Amazon’s Push to the Cloud Adds to Server-Market Woes

August 28, 2013, 6:42 p.m. ET

Amazon’s Push to the Cloud Adds to Server-Market Woes



To understand the challenges facing makers of server systems, look to health-care staffing firm Schumacher Group. The Lafayette, La., company, has been shifting a growing proportion of its computing chores to computers operated by Inc. AMZN +0.23% In the past year, Schumacher purchased just one server from Hewlett-Packard Co., HPQ +2.82%says Douglas Menefee, Schumacher’s chief information officer. Five years ago, the company may have bought 50 such servers for as much as $12,000 apiece. “We don’t really buy hardware anymore,” says Mr. Menefee.

Many other companies are turning to operations like Amazon Web Services orRackspace Hosting Inc. RAX -0.79% instead of buying and maintaining their own systems. The trend adds to a growing list of pressures for makers of servers, a crucial class of computers whose growth and profitability is being squeezed.

H-P, for example, last week said revenue generated by the most popular server variety declined 11% in its most recent quarter. International Business Machines Corp. in July also reported an 11% quarterly revenue decline for “standard” or x86 servers, which take their name from the chips supplied byIntel Corp. INTC +0.42% and Advanced Micro Devices Inc. AMD +0.88%

Yet some others are finding ways to grow, if largely by grabbing market share from others. Cisco Systems Inc., CSCO -0.17% for example, this month reported a 43% quarterly jump in its server business. Dell Inc. DELL +0.04% in August also reported 10% revenue growth for the unit that includes servers and networking devices.

The conflicting signs point to a fundamental question facing hardware makers: Will the ballyhooed shift to what the industry calls cloud computing actually reduce server sales, or possibly just change who buys them?

“There will absolutely be fewer buyers of physical machines,” predicts Bryan Cantrill, a senior vice president at Joyent Inc., another company that hosts computing operations. “But we don’t know if there will be fewer physical machines sold.”

The crosscurrents can be seen in new data from market researchers. Gartner, for example, on Wednesday said second-quarter server revenue declined 3.8% from the year-earlier period. Rival IDC put the drop at 6.2%, with x86 system revenue off 2.4%, and expects total server revenue to decline 4.5% to $52.5 billion this year.

But IDC expects slight growth in 2013 in x86 systems—which make up three-fourths of the market—with a stronger rebound in 2014 and 2015 for those systems and the whole market.

Servers are used for myriad tasks, including running corporate databases, sending email and managing websites. Matt Eastwood, an IDC analyst, attributes slowing sales growth mainly to regular purchasing cycles, caution about economic conditions and trend among corporate buyers to consolidate workloads onto fewer machines.

But it is hard to deny the growing popularity of cloud-based options, which include online software offerings like those offered by Inc. CRM +0.75% and those like Amazon’s that can run a company’s internally developed software. The latter category, called “infrastructure as a service,” can allow startups or corporate departments to quickly begin operations by charging computing time to credit cards.

Market researcher TechNavio puts the global infrastructure as a service market at $5.2 billion in 2012, and predicts the industry to quadruple by 2016 to $22.8 billion.

Amazon Web Services, widely known as AWS, doesn’t disclose financial details. But analysts put its annual revenue at $1.5 billion to $2.5 billion, and predict sales may grow as much as 12-fold in the next 10 years. More organizations are moving “to take advantage of both the economic benefits and business agility that cloud computing offers” said Adam Selipsky, marketing chief of AWS.

But the shift to cloud computing doesn’t necessarily point to a net decline in server purchases, many industry executives argue.

They base that view partly on what happened when a technology called virtualization became popular earlier in the decade. Such software allows each server to do more by running multiple copies of operating systems and applications on each physical machine. It also helps cloud-service p roviders run computing jobs from multiple customers on each machine.

But virtualization didn’t prove to hurt server demand, defying some predictions. In fact, many companies needed to buy higher-performance servers to use the technology.

Moreover, many companies have reasons to keep running their own servers for at least part of their operations—particularly firms in regulated industries like financial services.

“Some would argue that everything goes to the public cloud,” says Patrick Gelsinger, chief executive of virtualization software maker VMware Inc., VMW +0.52% which recently started its own cloud service. “We adamantly disagree with that.”

Other cloud-based businesses, meanwhile, are becoming a big force in server demand. Companies like Facebook Inc. FB +2.29% and Google Inc. GOOG -0.19%have been snapping up servers at a rapid rate.

IDC expects those “hyperscale” customers to buy 1.5 million systems in 2013, up 9% from the prior year. The infrastructure services are doing their part; Rackspace this month said it was operating nearly 99,000 servers in the quarter ended June 30, up 16% from the year-earlier period.

But the high-volume customers are a demanding bunch, particularly on price. Companies like Google assemble their own servers, or frequently turn to companies in Taiwan such as Quanta Computer Inc. 2382.TW 0.00% that offer steep discounts compared with big-name suppliers.

Dell has battled them aggressively, claiming to place servers in top search engines and social media sites, particularly in China. But price cutting-has hurt profit margins; operating income for Dell’s enterprise solutions group declined 9% in the most recent period despite its revenue growth.

H-P admits failing to make much headway among hyperscale customers, despite starting a high-profile effort called Project Moonshot to improve its position in that segment. The company’s share of total server revenue fell to 25.9% in the second quarter from 29.1% in the year-earlier period, IDC says.

“Weak execution has amplified the market challenges that we know exist,” said Meg Whitman, H-P’s chief executive, during a conference call last week.

Despite the tough conditions, most server makers and their suppliers think demand for new consumer and business applications will inevitably expand the server business, even if more companies leave the buying to AWS and its cloud rivals.

“There is more and more work to be done, more and more transactions to be processed,” says Dennis Quan, IBM’s vice president of cloud services.

Intel, for example, estimates that roughly one server is needed to provide services for every 122 tablet-style computers purchased, and for every 600 cellphones.

“In terms of server purchases, I do think the cloud in the short term has a negative impact,” says John Chambers, Cisco’s chief executive. “But in the long term the impact is positive.”

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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