International Think-Tank on Innovation and Competition
The Next Revolution of the New Economy: Cloud Computing
November 25, 2008
The development of cloud computing will shape the structure of the New Economy and probably not only that. This term refers to an Internet-based technology through which information is stored in servers and provided as a service (Software as a Service, or SaaS) and on-demand to clients (from the "clouds" indeed). Its impact will be spectacular on both consumers and firms. On one side, consumers will be able to access all of their documents and data from any device (the personal laptop, the mobile phone, an Internet Point..), as they already do for email services. On the other side, firms will be able to rent computing power (both hardware and software) and storage from a service provider and to pay on demand, as they already do for other inputs as energy and electricity.
In preparation to this new scenario, many hardware and software companies are investing to create new platforms able to attract customers. A “cloud platform” provides services for creating applications in competition or in alternative to “on-premises platforms”, that are the traditional ones based on an operating system as a foundation, a group of infrastructure services and a set of packaged and custom applications. The crucial difference is that, while on-premises platforms are designed to support consumer-scale or enterprise-scale applications, cloud platforms can potentially support multiple users at Internet scale.
Cloud computing could be seen as a step in the commoditization of IT investments (Carr, 2003), as the outcome of an evolution toward a utility business model in which computing capabilities are provided as a service (Rappa, 2004), as the core element of the move toward the so-called Web 2.0, in which Internet is used as a software platform (O’Reilly, 2005), or simply as an application of the generativity power of the Internet (Zittrain, 2007).
Many companies are building huge data centres loaded with hundreds of thousands servers to be made available for customer needs. Locations are chosen strategically to minimize energy and cooling costs (cold regions are favourite). But also international legal issues associated with the global movement of informations may be crucial in the future.
The first mover in the field has been Amazon, that provides access to half a million developers by way of Amazon Web Services. Any small company can start a web-based service on its computer system, add extra virtual machines when needed and shut them down when there is no demand: for this reason the utility is called Elastic Cloud Computing. Animoto, a service that lets users turn photos into music videos, provides an interesting example. When it was launched on Facebook, it was forced by exponentially increasing demand to bring the number of machines on Amazon Web Services from 50 to 3500 within three days, something that would have never been possible without relying on a cloud platform.
Google is also investing huge funds in data centres - one of its futuristic plans includes centres located on ships to exploit the energy derived from the motion of the water! Already now, Google Apps provides word processing and spreadsheet applications online that can be accessed from any web browser, while the software and data are stored on the servers. The same Google search engine or its mapping service can offer cloud application services. For instance, when Google Maps was launched, programmers easily found out how to use its maps with other informations to provide new services, for instance the location of houses from the rental and sales listings of Craiglist.
Social networks have moved in the same direction turning into social platforms for consumer based applications, with Facebook in the front road. Oracle has introduced a cloud based version of its database program. Also Yahoo! is developing server farms. Hardware producers as Dell, HP and IBM are investing as well. Microsoft has started later but with huge investments in the creation of new data centres. In the fall of 2008, has introduced a cloud platform called Windows Azure, currently available only in a Community Technology Preview version. The Azure platform is able to provide a number of new technologies: a Windows-based environment in the cloud to store data in Microsoft data centres and to run applications; an infrastructure for both on-premises and cloud applications through .NET Services; a cloud based database through SQL Data Services (which can be used from different users and different locations); and an application tool to access Live Services which allows to synchronize and constantly update data across systems joined into a “mesh” (for instance all the personal devices as the PC, the office’s computer, the mobile phone and so on). Windows Azure provides a browser-accessible portal for customers with a Windows Live ID: these can create a hosting account to run applications or a storage account to store data in the cloud, and they can be charged through subscriptions, per-use fees or other methods. While many applications and services can perform well either on-premises or in the cloud, Microsoft envisions a wider range of combinations, enabling developers and customers to manage applications and data in the cloud, or on-premises, or via some combination of the two that provides the best outcome in terms of functionality and other concerns such as security or privacy (this approach is defined as Software plus Services).
The battle for the clouds is going to reshape the IT market structure as PC distribution did in the 80s. But according to the Economist (2008, Where the cloud meets the ground, Report, October 25th , 387) “cloud computing is unlikely to bring about quite such a dramatic shift. In essence, what it does is take the idea of distributed computing a step farther. Still, it will add a couple of layers to the IT stack. One is made up of the cloud providers, such as Amazon and Google. The other is software that helps firms to turn their IT infrastructure into their own cloud, known as a ‘virtual operating system for data centres’ … Will this prospective platform war produce a dominant company in the mould of IBM or Microsoft that is able to extract more than its fair share of the profits? Probably not, because it will be relatively easy to switch between vendors... Nor is it likely that one firm will manage to build a global cloud monopoly. Although there are important economies of scale in building a network of data centres, the computing needs of companies and consumers vary too widely for one size to fit all.” Most important, the need of creating network effects in the development of a cloud platform will keep low the margins for a while and will maximize the speed of diffusion of cloud computing between firms at the global level. For this reason it is crucial to understand the economic impact of the introduction of this general purpose technology. What is sure, is that the diffusion of cloud computing will create a solid and pervasive impact on the global economy. Some of the potential benefits of cloud computing include:
- Generalized reduction of the fixed costs of entry and production, in terms of shifting fixed capital expenditure in IT, which represents half of total in modern industries (Carr, 2003), to operative costs depending on the size of demand. This contributes to reduce barriers to entry especially for small businesses (as infrastructure is owned by the provider and does not need to be purchased for one-time or infrequent intensive computing tasks) and generate quick scalability and growth. The consequences on the endogenous structure of the markets with largest cost savings will be wide, with entry of new small and medium firms, a reduction of the mark ups and an increase in market sizes.
- Creation of multidimensional network effects due to the new possibilities of product creation in the cloud, that is between companies exploiting in different ways the potentialities of cloud computing through the same platform or different ones. This is related to another new possibility, the rapid adoption of changes: it is not uncommon, that applications in the cloud are modified on a daily base (to accommodate new requirements, or enable new economic venues), which is impossible with on-premise solutions.
- The possibility of sharing of resources (and costs) among a large pool of users, allowing for centralization of infrastructures in areas with lower costs, peak-load capacity increases and utilization and efficiency improvements for systems that are often only 10-20% utilised. These features will lead to additional savings in energy and to greater environmental sustainability.
A recent study of the International Data Corporation (see IT Cloud Services Forecast – 2008-2012: A Key Driver for Growth, October 8, 2008) examines the role of IT cloud services across five major IT product segments representing almost two-thirds of total enterprise IT spending (excluding PCs): business applications (SaaS), infrastructure software, application development & deployment software, servers and storage. Of the $ 383 billion firms spend in 2008 for these IT services only $ 16.2 billion (4%) can be classified as cloud services. In 2012 the total figure is expected at $ 494 billion and the cloud part at $ 42 billion, which will correspond to 9% of customer spending, but also to a large part of the growth in IT spending. The majority of cloud spending is and will remain allocated to business applications, with a relative increase of investment in data storage.
Even if the relative size of IT cloud services may remain limited in the next few years, it is destined to increase and to have a relevant macroeconomic impact, especially in terms of creation of new small and medium size enterprises and of employment. In times of global crisis, this could be an important contribution to promote the recovery and to foster growth. Cloud platforms and new data centres are creating a new level of infrastructure that global developers can exploit, especially small and medium size firms that are so common in Europe. This will open new investment and business opportunities currently blocked by the need of massive up-front investments. The new platforms will enable different business models, including pay-as-you-go subscriptions for computing, storage, and/or IT management functions, which will allow small firms to scale up or down to meet the needs of their demand. As the Economist (2008) claims, “The internet disrupted the music business; Google disrupted the media; cloud-based companies could become disrupters in other inefficient industries.” The macroeconomic impact of the diffusion of this new general purpose technology may be quite large, as it happened for the introduction of the Internet in the 90s.
References
Carr, Nicholas, 2003, IT Doesn’t Matter, Harvard Business Review, May, 41-49
O’Reilly, 2005, What is Web 2.0. Design Patterns and Business Models for the Next Generation of Software, mimeo
Rappa, Michael, 2004, The Utility Business Model and the Future of Computing Services, IBM Systems Journal, 43,1, 32-42
Zittrain, Jonathan, 2007, Saving the Internet, Harvard Business Review, June, 49-59
