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Clouds bear down on computer hardware companies

Dell and IBM are two companies feeling the pinch by the growing corporate shift towards cloud computing. Mauritz Antin/EPA

When Amazon, known by most as an online department store, extended its web services business into Australia in 2012, few outside the IT sector noticed.

Data released last week by the Australian Securities and Investments Commission revealed Amazon Web Services grew from a A$1 million business in Australia in 2011 to a A$25 million business in 2012.

A rapidly growing aspect of Amazon’s global business is in providing technological resources underpinning many of the internet’s household names such as Pinterest, Spotify, Reddit, Foursquare and others. This now extends to major Australian brands including the Commonwealth Bank, MYOB, Suncorp and Fairfax.

Amazon Web Services is not only a growing part of Amazon’s future but is part of a more general trend that is disrupting and changing the way most businesses utilise both computers, and the technologies supporting their operations. This is bad news for companies such as IBM, HP and Dell that have made their money from selling physical boxes to customers.

The premise behind cloud computing is fairly simple. Instead of buying your own dedicated computers and housing them in a computer room, you utilise “virtual computers” and associated computing resources provided by the cloud provider. These virtual computers may be located in data centres around the world.

To the cloud computing user, the physical aspects of the service are largely unimportant. What is important are the numerous advantages that cloud computing offers over buying, owning and running your own data centre. There is no up-front cost in buying the hardware, setting it up, paying for a facility to house the computers or manage it on an ongoing basis. You simply pay for what you need and use adding to the configuration as your requirements change.

Companies like Amazon Web Services even provide the ability for users to specify that they want to use computing resources at times when it is cheaper.

The impact on companies such as IBM that have traditionally made money selling computer hardware is already being seen in their declining sales figures. In IBM’s last quarter, sales from its various hardware operations fell by 17% from the same quarter a year ago. This result was a continuation of the previous 5 quarters of declining revenue.

The story has been repeated at other hardware companies such as HP. Their enterprise sales have also steadily declined with server and storage revenue dropping in the last quarter around 10% from the previous year.

Like all companies that have a vested interest in preserving the status quo, companies like IBM had for some time turned a blind eye to the emergence of cloud computing and the meteoric rise of companies like Amazon and Microsoft in cloud services. IBM has now responded with a rapidly growing cloud platform business of its own, reportedly making US$1 billion in revenue for the third quarter of this year, but it is coming at the cost of not only operations but the loss of sales in hardware that these operations represent.

Cloud computing has largely been facilitated by virtualisation technology that allowed separate virtual computers to be run from a single physical computer. The advantages of this approach are that physical computers are rarely run at full capacity and running several virtual computers on a single physical box takes advantage of that fact. Also, computer data centres are constrained by space and the need for ever increasing amounts of power and cooling. For many data centres, it is the cost of the power to run them that becomes prohibitively expensive. Virtualisation partially addresses this issue, allowing for expansion without the increased demand for space and power.

Pioneers of virtualisation technology like VMWare have overseen the transformation of corporate data centres in moving from physical boxes running single computers to fully virtualised data centres. Even though VMWare has around 60% of the market for software virtualisation, their business has also been impacted by customers skipping the need for physical machines altogether and going straight to the cloud. Like the hardware vendors, VMWare is itself trying to offer a cloud service but like IBM, moving a customer to the cloud carries the penalty of lost revenue for its software.

With the number of companies offering cloud computing increasing daily, the future looks increasingly bleak for those companies that have relied on selling hardware and services associated with that. However, as with all things “cloudy”, the path of innovation never runs smoothly and there are some potential challenges for this industry too.

For non-US users of US cloud computing providers, issues of “data sovereignty” have long been an issue. Storing company data on computers that could potentially fall under US law or simply provide easy access to US security services is a significant risk. Even though companies such as Microsoft and Amazon have moved data centres outside of the US to try and tackle this issue, there is little faith that this would protect European or Australian companies from US lawmakers should they wish to gain access.

As with all disruptive technological innovations, the move from old to new is gradual and it is unlikely that we will see everyone suddenly abandoning their data centres and moving all of their software onto the cloud. A recent report showed the majority of the small to medium businesses surveyed were still working on virtualisation of their existing computing infrastructure. Given the investment in those changes, the subsequent move to the cloud will take longer. But in a world where most organisations will eventually utilise cloud computing in some capacity the future looks brighter for cloud services providers.

This is the third piece in our series on the disruptive forces hurting big business.

Read the other pieces:

Why there’s no Pepsi in cyberspace

The sharing economy spooking big business

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