CIA Chooses: Amazon or IBM? $600 million contract to set up a cloud-computing system shows the growing importance of intelligence-agency business for technology companies

Updated June 11, 2013, 9:47 p.m. ET

CIA Chooses: Amazon or IBM?

By SPENCER E. ANTE

The battle between International Business Machines Corp. IBM -0.51% andAmazon.com Inc. AMZN -2.24% over a $600 million contract to set up a cloud-computing system for the Central Intelligence Agency shows the growing importance of intelligence-agency business for technology companies.

The competition comes amid extraordinary disclosures of secret government-surveillance programs and shows that even in the rarified world of intelligence agencies, companies selling Internet-based cloud-computing services—like Amazon—are challenging the position of traditional technology vendors.

Companies like IBM have long supplied the U.S. military and intelligence services with computers, software and the know-how to operate them. Now, new contenders like Amazon are getting into the act, drawn by a fresh source of revenue as business spending on technology remains sluggish and by the imprimatur of providing services to clients that have the highest security standards.“The federal government opportunity is enormous,” said Adam Selipsky, a vice president at Amazon Web Services, the company’s cloud-computing unit. “We believe that will be a very significant business for Amazon Web Services going forward.”

The Defense Department, which manages many of the nation’s intelligence assets, including the National Security Agency, spent about $35 billion on information technology in the fiscal year that ended last September, down from the 2010 peak of roughly $38 billion, according to research firm IDC Government Insights.

The bulk of that technology spending went to large, older technology companies and contractors such as Raytheon Co., RTN -0.61% Hewlett-Packard Co., HPQ -1.02%Boeing Co. BA -0.48% and Computer Sciences Corp. CSC -2.06% Those companies primarily build and manage computer systems.

But the rise of cloud computing—where users share space on hundreds or thousands of Internet-connected servers—has created an opening for less traditional vendors.

The CIA surprised IBM earlier this year when it picked Amazon to build a cloud-computing service that would connect the broader intelligence community. The contract could be worth as much as an estimated $600 million over its initial four-year term. A win for Amazon could help unlock doors with other security-sensitive government agencies and commercial clients like Wall Street banks—big, profitable sectors that have long been IBM’s turf.

IBM protested the award, and the Government Accountability Office recommended last week that the CIA reopen negotiations. The agency has 60 days to say whether it will follow the GAO’s recommendation. “At this time the agency is reviewing details of the GAO decision,” a CIA spokesman said.

A spokesman for IBM said the company anticipates the reopening of the contract proposal process. A spokeswoman for Amazon Web Services said it looks forward to a fast resolution of the issues.

Cloud computing, which allows enterprises to cut costs by renting computing technology over the Internet instead of building and running their own data centers, has become a priority as the U.S. government looks to reduce spending and capitalize on new technologies that use clusters of basic computer servers in place of supercomputers to handle big data-crunching tasks. Some officials also believe cloud computing can enable better information sharing among turf-sensitive agencies.

Cloud computing, paired with special data-crunching tools, has enabled the National Security Agency to collect communications data and sift it for clues in an attempt to head off possible terrorism, people familiar with the matter have said. Recent disclosures about that and other highly secret intelligence programs have sparked a debate about the role of technology companies in spying related to national security.

Amazon is the leading provider of cloud-computing services. Launched in 2006, Amazon Web Services now serves hundreds of thousands of customers in more than 190 countries, said Mr. Selipsky.

The company doesn’t break out the division’s sales, but Morgan Stanley MS -3.90%recently estimated it generated $2 billion in 2012 sales, and could grow to $24 billion in 10 years.

The division supplies computing power on demand and other services to a range of startups like music-streaming service Spotify Ltd. and online scrapbook Pinterest. It also handles the computing needs of Netflix Inc., NFLX -2.93% which at peak hours can account for about a third of U.S. Internet traffic on fixed networks, according to a recent report by networking-gear provider Sandvine Corp.

In May, Amazon Web Services announced its U.S. businesses received security authorization from the U.S. Department of Health and Human Services to provide some cloud-computing services. The key stamp of approval could help bring more government business to the Amazon unit, which already works with 300 U.S. government agencies including the Treasury Department, Mr. Selipsky said.

IBM is a technology supplier to the intelligence agencies. It sometimes installs software for free, with the benefit being that it gets to test new technology and keep the intellectual property, a person familiar with the matter said. Over the last two years, the NSA and the CIA have been testing parts of Watson, IBM’s Jeopardy-playing artificial-intelligence system, the person said.

The New York Times reported the intelligence agencies’ testing of Watson earlier.

The symbiotic relationship between the military and the technology industry dates back to at least World War II. In the early 1950s, IBM built one of the first air-defense computers with the Massachusetts Institute of Technology.

Ted Schlein, a partner with venture-capital firm Kleiner Perkins Caufield & Byers, sits on the board of In-Q-Tel, a nonprofit venture-capital firm established by the CIA in 1999. He said the intelligence community and Defense Department are working ever more closely with technology companies.

“Now you are seeing a lot of those walls are breaking down,” he said. “They are working with private technologists to figure out solutions to some of their problems.”