The power of on-demand, and the reason cloud providers dont like it

The power of on-demand, and the reason cloud providers dont like it
My role at 451 Research is to help customers understand the economics behind digital and cloud technology, so they can make informed choices when costing and pricing their own products and services, and those from their vendors, suppliers and competitors. I've previously held product management positions at Cable&Wireless and Claranet, and have developed a number of hosting and cloud services. In 2013, I completed my thesis on the economics of cloud computing at the University of Bristol. I'm a Chartered Engineer and a Member of the British Computer Society.

IT vendors had a golden age before the invention of the cloud. It was essentially a risk-free implementation. Customers required a product, sales would propose a solution to which the customer would sign and commit, the customer would pay upfront, the vendor would start manufacturing, and eventually the solution would be delivered to the customer. Once delivered, it was unlikely the customer would suddenly drop the technology, and move on to something else.

At every step of this journey the vendor took steps to prevent its risk. The contract was negotiated per customer, thereby ensuring the deal was profitable. The customer paid upfront so the vendor didn’t need to borrow money or risk the customer defaulting on a debt. The contract commitment was made beforehand, so the customer took the risk that the solution might not be used. And finally, the customer was told when delivery would be made, so the vendor could optimize its stock levels. Even after it was delivered, the customer was essentially locked-in to the technology for the foreseeable future.

Cloud computing changed this. Being able to buy computing resources on-demand, with no advanced notice, no commitment, no upfront payment and immediate delivery, means the financial risk on the customers part is negligible. If you don’t consume a resource, you don’t pay for it; if you do, pay only for what you used at the end of the month. This is the power of on-demand – being able to grow the business without taking excessive risks.

Unfortunately for the cloud provider, this financial risk was placed squarely back in their hands. The provider must borrow funds to invest in infrastructure that might not be used sufficiently to make a return. The provider must build the technology in advance of when its customers need it – consumers can’t wait for a resource, it must be delivered immediately. And the provider must take the risk that consumers won’t pay its bills at the end of the month. Furthermore, just because a customer is using a technology today is no guarantee they’ll be using it tomorrow – with no commitment, cloud consumers have a lot more flexibility to move if they aren’t satisifed.

With this in mind, it’s easy to see why none of the larger IT companies disrupted the market with cloud computing and it was left to Amazon.com, a company more commonly associated with books and films. IT companies had lots to lose by introducing pay-as-you-go; AWS on the other hand had a lot to gain.

However, the tide is turning, and many cloud providers now offer alternative pricing schemes alongside on-demand, allowing consumers to take on more risk, thereby getting a discount. In fact, the Cloud Pricing Codex found 50% of cloud providers now offer on-demand alternatives, as shown in the cloud pricing taxonomy shown above. So don’t thank cloud providers too much for giving you that discount for a commitment – trust me, they wouldn’t if it didn’t ultimately benefit them too.

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