Weekly Update

Does Diversification Equal Domination in the Cloud Stack?

In cloud computing, “the stack” typically refers to a simplified three-tier view that divides the cloud’s components into infrastructure, platform or software/applications. While conventional wisdom suggests that vendors constantly try to move up this stack, from the lower margins of infrastructure toward the higher margins and customer loyalty of services/applications/software, companies such as AmazonSalesforce and VMware are increasingly trying to dominate several points at once.

Amazon Web Services began at the bottom of the cloud stack by offering basic storage and basic virtual machines, with price a key part of the proposition. Third parties like RightScale emerged, layering value and functionality on top of Amazon’s bare bones, and as Amazon added features and began to move up the stack, dependents such as RightScale were forced to diversify in order to remain relevant.

Toward the top of the stack, Salesforce began by offering a hosted CRM application. The company has subsequently diversified down the stack, releasing and continuing to enhance the Force.com platform upon which a growing range of third-party developers build and sell their own applications. In parallel, the Salesforce CRM application has continued to gain functionality, often adding features that challenge vendors selling products on top of Force.com.

Similarly to Amazon, VMware started with infrastructure, developing a virtualization solution for desktops and servers. The company has diversified greatly since then, with this week’s addition of Horizon App Manager leading cloud computing analyst Ben Kepes to remark that “[VMware does] the entire stack now.”

These companies, among others, are diversifying their products for a wide variety of reasons. The Leading Edge Forum’s Simon Wardley describes the approach adopted by both Salesforce and more recently VMware as a classic example of a “tower and moat” defense, in which the “principle here is to defend a revenue stream (the tower) by creating a moat devoid of differential value with high barriers to entry around it.” In other words, Salesforce prevents the competition from developing viable challengers to its revenue-generating CRM products by filling the space around them with open-source or low-revenue products. There is no easy way for potential competitors to get close, especially when those competitors are companies like Oracle and Microsoft, which are more accustomed to the very different revenue models associated with on-premise installed software.

Amazon, Salesforce and VMware also work hard to build a network of complementary products and solutions in which the whole is far more compelling than each of its parts. Amazon, for example, began by selling access to commodity storage with S3. This area of the market is one in which anyone can compete, as one source of online storage is typically much the same as any other. Amazon keeps its storage offer compelling by means of reasonably low pricing and by surrounding it with a range of other web services such as EC2. Individually, none are really much better than those offered by Amazon’s competitors. But together they offer a proposition that is hard to beat without replicating everything Amazon already offers and in the process incurring huge costs.

As the companies that underpin the cloud continue to grow, the range of products they offer will continue to expand. Some of those products provide new revenue-creating opportunities, while others are simply there to squeeze the competition. However, as the ecosystem (value-adding partners of Amazon such as RightScale, revenue-generating customers of Force.com, etc.) itself grows in scope and value, a long-visible tension will become increasingly serious for all concerned. Every feature added to Amazon Web Services as it competes with Rackspace and other cloud infrastructure companies is potentially a feature that encroaches on the service offered by partners like RightScale. Can Amazon grow its own capabilities at the same time as it nurtures an ecosystem of partners? Can any of these companies pursue their original product strategies while still remaning platforms upon which others can build and rely? Whether they must become one or the other remains to be seen.

Question of the week

Can sustainable companies be built to occupy a single point in the cloud stack, or is diversification inevitable?