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Akamai strategic analysis

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An analysis of Akamai's strategy, competitive positioning, growth analysis, and future projections.

An analysis of Akamai's strategy, competitive positioning, growth analysis, and future projections.

Published in: Technology, Business

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  • 1. Akamai Case Study October 13, 2012 Aman Mehra, Amit Bhatia, Ana-Lisa Jones, Andres Klose, Nabeeha Qazi, Xu Gong
  • 2. Akamai Case Study Akamai is currently a Content Delivery Network industry leader. However, over the past five years the industry has begun to shift, resulting in more competitors entering the market and additional demand for new services. We recommend that company leadership adjust their strategy to reflect these changes and incorporate the following strategies into their business:  Continue to operate as a decentralized, distributed network  Refrain from entering a price war over video content delivery  Target E-Commerce as the next area for business growth  Expand developments in cloud computing  Capitalize on the advertising arm of the business through the relationship with Acerno
  • 3. Strategy and Customer Value Proposition Since its founding in 1999, Akamai has defined itself as an “architecture of network servers,” thereby differentiating itself from other Content Delivery Networks (CDN‟s). Such architecture means that they have a decentralized setup in their servers which allows them be as close as possible to its users. This decentralization was made possible by negotiating early with Internet Service Providers (ISP‟s) for locating servers in strategic places, which allowed Akamai to deliver a more efficient route from the user to the server. This resulted in a faster response time and lower error rates for the end user. The decentralized set-up, referred to as “The Edge,” has also allowed Akamai to market itself as unique among CDNs, and advertising efforts have been focused on explaining to the user how it is different from “traditional, centralized” networks by being closer to the user. Although they were not early movers in the CDN market, Akamai was the first to establish a decentralized setup for their servers, allowing them to price at a rate of twice that of their competitors. In more recent years competition has forced Akamai to lower its prices in an attempt to increase traffic. The following table summarizes the Gross Margin of Akamai from 2007 to 2011. Year 2007 2008 2009 2010 2011 Margin 73.7% 71.9% 70.9% 70.4% 67.7% Akamai has faced threats to its Intellectual Property from other competitors. They entered a litigation process with Limelight in 2007, which resulted in a ruling in favor of Akamai and granted them an award of $45 million in lost profits and reasonable royalties. To date
  • 4. Limelight is expected to appeal, and there is a possibility that the ruling will be overturned. This suit demonstrates that Akamai‟s strategy of differentiation has worked, and competitors are attempting to capitalize on its intellectual property. In recent years Akamai has focused on building new capabilities in addition to its basic Content Delivery and has expanded to Dynamic Content Delivery and Application Accelerator where it has less competition. Akamai has also begun focusing its services on new customers in Enterprise and E-Commerce and has explored developments in cloud computing. As demand for video streaming began to grow in 2008, Akamai saw an opportunity to continue its differentiation strategy and expand its advanced services offerings. Rather than solely focus on video and compete head to head with other companies entering the arena, they also looked to additional emerging trends in cloud computing, security and mobile content in order to diversify their services. By having a decentralized setup of its Distribution Network, Akamai has been able to:  Deliver data faster and in a more reliable way than its competitors  Pre-fetch data for users, before they ask for it  Compress files for more efficient storage  Deliver new products to its customers faster than its competitors  Provide superior global analytics of internet activity
  • 5. Industry Profitability Examining the Content Delivery Network (CDN) industry through the lens of the Five Competitive Forces Model allows us to analyze the overall profitability of the industry. For this particular example, we have also identified a sixth force – the Internet Service Providers. Threats To Entry MODERATE  Capital Intensive Industry: Software Development , Servers and maintenance of these was expensive.  Intellectual Property Protection  Deep Pockets needed for survival and growth overtime. HOWEVER  Expected explosion in online video market enticed new players.  Venture capital was easily available for new entrants. Bargaining Power of Buyers HIGH  Fragmented Industry with over 50 CDN players  Low Switching Cost from one supplier to another  Big Players had incentive to develop their own in-house network to cut down on outsourcing expenses. Threat of Substitutes LOW  CDN is an integral part of internet value chain and there are no existing or foreseeable substitutes. Bargaining Power of Suppliers LOW  Suppliers include server manufacturers and network providers.  Cost of basic server was constantly declining over time.  Network providers were fragmented. Rivalry HIGH  Intense competition as players create a price war.  Backward Integration by ever-growing CDN customers  Changing Market trends and technologies i.e. cloud computing, mobile, HD Video Partners (ISPs) HIGH  Symbiotic Relationships between CDN and ISPs: ISPs need CDNs to cut down on data communication costs whereas the CDNs need ISPs to reach to end user. Rivalry Threat to Entry Buyers Substitutes Suppliers MODERATE LOW HIGH LOW ISP HIGH HIGH
  • 6. Akamai’s Competitive Advantage The de-centralized network of distributed servers has greatly benefited Akamai by providing them with the advantage of faster response time and lesser error rates – paramount to a CDN‟s core operations. The decision to locate their servers in the ISP‟s premises has been paramount to Akamai‟s success. This has enabled the company to grow outside of its core and produce new, differentiated products including:  Internet usage analytics  Consulting services  Online storage  Customizable content delivery  Advertising Financial Model Footprint Akamai‟s revenue model is based on the following:  Periodic contracts with its customers.  One-time integration fee for new customers.  Use of direct sales force  Use of re-sellers - compared to the industry average of 15%, Akamai‟s revenue from its resellers (through non-refundable minimum purchase contracts) was slightly higher at 19% (Year 2011, Page 23 of 10-K). CAGR (compounded annual growth rate) of its revenue was 18% for the five-year period between 2006-2011. Years 2006 2007 2008 2009 2010 2011 Revenue Growth 51.4% 48.4% 24.3% 8.7% 19.1% 13.2%
  • 7. Revenues Prior to 2009:  The majority of Akamai‟s sales (40 to 45%) came from media & entertainment, and average revenue per customer for this segment was twice that of others.  The Hi-tech segment accounted for 20% of its revenue while 30% was captured by e- commerce.  Akamai was a price setter, which allowed them to charge twice as much as competitors. Revenues from 2009 to 2011: According to the 2011 10-K statement, Akamai reduced prices in the Media & Entertainment segment in order to increase volume between the years of 2009-2011. As a result, 41% of their $300 million increase in revenue came from this vertical. Additionally, 18% of revenue growth came from Enterprises while 28% came from E-commerce. This increase was primarily due to development of new products related to application and cloud performance solutions. Also, 29% of revenue was attributed to international operations, exhibiting the global growth potential of the business. Costs Breakdown: Figure 1:Total incremental revenue from 2009-2011 = $300 million Total costs as a % of revenue (cost of revenue + operating expenses) have decreased from 80% in 2006 to 75% in 2011. A closer look at the break down of cost shows that the company is not benefitting from economies of scale. This is attributable to their decentralized distributed Media 41% Enterprises 18% Ecommerce 28% Rest 13%
  • 8. network, which does not allow the company to benefit from reduced costs as they expand the business. Even though operating expenses have decreased, savings have been offset by the cost of revenue. This is demonstrated by the following:  Cost of Revenue as a percentage of sales increased from 22% in 2006 to 32% in 2011.  Meanwhile, operating expenses as a % of sales decreased from 58% in year 2006 to 42% in year 2011.  Bandwidth and Co-locating costs increased from 14% to 19% during the five year period because of expansion in the business.  Between 2006 to 2011, Akamai capitalized $371 million worth of internal use of software; this depicts their efforts to maintain their servers as they grow. Years (As % of Sales) 2006 2007 2008 2009 2010 2011 Costs of Revenue 22.0% 26.3% 28.1% 29.1% 29.6% 32.3% Operating Expenses 58.7% 50.9% 45.0% 44.9% 45.5% 42.9% Total Costs 80.62% 77.22% 73.16% 74.00% 75.16% 74.91% Akamai’s success: Akamai positioned itself as a high quality industry leader because of its “differentiated” Edge Network. This is clearly reflected in the company‟s financial footprint, as evidenced by these five points. 1) Akamai‟s operating margins grew from 19% to 25% between the years of 2006-2011. This demonstrates an increase in volume despite price reduction for specific customer segments (media & entertainment).
  • 9. 2) Akamai increased its R&D expenditure by 58% from 2006 to 2011 to support expansion of their product line and refine the sophisticated nature of its server. 3) From 2009 onwards, Akamai spent $380 million on acquiring new equipment to support this expansion. 4) Akamai historically spent on average 20% of revenue on sales & advertising (from 2006 to 2011) which is consistent with its initiative to promote itself as a highly distributed computing network as opposed to its competitors. 5) Akamai leveraged its learning curve experience as the first content delivery network to set up distributed networks. Between 2006 and 2011, they brought down their operating and maintenance expenses from 58% to 42%. Akamai‟s differentiation strategy has proven to be successful thus far, but due to increased competition, they are likely to face challenges in the future. Competitor Assessment The three largest competitors for Akamai are LimeLight in the standalone CDN players, AT&T in the Telecom and Network firms and Microsoft in the potential CDN customers looking to develop their own CDN‟s turning into competitors. We have ranked them in the following order: Key Competitor 1 Limelight Limelight competes with Akamai in almost every pillar of Akamai‟s operations: Limelight focused on content delivery, but since April 2009, it introduced LimelightSITE – a service of full website delivery as well. Using private dedicated network, they have engaged accelerated data communication. Limelight adopted the centralized model of network servers, which has several
  • 10. technical advantages, including ease of capacity expansion and increased flexibility. A centralized model also gives Limelight a simplified network. The company is very likely to appeal the $45 million case of IP litigation with Akamai, which will reduce the technical advantage of Akamai. Key Competitor 2 AT&T Due to its telecommunication and networking business, AT&T already owns not only a global network, but also cheap access to some of the key inputs. These factors enable it to enter and expand its CDN and other similar services of operations. AT&T has „deep pockets‟ – it is a company with more than $100 billion revenue in 2008. It invested $70 million in CDN infrastructure in 2008 and came back to CDN business again. As a result, it got about 15% of Limelight‟s content delivery capacity. Key Competitor 3 Microsoft Microsoft, formerly Akamai‟s largest customer, is beginning to develop its own CDN rather than to outsource these activities. Microsoft has shifted most of its content delivery in-house – as they had already deployed servers globally for cloud computing and other such activities. Akamai has been hurt a lot, since this trend reduced Akamai‟s revenue by 10% directly. This also rings alarming bells for Akamai, as Microsoft has the resources – software development, server network – and the deep pockets – to enter into commercial CDN business and become a strong competitor.
  • 11. Future Strategy Recommendation We first recommend that Akamai continue to stay with their current Distributed Edge Network. The company has already made large capital investments in physical infrastructure, R&D and patent protection. As the first to establish a decentralized distributed network, Akamai has benefited from relationships with ISPs through long-term purchase contracts, as well as government entities, which provide a stable source of income. Furthermore, by keeping the distributed network they will maintain their high quality standards of content network delivery and continue to benefit from the positive spillover effects of the learning curve. Finally, because of its distributed decentralized network of servers the company is able to cater to both sophisticated and basic customer needs. Akamai is also currently able to better serve its international markets, which account for 29% of current revenues. Secondly, we suggest that the company not chase the online video CDN market. Although the market provides a high degree of growth potential, there is too much competition from stand-alone CDNs, telecommunications companies and current potential CDN developers. There is also interest from media and entertainment companies themselves to cater to this growing volume by establishing their own networks. Although Akamai could likely defeat stand- alone CDNs such as Limelight in a price war, larger competitors with deeper pockets such as Microsoft and AT&T have the resources to outlast them. This is supported by the fact that incremental revenue from the media segment has been decreasing since 2009. In 2010 the company experienced an increase of $76 million in this vertical, while in 2011 the increase only amounted to $46 million. This proves that stiff competition in the video market will likely prevent Akamai from capturing more of the segment despite price reductions. Nonetheless,
  • 12. Akamai will likely remain competitive due to the nature of its high quality delivery which is especially important in this industry. Thirdly, we encourage Akamai to focus their efforts and future development in the E- Commerce market. This segment demands complete website delivery as well as accelerated application; two services that the company has already expanded into due to the competitive advantage of the distributed network. Between 2009 to 2011, 28% of incremental revenue was attributed to the commerce segment and there is great potential for further growth. A focus on E- commerce will result in:  Increased R&D expenditure  Increased marketing & sales expense  Ability to continue to charge price premiums  Higher gross margins In addition to targeting E-commerce, Akamai will also benefit from continuing developments in cloud computing, another emerging trend. The company already offers services for cloud computing and is consistent with its current business. Finally, Akamai‟s 2008 acquisition of the behavioral marketing company Acerno allows them to benefit from in-house advertising for its customers. Akamai can also leverage its data analytics capabilities to better reach these customers in terms of lower cost per acquisition. 2015: Akamai as an Industry Leader Should Akamai continue to operate as a major player in the CDN market in 2015, the following internal and external developments must have taken place:
  • 13.  The E-commerce CDN market continued to experience growth; as a result Akamai increased its revenue and captured additional market share.  CDN competitors fought amongst themselves over the video/media market; leaving cloud computing space open for Akamai to capture.  Akamai continued to invest in software; leading to a reduction in co-location costs through better server management and efficient routing capabilities.  The judgment in Limelight‟s IP case was not overturned.  Akamai capitalized on its new advertising business, attracting new clients and adding a new revenue stream. 2015: Akamai Is Struggling Should Akamai experience difficulties in the future, we believe they would result from the following scenarios:  The total CDN industry failed to grow as expected.  A price war among players in the video/media segment resulted in benefits to participating companies.  Hi-tech companies developed their own CDNs, resulting in additional loss of revenue for Akamai.  Large E-commerce players such as Amazon began to offer sophisticated CDN services.  Google & Facebook were able to capture a chunk of the advertising segment.  Emerging markets such as China and India replicated the distributed network in a cheaper and more efficient way.  Intense competition deteriorated the price premiums that Akamai currently enjoys.
  • 14. In order to increase the likelihood of achieving scenario I, Akamai management should not:  Move from a de-centralized distributed network to a centralized one  Participate in a price war for the video segment  Reduce investment in R&D and product innovation; which could result in potential customers turning to competition  Divert its focus from B2B to volume based business  Underestimate its competition from telecom firms  Alter its contract policies with customers in fear of losing them  Fail to continue serving international markets