Original title: Amazon.Com IncHow does the cloud business generate billions of profits?

Source: Zhitong Finance and Economics Network

Since at least 2014, more than half of Amazon.Com Inc's operating profit has come from the cloud services department, Amazon.Com Inc Web Services (Amazon Web Services), which mainly provides online services and tools that software developers can integrate to run websites and applications.

In absolute dollar terms, AWS's operating income in 2020 was $13 billion, which gave Amazon.Com Inc a net profit of $21 billion in 2020. It is not hard to understand why Amazon.Com Inc chose Andy Jassy, who has been at the helm of AWS for 15 years, as chief executive after the resignation of Jeff Jeff Bezos. In the second quarter of this year, the last quarter when Jassy became CEO of AWS, AWS's revenue was $4 billion, up about 25% from a year earlier, exceeding analysts' expectations.

Zhitong Finance has learned that AWS is like a buffet, offering hundreds of services to developers and end users, and new services are launched every year. From a financial point of view, this is a bit like a black box: Amazon.Com Inc does not provide information about AWS's revenue sources, nor does he publish the most profitable parts of the sector. But AWS started out as an outsourced supplier of the most basic computing functions-computing power and data storage-which may still be the source of most of its funding.

Corey Quinn, chief cloud economist at privately held company Duckbill Group, has helped companies reduce the cost of AWS. He estimates that more than 50 per cent of AWS's revenue comes from EC2 computing services. The service essentially allows customers to rent the virtual portion of the physical computer server in Amazon.Com Inc's data center. Quinn points out that, coupled with data storage services for resilient block storage and simple storage services, cloud relational databases for storing and providing data, and data transfer fees, this generates more than 70 per cent of revenue.

Nowadays, however, Amazon.Com Inc is putting more and more emphasis on more complex and higher-level functions, which also provides higher profits, which may make it harder for customers to switch to other suppliers. In May, for example, Adam Selipsky, the current head of AWS, launched a new service called App Runner on Twitter, which deploys applications in virtual containers, saying it can help customers "focus on building their own business."

Bernstein analysts estimated in June that 14 per cent of AWS revenue in 2015 came from platform as a service (PaaS) products with higher profit margins, while the rest came from infrastructure as a service (IaaS) products with lower profit margins. In the first half of 2020, analysts estimated that the proportion of PaaS had risen to 18%.

Revenue and profits may not average from AWS's millions of customers. Joe Kinsella, founder and former technical director of CloudHealth, says that if 20 per cent of AWS customers provide 80 per cent of revenue, the biggest profits of the remaining 80 per cent come from small and medium-sized customers.

Core computing: EC2

Bhavan Suri, co-head of technology research at William Blair, said EC2 is one of AWS's oldest services and remains the main driver of gross margins and operating profits. Suri said the gross margin for EC2 services could be around 50 per cent. Although AWS's operating margin was about 31% in the first quarter, Amazon.Com Inc did not disclose the profit margin of a separate AWS service. Gross margin does not reflect R & D and marketing costs.

Cloud infrastructure provider DigitalOcean has a gross profit margin of 58% in the second quarter, and most of its revenue comes from virtual machines that are similar to the concept of EC2 instances. A spokesman for DigitalOcean said about 90 per cent of the company's revenue came from computing, storage and network services.

Customers can reduce their bills by keeping EC2 instances for future use. According to the AWS website, keeping instances is 75% cheaper than on-demand instances. Another option is to use EC2 spot instances, which are free computing resources available to Amazon.Com Inc and can be quickly recycled when needed. AWS claims that the cost of Spot instances is 90% lower than that of on-demand instances.

Companies can make their applications run as if they are on AWS, or they can reduce the cost of operating them by switching between the underlying components. When AWS launched EC2 in 2006, there was only one instance, but now there are more than 300 instance types. Brooke McKim, co-founder and technical director of startup Vantage, says it's not easy to keep abreast of the release of new examples.

AWS customers can use EC2 instances, which use AMD、 Intel CorpAnd NVIDIA Corp's chips can also use artificial intelligence processors designed internally by Amazon.Com Inc and low-power chips based on Arm. David Brown, vice president of EC2, said AWS itself was using Arm chips "in all meaningful places" to provide services to customers. This reduces Amazon.Com Inc's own costs. And Microsoft Corp, Amazon.Com Inc's closest competitor in the field of cloud computing.(MSFT.US) doesn't talk about doing similar things.

Data storage: S3, EBS

Another early AWS service was the simple Storage Service (S3), which was launched in 2006. The objects that customers use S3 to store include photos, videos, and other types of files. S3 has reached a huge scale and now stores more than 100 trillion objects.

The company may end up storing more data in S3 than it needs. For example, one of CloudHealth's customers stumbled upon that it stored log files in S3 indefinitely; when it solved the problem, it ended up saving $1.2 million a year. Last year, AWS launched its own tool called S3 Storage Lens, which can help companies find unnecessary expenses. Mai-Lan Tomsen Bukovec, vice president of object and block storage, said the service was adopted quickly.

Other cloud service providers sometimes offer discounts to attract business, but customers are often much smarter than that, she says. For example, she talked about the ability to run computing jobs when a customer submits a request to retrieve an object without having to deal with the underlying infrastructure.

One of the cloud storage vendors that competes with AWS is Wasabi. David Friend, CEO of Wasabi, said that Wasabi does not provide a large number of services such as AWS, but only focuses on data storage, charging only 1/5 of Amazon.Com Inc S3. But he doesn't think Amazon.Com Inc's operating costs will be much higher-in other words, he thinks S3 is Amazon.Com Inc's cash cow. "I would be surprised if AWS's S3 gross margin is less than 70 per cent," Friend said.

Moving data to Amazon S3 is free. But the monthly cost of transferring 1 terabyte of data from S3 may be three times that of storing that terabyte in S3. Friend said these fees could make the cost of AWS difficult to predict. This is also a strong incentive for companies to stay in AWS rather than transfer data to competitors.

Many AWS customers also rely on elastic block storage (Elastic Block Store), which can be attached to and save data for EC2 compute instances. Even after the customer deletes the EC2 instance, the storage volumes in the service are still available. AWS offers EBS services on hard drives for as little as 4.50 cents per gigabyte per month. Suri said EBS's gross margin could be between 60 and 70 per cent.

Database software

AWS's product lineup includes several databases to choose from. The most traditional approach is to use a relational database, which organizes data into tables with columns and rows. Programs can store information in a database and get information from them.

AWS's relational database service offers several options: proprietary but popular database systems by other companies, such as Microsoft Corp's SQL Server and Oracle CorpFlagship database software; open source versions such as MariaDB, MySQL and PostgreSQL;, as well as MariaDB and PostgreSQL compatible Aurora developed by Amazon.Com Inc himself. According to Suri, using Aurora through relational database services could generate a gross margin of about 60 or 70 per cent.

By BabaMariaDB, a startup backed by companies such as BABA.US and INTC.US, offers a cloud version of its open source MariaDB database commercial version. Michael Howard, the company's chief executive, said in an interview that under the MariaDB model, the price of the company's cloud service is half that of AWS relational database services.

Mobile data

AWS does not have dedicated data transfer services between or outside the infrastructure. Instead, it charges a variety of fees for different types and methods of data transmission, which can be added up. These network costs may be a major source of unpredictability.

For example, NASA signed a five-year, $65 million contract with AWS in 2018, but the inspector general reported that the agency had not yet predicted the cost of online exports, which occur when people try to download files stored in S3. The inspector general warned that scientific information could become less readily available if the NASA limits the output of data in order to control costs.

In 2018, Cloudflare announced the formation of the bandwidth Alliance (Bandwidth Alliance), a consortium of cloud and host providers willing to reduce or eliminate data transmission costs. Matthew Prince, chief executive of Cloudflare, said Amazon.Com Inc had not yet chosen to participate.

Prince said bandwidth costs have fallen every year since the announcement in 2018, but AWS's data transmission fees in the US and Europe have remained the same, which could be 80 times the potential cost. He estimates that the service has a gross profit margin of at least 99%.

Cloud computing market

More and more companies that have a lot of cooperation with AWS are developing software on basic elements such as EC2 and S3, and buying software from other companies through AWS's Marketplace; this is good for AWS. UBSGroup analysts estimated in May that Amazon.Com Inc charged an average listing fee of about 5 per cent. In July, Microsoft Corp cut its market fees from 20 per cent to 3 per cent.

Mobile app stores charge higher fees. The media quoted an unedited court document in August as saying that Alphabet Inc-CL CPlay Store's operating margin exceeded 62% in 2019.

AWS Marketplace's operating margin "may be much higher than the overall level of about 30 per cent of AWS", the analysts wrote, and they rated Amazon.Com Inc's shares as "buy". However, Marketplace is still small compared to EC2 and S3. Analysts say Marketplace is expected to generate revenues of between $1 billion and $2 billion, which could account for 3 per cent of AWS's total revenue in 2020.