Cloud Computing’s Catch-22

As businesses gain more experience with public cloud services, the long-term economic impact of cloud use is coming into focus. Estimates from venture capital company Andreessen Horowitz suggest that for companies operating at scale, the cost of using public cloud is conservatively two to three times as much as maintaining private infrastructure.

Cloud costs might outpace private infrastructure by more, depending on the business, according to Tim McCallum, Director, Business Value Programs and Strategy at Nutanix.

“I’ve had some customers tell me the cloud is six times more expensive,” McCallum said.

Many companies that embraced the digital transformation by diving headlong into public cloud services are experiencing a rude awakening, according to analyst Mike Feibus.

“The hangover from that overreach has been well documented,” Fibus wrote in an opinion piece for CIO.com.

One such document by Andreessen Horowitz General Partner, Martin Casado, and Partner Sarah Wang shows how cloud services expenses can severely impact a company’s market cap.

“Excess cost weighs heavily on market cap by driving lower profit margins,” the article authors wrote in their widely circulated and talked about 2021 article, “The Cost of Cloud, a Trillion-Dollar Paradox.”

They based their analysis on 50 public software as a service (SaaS) companies but noted that the calculations could be extended more broadly to include all public companies operating at scale.

“When you're spending so much more on the cost of revenue or cost of goods, it reduces your free cash flow,” added McCallum. “That makes you less profitable from a cash perspective and the company less valuable.”

Cloudy With Chance of Reduced ROI

But wait a minute. What’s happened to the cloud as a data center panacea?

Cloud computing makes nearly unlimited, cutting-edge IT resources immediately available, minus the time-consuming and costly process of evaluating and buying equipment, then testing, deploying and managing it on-site. The cloud allows businesses to pay for what they use, rather than having to amortize infrastructure capital costs over time.

Experts agree that these cloud benefits remain intact and welcome early in an enterprise’s or application’s lifecycle. The cloud can even make starting a business feasible when it otherwise wouldn’t be.

However, while the rent-not-buy approach makes procuring any big-ticket asset – whether it’s data infrastructure, a home, a vehicle or something else – faster, easier and more affordable at the front end, the consumer invariably pays a premium over time.

In fact, “Trillion-Dollar Paradox” co-author Casado told Nutanix CEO Rajiv Ramaswami in September 2021 .NEXT Conference interview that an eye-popping 50% of the cost of goods (COGS) in the companies he researched was attributable to cloud.

“That’s an enormous number that greatly, greatly suppresses the share price unless you’re able to drop it,” he said.

On a grand scale, the consequences can be intolerable. Andreessen Horowitz estimates that the top 50 public software companies currently utilizing cloud infrastructure are collectively losing $100 to $200 billion of market value due to the cloud’s impact on their margins relative to running infrastructure themselves. When the company extends its analysis to include the broader universe of public companies, those losses grow to more than $500 billion.

In and Out of the Cloud

The real-world cost implications of cloud usage have caused mass repatriation of applications from the cloud back to on-premises infrastructure over the past few years. In an IDC 2019 Cloud Pulse survey, for example, 85% of organizations said they were repatriating workloads from cloud environments, up 5% from the previous year, even as they expected to increase their cloud usage for other, newer workloads during the coming year.

The Andreessen Horowitz research indicates that “repatriation results in one-third to one-half the cost of running equivalent workloads in the cloud” and that “for every dollar of gross profit saved, market caps rise on average 24 to 25 times the net cost savings from cloud repatriation.”

Dropbox, for example, famously embarked on an infrastructure optimization initiative in 2016 and reported savings of nearly $75 million over two years by shifting the majority of its workloads from public cloud to custom-built infrastructure in collocation facilities that it operates itself. From there, the company reported a gross margin increase from 33% to 67% from 2015 to 2017.

The trick is getting off the public cloud platform when its economic benefit starts to wane. Achieving this without planning is difficult because enterprise software code is usually tightly integrated with a cloud platform's code to enable taking full advantage of that cloud’s unique capabilities, a situation that results in vendor lock-in.

“Because this [cloud economic] shift happens later in a company’s life, it is difficult to reverse as it’s a result of years of development focused on new features, and not infrastructure optimization,” the Andreessen Horowitz authors wrote. “Hence a rewrite or the significant restructuring needed to dramatically improve efficiency can take years, and is often considered a non-starter.

Continual Optimization

The lesson is that businesses need to be continually optimizing their workloads to run in just the right infrastructure and service tier at all times

“We’re entering an era of Cloud V.2, where we’re asking, ‘What is the right architecture? How can I use the cloud in the right ways?” Andreessen Horowitz’s Casado said during the .NEXT Conference interview.

McCallum said those questions must be asked and answered. 

“That necessitates building a decision framework of criteria that defines the conditions under which a given cloud service is used and conditions under which the workload(s) should be moved elsewhere.”

He said preparing for optimization in this way means “thinking about your exit strategy even on your way in” to using cloud services, which can seem counterintuitive.

Case in point: Microsoft Azure’s issuance of credits to corporate customers based on their Microsoft product spend levels.  

“A company may want to set itself up today to use AWS for certain functionality with the ability to use available Microsoft credits in mind,” said McCallum. 

“They’d need to plan for the ability to slide from AWS to Azure to use those credits, which could potentially equate to huge savings. But later, when they’ve used up their Azure credits, they may want to move somewhere else” and have to be positioned for it.

For these reasons, mobility across the data plane is important, but it means companies need a decision matrix for what they run in the various clouds and how often they’ll move, “so movements don’t become the cost,” said McCallum. “We don’t want to pay an army to move apps then pay the same army to move them back.”

These issues boil down to an organization’s culture and how it makes decisions, he said. Companies can choose to use cloud management tools to enforce the policies and decision criteria they create – such as Nutanix Beam for cost optimization and Nutanix Calm for application optimization.

“But those tools can’t create the criteria for them,” McCallum said. “Businesses have to do that work themselves.”

Technical Assistance

Newer development and management tools can also have a big impact on preparing businesses for cloud changes by providing an abstraction layer between apps and the underlying cloud platform, said Sahil M Bansal, Senior Product Marketing Manager at Nutanix.

“If you don’t have an abstraction layer, it becomes really challenging to exit one cloud for another,” he said.

That problem is the primary one that the Nutanix Cloud Platform, which runs the Acropolis Operating System (AOS), attempts to solve, he said. AOS once ran in data centers only, but now provides a common platform that spans private data centers, private clouds and AWS and Azure (in preview) public clouds, allowing seamless workload movement among the dissimilar environments.

In addition, through a recent development agreement with Red Hat, businesses can also build containerized applications on the AOS platform so they  “no longer have to worry if an app has to move to another environment,” Bansal said. “Apps can move to any supported platform.”

Moving Forward

Andreessen Horowitz’s Casado said the industry is “in the early days of cloud and just starting to understand its economic implications.  

“Cloud isn’t a location or a company,” he said. “It’s an operating model.” One that can be deployed on-premises in a private data center, in a collocation facility, or as a service over the public Internet.

“What’s important is having optionality in how you consume it. The right way to do that upfront is [to deploy] multicloud,” which lets enterprises continually match workloads to the infrastructure best optimized to run them.

Editor’s Note: A real-world analysis of some of Nutanix customers’ cloud usage trends revealed that just three simple actions could help them reduce their cloud spend by 15% or more. These include eliminating old and unused VMs or VM snapshots, rightsizing underused VMs and rightsizing underused databases. Learn more in the Nutanix Cloud Usage Report.

Follow industry insights from Andreessen Horowitz Partners Sarah Wang and Martin Casado on Twitter at @sarahdingwang and @martin_casado.

Joanie Wexler is a contributing writer and editor with more than 25 years of experience covering the business implications of IT and computer networking technologies.

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