of double or triple the on-demand price: when the price starts to spike it will easily go way beyond any rational price. Do you want to be the gal who explains to the CEO why the company is paying $100 an hour for servers?
• Don’t run all your infrastructure on spot market machines. In fact, don’t run more infrastructure than you are prepared to lose on spot machines. We use a thumb rule of 50 percent at SlideShare, since our system can easily survive 50 percent of our machines disappearing at one time (which is what will happen during a price spike).
• Write the code that manages your cloud infrastructure so that it responds intelligently to spot market price spikes. If you can’t get a spot machine at a reasonable price, your code should automatically request an on-demand server.
• Consider having some “reserved instances,” so that you are guaranteed the right to a minimum base level of machines. I’ve argued in the past that reserved instances don’t make sense for startups, but it’s clear that when supply dries up at Amazon it happens all at once, without warning. Your portfolio of servers on Amazon is almost like a financial porfolio. You want some diversification between risky high-reward elements (spot market) and more conservative elements (reserved instances).

These are early days for real-time pricing of cloud computing, and the spot market on Amazon is finally acting like a real market, with extreme price fluctuations. The “free ride” of getting reliable spot priced machines for less than the on-demand price is over. So if you want to play with cheap cloud servers, make sure you have the infrastructure in place to handle a price spike that could make all your servers vanish in the blink of an eye!

Jonathan Boutelle is co-founder and chief technology officer of Slideshare a web site for presentations that relies heavily on cloud computing. Previously, Jonathan was a principal at Uzanto, (a UI consulting firm) and worked as a software engineer at CommerceOne (a B2B enterprise software firm) and Advanced Visual Systems (a 3D graphics startup) You can find his presentations on cloud computing at slideshare.net/jboutelle, and his Twitter is @jboutelle. He also blogs at www.jonathanboutelle.com.

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Stuart Elby, VP and network architecture & technology chief technologist for Verizon Digital Media Services, laid out how the promise of software-defined networking could make the company’s cost curve match its revenue by cutting down on the need for expensive gear that is costly to buy and even more costly to operate. In a conversation before his presentation, Elby explained how Verizon’s network can view every single packet on the network, but how keeping track of those packets is both a big data problem and expensive from a network management perspective.

For a while already, Verizon has been trying to host as much of its network as possible on commodity boxes, running commodity servers and some Sun boxes at the core of its network and keeping the big, expensive gear from the likes of Juniper and Cisco at the edge of the network. Elby was cagey about how his preference for lower-cost bit delivery might affect Verizon’s big suppliers, especially since he was seated onstage next to David Ward, CTO of Juniper. When Elby said he wasn’t planning on ditching any of the recent Juniper boxes he’s just bought, Ward quipped, “I appreciate that, Stu.”

However, Elby is dealing with his costs exceeding his revenue, which he explained was coming in “a matter of years,” although he didn’t specify how many. The chart above is not limited to Verizon. Nick Mckeowan, an ONF board member and a pioneer of the protocol, said that he has seen charts like that one from other carriers, including Deutsche Telecom. It’s also a topic we at GigaOM have covered many times in the past.

So how exactly does a new protocol help?

OpenFlow is a protocol that allows someone to separate the intelligence inside a switch and router from the hardware itself. The promise of OpenFlow is that operators can create software-defined networks that are programmable. For more on the topic, see this video explaining it or this GigaOM Pro article (sub req’d). For an operator, it could make it far easier to direct the packets flowing around their networks because they could have more freedom and flexibility in programming their networks to do whatever the operator wanted.

Elby, for example, proposed several use cases, including traffic steering, which involves understanding what service a packet represented and what the subscriber’s plan was and then shunting that traffic over to the most appropriate path. This might mean recognizing that a succession of packets coming from Netflix is a streaming movie, so it could be sent on its way without further investigation, or it could eventually be a way to manage heterogeneous networks.

Another example comes form the data center world, which Verizon doubled down on when it bought Terremark this year for $1.4 billion. Elby describes a scenario where a customes trying to send huge files from one data center to another could guarantee their delivery by upping their bandwidth capacity on demand as opposed to paying for a consistent connection. In this way, Verizon begins to deliver capacity as a service in a manner similar to how Amazon delivers compute as a service.

Elby described more options, but the message underlying his talk was that OpenFlow and software-defined networks could lower Verizon’s costs, but it also turns Verizon into a service provider with a change in the type of cost model it will have. Understanding the technology as Verizon implements it and how it will change its spending on equipment and operating its network is one thing. Understanding the new business models that Verizon can implement as it provides what can become a multi-tenant, shared network model even for enterprise clients is another. It’s going to be fun, but I’m not sure if it will actually result in a lower mobile phone bill.

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San Francisco-based Stackmob offers mobile developers a back-end cloud platform that allows them to easily build, deploy and manage their applications without having to fuss with many of the infrastructure issues that can plague startups. That means developers can spend less time building out the basic services that most mobile apps have anyway and focus on a differentiated experience. Especially with many startups scrambling to add talent, StackMob allows them to avoid having to hire as big a team.

“We see ourselves as the experienced back end for the masses. Everyone forgets how early we are in mobile. There will be great ideas out there but people don’t know how to implement the back end,” said CEO and co-founder Ty Amell.

StackMob offers things like simple API creation and management, social integration, messaging and analytics. Monetization tools are coming shortly. Startups tie into StackMob’s platform and they don’t have to build those services themselves. They still need to hold on to some back-end programmers, but they don’t need the same number of employees working on infrastructure.

So far, StackMob has been in private beta with about 200 iOS apps on the platform. Amell said the company, which has a wait list of thousands, is preparing to open up later this year when it starts supporting Android. While StackMob builds out most of its services, it will likely need to partner for some things like location. Amell said the company is looking to integrate data from Simple Geo or Location Labs for that.

StackMob has been compared to Heroku, a Ruby on Rails cloud platform that has caught on with web developers. It’s not coincidental. Some of StackMob’s original seed investors — Harrison Metal and Baseline Ventures — were also funders of Heroku, which has been bought by Salesforce. Harrison Metal founder Michael Dearing will be joined on the StackMob board by Dan Scholnick, general partner at Trinity Ventures.

StackMob could be a major success if it follows in the footsteps of Heroku. There’s a lot of opportunity in helping power apps, and there are very few tools like this for mobile developers in particular. By empowering developers, StackMob can help apps go from ideas to real software much faster and can give rise to a lot more start-ups that don’t have enough technical talent but have some interesting takes for their apps. Amell is right, it’s still early in mobile and platforms like StackMob could ensure that the app boom continues to explode well into the future.

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Assuming the provisioning engine comes to fruition, OpenStack will undoubtedly see adoption from service providers wanting to offer cloud computing, enterprises wanting to build their own internal clouds, and IT vendors looking to beef up their cloud software offerings. If all comes together as planned, it should be a very nice solution. Just like everywhere else in life, competition in the cloud is a great thing.

However, competition for dollars and developers is plentiful, including large cloud providers, software vendors and even other open source options. The idea of a network of interoperable OpenStack-based public and internal clouds is appealing, but it would require stealing business and developers from a wide variety of other proven, innovative and commercially supported offerings.

Even within the OpenStack membership, conflicts of interest exist. How supportive can Rackspace really be of other service providers without cannibalizing its own cloud revenue? Plus, it’s also considering offering Windows Azure as a service. Dell already sells Joyent’s cloud software, and it’s also an early Windows Azure Appliance partner. If Dell does offer OpenStack as an open source alternative, it will be just that — an alternative. Other partners will support the OpenStack platform, but that’s on top of existing support for AWS, VMware and other industry-leading offerings. Supporting OpenStack is one thing, but pushing it to the exclusion of other options is something else.

Is OpenStack important? Yes. Will OpenStack attract a broad community of users? Yes. Will OpenStack-based offerings and deployments gather enough market share to make current leaders lose sleep? That’s not such an obvious answer.

Read the entire column here.

Photo courtesy of Picasa user elinenberg.

Engine Yard provides a prime example of how the market might play out. The company already hosted its Ruby on Rails PaaS offering, AppCloud, on Amazon Web Services, but last week it partnered with Terremark to roll out its enterprise-grade xCloud offering. The benefits it gets from each provider are passed on to customers, along with prices to match. Of course, Engine Yard isn’t the first specialty cloud provider to rely on the big boys for infrastructure.

As I discuss in my weekly column at GigaOM Pro, this seems to be the direction the market is moving; large IaaS providers — such as Amazon and Terremark — could end up serving as arms dealers for cloud specialists like Engine Yard. As IT consumers begin demanding increased automation of PaaS, and as demand for SaaS applications spreads, providers of these services will need infrastructure to house them, and large providers have plenty to sell.

I’ve been adamant recently that AWS, in particular, needs to offer its own PaaS to compete with growing cloud competition from IT goliaths like Google, Microsoft and, to a lesser degree, Salesforce.com, but that doesn’t necessarily have to be the case. If Amazon can undermine those companies by arming their competitors — not to mention any and every other flavor of cloud service — with infrastructure, maybe that’s profit enough.

When all is said and done, Google, Microsoft and Salesforce.com might be battling it out for PaaS (and SaaS) dollars against a whole slew of smaller providers operating within the infrastructural confines of AWS, Rackspace, Terremark and Savvis. I’m not making a prediction, but this does seem like a possibility.

Read the GigaOM Pro post here. Also, plan to attend Structure 2010 or watch the live stream to hear a lot more about the cloud market from thought leaders at the vendor, provider and user levels.

That’s because App Engine for Business further advances the value proposition for PaaS. PaaS offerings have been the epitome of cloud computing in terms of automation and abstraction, but they left something to be desired in terms of choice. With solutions like App Engine for Business, however, the idea of choice in PaaS offerings isn’t so laughable. Python or Java. BigTable or SQL. It’s not AWS (not that any PaaS offering really can be), but it’s a big step in the right direction. App Engine for Business is very competitive in terms of pricing and support, too.

Google is often is cited as a cloud computing leader, but until now had yet to deliver a truly legitimate option for computing in the cloud. Mindshare and a legit product make Google dangerous to cloud providers of all stripes, including AWS.

The integration of the Spring Framework in App Engine for Business is important because it means that customers have the option of easily porting Java applications to a variety of alternative cloud environments. Yes, AWS supports Spring, but the point is that Google is now on board with what is fast becoming the de facto Java framework for both internal and external cloud environments.

Meanwhile, in the IaaS market, AWS is busy trying to distinguish itself on the services and capabilities levels now that bare VMs are becoming commodities. Thus, we get what we saw this week, with AWS cutting storage costs for customers who don’t require high durability (a move some suggest was in response to a leak about Google’s storage announcement), and increasing RDS availability with cross-Availability-Zone database architectures. It’s all about differentiation around capabilities, support and services, and every IaaS provider is engaged in this one-upmanship.

If PaaS is destined to become the preferred cloud computing model, and if the IaaS market is becoming a rat race of sorts, why not free cloud revenues from the IaaS shackles and the threat of PaaS invasion? Amazon CTO Werner Vogels will be among several cloud computing executives speaking at Structure 2010 June 23 & 24, so we should get a sense then what demands are driving future advances for AWS and other cloud providers. For more on Google vs. Amazon and PaaS vs. IaaS, read my entire post here.

The hype surrounding cloud computing is creating upward pressure for the industry to produce rainmakers.  And there are a lot of cloud startups forming — at Panorama, I see a venture funding pitch from at least 10 new startups every week, at least half of which are cloud startups working in the Infrastructure as a Service (IaaS) and Platform as a Service (PaaS) spaces.

In order for a cloud computing company to make it rain, there needs to be evidence that it has the potential to take a market by storm.  After talking to a number of large incumbents that could be acquirers of cloud startups, the key items that would drive them to an acquisition are:

1. Rapid customer growth — Solid evidence of non-linear customer growth. Not every cloud needs to grow like Facebook or Salesforce, but it needs to be growing — quickly.
2. Sustained revenue growth — Monetization of the customer growth.  Even Twitter has a monetization strategy now and acquirers are looking for clouds that are accretive to revenues.
3. Low churn — Keeping existing customers lowers the cost of acquiring news ones — and proves that people will continue to pay for the company’s cloud services.
4. Widespread use — Adoption in multiple geographies shows that the cloud is not a one-market player but can scale to a global level.

Consider Slicehost. It was acquired by Rackspace after just two years of operations, during which its user base grew to over 15,000 from nothing. Such rapid customer growth, combined with strong business metrics and hosting services that were complimentary to those of Rackspace made clear the value proposition of buying Slicehost. And Rackspace got a great deal — the combined purchase price of Slicehost and another acquisition announced at the same time, Jungle Disk, was around $11.5 million.

While the purchase price may have missed the venture capital returns mark, buying Slicehost appears to have reaped major benefits for the company: Rackspace currently has a $2.3 billion market capitalization and a 4X multiple on enterprise value to trailing 12 months revenues. Granted, cloud computing is only part of the Rackspace services offering that also includes dedicated hosting, but the market is clearly valuing the company’s cloud business at a higher multiple than a normal managed hosting provider. For example, Savvis, a competitor in the managed hosting space that recently enhanced its own cloud computing offering, has a market cap of $895 million and a 1.5X multiple on enterprise value to trailing 12 months revenues. The market appears somewhat kinder to Terremark, another managed hosting competitor that offers cloud services; it currently sports a 2.8X multiple.

Once a cloud startup has appealing business metrics, there are a number of potential acquirers that can help make it produce rain. There are the large cloud incumbents like Amazon, Google, Microsoft and of course, Rackspace. Likewise, there are large companies trying to move into the cloud marketplace from adjacent markets, such as Akamai, AT&T, Cisco, EMC, HP and IBM. There are also the managed hosting providers like Savvis and Terremark that will likely be looking to continue bolstering their cloud offerings.

With Rackspace setting the mark, the current market enterprise values and revenue multiples for cloud startups is compelling. If they can follow the path of Slicehost, then it appears that those of us in the venture capitalist community focused on the cloud will indeed be breaking out our umbrellas some two years after first funding such startups.  And, according to my calendar, the rainy season will start by late 2010.

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So what does this mean for the myriad companies small and large trying to provide infrastructure as a service or a platform as a service (software as a service is already pretty mature)? Well, that the opportunity is out there, but that it’s going to take a while to reach a critical mass of customers. The report is also cautious when it comes to enterprise willingness to adopt technology from startups, which means that competing services from established vendors may win out. But it’s flat-out pessimistic about services such as business process outsourcing in the cloud, which is offered by the likes of Appian, Cordys and Lombardi.

It also doesn’t foresee success for test and development platforms built on a multitenant infrastructure as a service, such what’s offered by Citrix, CollabNet, Interactive TKO and Skytap, partly because many of these vendors are startups and partly because an enterprise would have to still run its application on the same IaaS provider to ensure it works. IBM just opened its own test and dev cloud to a public beta yesterday, which will address the fears of using a startup, but not the issue of testing an app on one cloud and then having to move it to another. After all, there’s only so much one can abstract, even in the clouds.

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Case in point: a business plan sent to our firm from a startup claiming to be a purveyor of human-powered vehicles, with a cloud-based infrastructure. Sorry, but a bicycle shop with a web site is not a cloud startup. But while startups using the cloud term to get my attention are amusing, marketing departments of large technology and infrastructure companies that do the same are both annoying and ingenious. Annoying because for those of us who think we understand the technical definition of the cloud, the reality distortion field that these companies are trying to overlay in order to attract enterprise IT buyers is easy to see. That, however, is also why they’re ingenious. After all, the stretching of product definitions or technical features to match a hype-driven market is not unique to the cloud. And the large volume of marketing does help drive perception that the nascent cloud computing market is actually quite mature, which helps to give the cloud startups I would fund a head start with enterprise IT buyers.

So if not everything in IT is a cloud, what is?  When in doubt, I defer to the five essential characteristics recently laid out in the NIST Cloud Computing definition: on-demand self-service, broad network access, resource pooling, rapid elasticity and measured service. If I can see that the products or services I’m examining embody these characteristics — without forcing myself to squint too hard — then I consider them part of the cloud computing market in which I want to invest as a VC. If, on the other hand, they exhibit just a few of those characteristics (if any at all), then I’ll typically conclude that they represent an interesting but not crucial segment of the market — or that they’re simply using the cloud term in an effort to harness the hype surrounding it.

Personally, I’m interested in investing in Infrastructure as a Service (IaaS) and Platform as a Service (PaaS) startups. I think that such cloud computing service models bring new economic realities to enterprise IT; the companies helping to leverage this trend are compelling and have large market opportunities. Bicycle shops with web sites — not so much.

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AWS is not without its faults. Notably, a person using AWS services like EC2 must still perform all the manual “plumbing” such as applying patches, managing configurations, etc, that they would have to if their servers were in their captive data center.  For entrepreneurs and investors alike, this creates an exciting opportunity: The sheer size of EC2 means that thousands of EC2 customers need a new toolkit to help manage their infrastructures in the cloud. This is also great for Amazon. While Rackspace needs to dedicate development resources to build a management console for Mosso, vendors like Rightscale are doing this work for Amazon. As Amazon’s ecosystem matures, AWS only stands to benefit.

In many ways, this parallels what happened in the virtualization management space. As VMware’s hypervisor, ESX, penetrated the data center, IT administrators realized their existing data center management tools were ill suited for virtual environments. So startups emerged to fill the holes in VMware’s only management console, Virtual Center.

But once VMware realized that the hypervisor was getting commoditized, it rushed to build a deep management layer toolkit that it could then sell with juicy margins. Just by announcing its vCloud product roadmap at VMWorld 2008, VMware paralyzed swaths of startups in its vendor ecosystem that had been trying to solve the various management pain points companies were feeling with their VMware implementations.

Amazon Web Services is almost by definition a commodity service. Consequently, Amazon, like VMware, is probably eyeing the management layer as an opportunity to generate high-margin revenues. This is not to say that there isn’t an opportunity to build a significant company by supporting AWS; Amazon can’t fight all fires in all customer segments as well as a specialized startup can. But Amazon’s entrance into the management space is probably less a question of if than when. Startups looking to innovate in the space would be do well to look at which startups have thrived in the virtualization management ecosystem — and which ones haven’t.

Sarah Tavel is an associate with Bessemer Venture Partners in New York.

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