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Soft machines - Cloud computing and the software ascendancy - Ed Maguire

A report that identifies the PaaS layer as most strategic

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Soft machines - Cloud computing and the software ascendancy - Ed Maguire

  1. 1. Soft machinesCloud computing and the software ascendancy Special report September 2013
  2. 2. Global technology 2 ed.maguire@clsa.com 20 September 2013 Contents Executive summary .......................................................................... 3 Vaporizing IT.................................................................................... 4 PaaS - Key to the hybrid cloud .........................................................13 The cloud as an economic catalyst ...................................................22 Ripples turn to waves ......................................................................33 Company profiles Akamai .....................................57 Amazon.....................................61 Delta ........................................67 EMC..........................................69 Google ......................................73 IBM ..........................................77 Intel .........................................83 Microsoft ...................................87 Oracle.......................................93 Quanta......................................99 Rackspace ............................... 101 Salesforce.com......................... 105 Tata Consultancy...................... 111 PC OEMs ................................. 115 Appendices 1: What it’s all about......................................................................... 117 2: The software cloudscape................................................................ 126 All prices quoted herein are as at close of business 16 September 2013, unless otherwise stated Read Nic Baratte’s companion report Hard rain: Cloud computing and the hardware demise CLSA technology incites new perspectives Produced by CLSA Americas, LLC. For important disclosures please refer to page 140 Ed Maguire ed.maguire@clsa.com +1 212 549 8200 With contributions from Avi Silver, CLSA Americas Chitra Gopal, CLSA James Lee, CLSA Americas Lou Miscioscia, CLSA Americas Nicolas Baratte, CLSA Nimish Joshi, CLSA Srini Pajjuri, CLSA Americas
  3. 3. Executive summary Global technology 20 September 2013 ed.maguire@clsa.com 3 Soft machines The soft machines of cloud computing transform the technology landscape, economic models and strategies. The Platform-as-a-Service (PaaS) architecture will play a key role in unlocking applications from the components of infrastructure, which is subject to the forces of commoditization. As cloud computing disrupts the entrenched IT leaders, new innovations power emerging economic benefits. Open-source and services models exacerbate competitive pressures for infrastructure software and hardware vendors. We see value accruing towards Software as a Service (SaaS) and solutions. Salesforce.com, Akamai and Microsoft are our top picks. Cloud computing changes IT from a bespoke to utility model. Commoditization of IT will accelerate demand and innovation. Adoption has passed the inflection and signs point to the hybrid public/private cloud as the preferred approach. As a wave of new social, mobile and analytic applications emerges, custom software development becomes a key competitive weapon. The PaaS market is far smaller than SaaS and Infrastructure as a Service (IaaS), but size vastly understates its strategic consequence. PaaS promises code portability, the ability to swap out infrastructure components as a commodity. Microsoft, Pivotal, Google and Salesforce.com lead this highly fragmented landscape. We expect consolidation of smaller vendors to accelerate mainstream adoption. Cloud computing alters the economic calculus of information technology via transition from products to services, from capex to opex. Quantifying ROI is elusive, as lower costs spur elastic demand. The broader benefits of cloud computing translate into innovation, net job creation and economic growth. Cloud architecture amplifies competitive threats to middleware, database, operating-system and hardware vendors from open-source and service-delivery models. Storage should do better than networking, which should do better than servers (see Nicolas Baratte’s Hard rain report, which explores the shrinking hardware profit pool). IT services will see value churn as IaaS commoditizes outsourcing and automation displaces people-intensive tasks. As value accrues towards SaaS and solutions, our top cloud picks are Salesforce.com, Akamai and Microsoft. We also like cloud-service providers Amazon and Google, while Rackspace appears at risk. EMC is a cloud-infrastructure beneficiary, whereas HP, VMware, Oracle and Intel look vulnerable. Share performance across the software sector reflects this bifurcation of value creation. Comparable valuations (Local currency) Ticker Rating Analyst Curr Target Last close EPS FY13 EPS FY14 PE (x) FY13 PE (x) FY14 Upside (%) Akamai AKAM US BUY1 Ed Maguire US$ 66.0 51.37 1.96 2.32 26.3 22.3 28.5 Amazon AMZN US O-PF1 James Lee US$ 325.0 296.06 3.83 6.02 77.3 49.2 9.8 EMC EMC US O-PF1 Louis Miscioscia, CFA US$ 30.0 26.88 1.87 2.20 14.3 12.2 11.6 Google GOOG US BUY1 James Lee US$ 1,075.0 887.76 43.87 54.49 20.2 16.3 21.1 Hewlett Packard HPQ US U-PF1 Avi Silver US$ 23.0 21.74 3.55 3.40 6.1 6.4 5.8 IBM IBM US O-PF1 Ed Maguire US$ 225.0 193.15 16.57 18.72 11.7 10.3 16.5 Intel INTC US U-PF1 Srini Pajjuri US$ 22.5 23.39 1.89 1.82 12.4 12.9 (3.8) Microsoft MSFT US O-PF1 Ed Maguire US$ 38.0 32.79 2.58 2.72 12.7 12.1 15.9 Oracle ORCL US U-PF1 Ed Maguire US$ 35.0 32.97 2.68 2.88 12.3 11.5 6.2 Rackspace RAX US SELL1 Louis Miscioscia, CFA US$ 40.0 52.26 0.69 0.85 75.2 61.7 (23.5) Salesforce.com CRM US BUY1 Ed Maguire US$ 64.0 49.65 0.41 0.34 122.6 147.7 28.9 Delta 2308 TT O-PF2 Chitra Gopal, CFA NT$ 157.5 135.00 7.07 8.16 19.1 16.5 16.7 Quanta 2382 TT O-PF2 Chitra Gopal, CFA NT$ 75.2 68.00 4.82 5.02 14.1 13.5 10.6 Tata Consultancy TCS IB O-PF2 Nimish Joshi Rs 2,200.0 1,902.55 71.23 92.47 27.3 21.1 15.7 1 Covered by CLSA Americas, 2 CLSA. Source: CLSA Americas, CLSA Cloud computing and the software ascendancy Vaporizing IT: Commoditization accelerates innovation PaaS is a small but important catalyst for technological disruption Cloud as a net-positive economic catalyst Ripples turn to waves Nicolas Baratte’s Hard rain report
  4. 4. Section 1: Vaporizing IT Global technology 4 ed.maguire@clsa.com 20 September 2013 Vaporizing IT Cloud computing is more than an architectural shift, it’s a massive wave with profound implications for strategies, business models and the technology landscape. A new architecture decouples applications from infrastructure, providing increased agility and immense scalability at declining cost. As these factors lower barriers to accelerate innovation in social business, mobile and analytics (Big Data) use cases, the corporate view of technology shifts from operating expense to strategic asset. Consequently, we expect aggregate IT spending to continue to grow while share of wallet moves away from a bespoke infrastructure towards applications and solutions that generate business value. Cloud computing represents the transition of information technology to a utility model. A new architecture is emerging that lowers costs and stimulates innovation. Business adoption has hit an inflection point as the preferred deployment model evolves towards the hybrid cloud, embracing both the public and private clouds. As infrastructure becomes commoditized, value migrates upwards to applications as custom development gains increasing strategic importance.  Cloud computing commoditizes technology infrastructure “from the bottom up”. It’s increasingly difficult for proprietary hardware, storage, networking and software vendors to charge premium “rents” in the face of software-defined automation and open-source alternatives.  Declining costs will grow IT spending in aggregate. The Jevons Paradox refers to the proposition that technology advancements that improve the efficiency of resource usage will raise (rather than reduce) the rate of consumption of that resource. We believe this applies to cloud computing.  Adoption of cloud architecture accelerates “creative destruction”. Incumbent vendors face existential threats from disruptive models: alternative delivery approaches (everything as a service); economics (pay as you go/subscription); architecture (PaaS); and development and intellectual-property (IP) paradigms (open source).  Infrastructure becomes a commodity game. Providers of cloud compute infrastructure (compute, storage and networking) will compete on economies of scale and supply-chain efficiencies.  It’s all about business value. Value migrates upwards from platform to applications as infrastructure components become automated. When infrastructure is a commodity, a greater proportion of the value comes from solving business problems. Apps rule the day through specialized knowledge, domain expertise and process automation. What’s old is new again . . . really new In recent years, cloud computing has been the subject of massive hype and speculation; however, the impact of this shift is profound for the technology sector and economic activity overall. In 2013, cloud computing is being broadly embraced by the mainstream. There are many aspects of the cloud delivery model that are a natural reiteration of prior computing models such as the time-sharing and resource- pooling characteristic of the mainframe era. However, it is the combination of declining costs, open standards, easy availability, increasingly powerful Cloud computing industrializes technology as applications are engines of business value The mainstream is embracing cloud computing Cloud computing is a massive wave with profound implications
  5. 5. Section 1: Vaporizing IT Global technology 20 September 2013 ed.maguire@clsa.com 5 development and management technologies, and above all, the enormous expansion of connected devices that accelerate the transformative impact on the technology landscape, industries of all types and the economy at large.  Commoditization of infrastructure is moving up the stack as technologies and cloud architecture mature. The first cloud wave of public IaaS adoption disrupted the server-hardware market. The adoption of maturing PaaS solutions will further commoditize infrastructure software, particularly application servers and related middleware.  A new cloud software architecture causes a shift away from the enterprise IT economic model built around tightly coupled systems, proprietary software & hardware and extensive IT implementation, development, monitoring and support services towards a more open model built for massive scale. It emphasizes commodity hardware, open-source software and more automated processes.  The decoupling of apps from the underlying infrastructure alters competitive dynamics as advantages for vendors of cloud-infrastructure components are derived from economies of scale and efficient delivery models.  Cloud computing also enables the decoupling of business processes from the underlying technology stack, with profound ramifications for companies across industries. Those businesses that are most able to harness the cloud economic model in their favor will prosper, while those that fail to adapt to disruption will struggle. A key capability is code portability - the ability to run applications on public or private clouds with minimal changes. Cloud computing alters usage and consumption of IT resources by transforming the enterprise technology model from dedicated “silos” to a sharing architecture. The term cloud computing encompasses more than public infrastructure services providers. Cloud computing also refers to an emerging management model for organizing computing resources. This has implications for the vendors that provide the various components of infrastructure as well, not just their technologies but also their business models. Like all major technology transitions, cloud computing gives rise to winners and losers, although it’s still early days. Beneficiaries include internet/ecommerce vendors, tech startups, application software companies, consumers and forward-thinking businesses across industries. At risk are incumbent vendors of enterprise hardware, infrastructure software, IT implementation and support services and businesses subject to competitive or secular disruption. The cloud industrializes computing to a utility model The IT industry is undergoing a process of industrialization around cloud- computing architecture, as the cloud model allows resources to be easily provisioned and paid for on a per-use model. We have previously discussed why cloud computing matters and some of the key aspects of what is becoming arguably the most significant paradigm shift in technology since the introduction of the worldwide web. The benefits of cloud delivery models are helping organizations of all sizes scale their investments, enjoy increased flexibility and spur innovation. Simon Wardley, researcher at Computer Sciences Corporation’s (CSC) Leading Edge Forum, developed a model that illustrates how activities in new markets evolved due to competition on both the demand (user) and supply (vendor) IT industry is undergoing a process of industrialization around cloud computing Transforming the enterprise tech model from dedicated silos to a sharing architecture Moving towards a more open model built for massive scale Cloud computing gives rise to winners and losers
  6. 6. Section 1: Vaporizing IT Global technology 6 ed.maguire@clsa.com 20 September 2013 side. New technologies evolve from their genesis through a custom-built stage, to product stage to commodity stage. Enterprise information has followed this path, and according to Figure 1, we see Amazon’s Elastic Compute Cloud (EC2) positioned at the commodity/utility stage. Figure 1 Evolutionary processes apply to technology - and to the cloud Source: Simon Wardley, http://blog.gardeviance.org What the new cloud architecture means for the rest of technology As cloud computing has matured, it is increasingly commoditizing the underlying components of technology infrastructure (hardware and software). Wardley believes that as cloud computing matures into a utility model, declining costs have an elastic effect on demand, stimulating consumption and driving innovation in value creation atop the utility cloud infrastructure. Figure 2 Pre-cloud era value to cloud model commoditization Source: John Zysman, Jonathan Murray, Kenji Kushida Platform includes management logic Offering (eg, database, server, router, etc) Management logic Offering (eg, database, server, router, etc) Offering (eg, database, server, router, etc) Cloud ModelPre-Cloud Era Integratedoffering Commoditized! Cloud computing has advanced to the commodity stage As cloud computing matures into a utility, declining costs have an elastic effect on demand The cloud model makes technology infrastructure interchangeable
  7. 7. Section 1: Vaporizing IT Global technology 20 September 2013 ed.maguire@clsa.com 7 As we wrote with Jonathan Murray, John Zysman and Kenji Kushida in Clouducopia in January 2012: ‘Management functions within software are increasingly migrating to the platform rather than being encapsulated in individual components of datacenters, whether it be storage, networking or databases. This drives commoditization of the components.’ With industrialization comes commoditization, spurring innovation The evolution of the cloud-computing model reflects a steady process of maturity of enterprise IT. Commoditization occurs when users perceive competitive offerings as more or less similar commodities to be bought or sold - hence price becomes a determining factor in purchase decisions. Cloud- infrastructure services are increasingly commoditized, and a measure of this is the willingness to switch for small price differences. According to a Gartner survey in September 2012, buyers of public cloud services demonstrated early signs of price sensitivity particularly for IaaS. A survey of 556 organizations revealed that 19% of leading cloud adopters would change cloud providers for less than a 5% price difference. As we discussed in our CLSA Blue Book Clouducopia, the rapid declines in the cost of compute power and storage give rise to a transition from eras of scarcity to an era of abundance, in the words of Jonathan Murray, EVP of strategy at Warner Music Group. When compute power was expensive and limited, and technical expertise at a premium, enterprise systems were typically custom built while software was architected to squeeze the maximum amount of performance out of hardware. With compute and storage costs declining, the abundance of resources allows a new generation of architecture to emerge. Over time this technology itself matures and fades from the foreground to become an enabling component of the next generation of applications. Figure 3 Componentization of technologies Source: Simon Wardley, http://blog.gardeviance.org Computing infrastructure Electricity Mechanical components Large-scale analytics IndustrialisedTransitionalUncharted Genesis Custom built Product (+ rental) Commodity (+ utility) Evolution InvisibleVisible Valuechain As the cloud commoditizes computing infrastructure, this enables new types of apps to emerge Buyers of public cloud services demonstrate early signs of price sensitivity for IaaS Management functions within software are increasingly migrating to the platform
  8. 8. Section 1: Vaporizing IT Global technology 8 ed.maguire@clsa.com 20 September 2013 The emerging cloud-computing architecture benefits from resource abundance, and software architectures can therefore afford to be more “wasteful”. Automation is typically highly process intensive, and with increasing computational power, it’s possible to perform higher-level functions and activities. We’ve passed the inflection point There is growing evidence that cloud-computing adoption has experienced an inflection over the past year. CDW’s 2013 State of the Cloud Report found that 39% of organizations surveyed were implementing or maintaining cloud solutions in 2012, up from 28% in 2011. Much of this is anecdotal, as investors become increasingly aware of momentum around Amazon Web Services (AWS) on the IaaS side. SaaS vendors such as Salesforce.com, NetSuite and others continue to gain share of IT spending, while both Google Apps and Microsoft Office365 are seeing strong adoption trends. Below, we endeavor to frame the downstream impact of cloud computing. Anecdotal evidence, a raft of recent surveys and industry commentary suggest that adoption of cloud-based services continues to see solid momentum. Cloud-computing adoption has accelerated over the past year, propelled by ongoing momentum in IaaS and virtualization as well as the personal use of cloud computing by IT professionals. CDW’s report found that respondents expect to spend 23% of their organizations’ IT budgets using cloud resources and applications over the next year and 33% in four years. Seventy-three percent of IT professionals from companies that were implementing or maintaining clouds said their personal use of the cloud has influenced their recommendations about organizations moving to the cloud. InformationWeek conducted its State of Cloud Computing Survey of 446 organizations with 50 or more employees in February 2013. Respondents reported increases from 2012 to 2013 in overall cloud usage from 33% to 40%, which was reflected in a jump in virtualization from 56% to 64% and IaaS from 27% to 30%. However, respondents reported a notable decline in the use of SaaS from 2012 to 2013 from 57% to 49% and in the use of PaaS from 42% to 36%. This survey suggests that enterprises are investing in cloud infrastructure, while backing off from early stage technologies like PaaS. However, more users report using PaaS than IaaS, reflecting ease of adoption. Mathew Lodge, VP of cloud services at VMware, noted roughly 40m virtual machines running on VMware as of February 2013 versus 2m IP addresses at AWS, according to InformationWeek. From creative disruption, benefits emerge Cloud-computing infrastructure is disruptive on several levels. Virtualization improves hardware utilization and decouples workloads from the underlying physical hardware. Free open-source software is foundational to the cloud, often supplanting expensive proprietary software. The design of datacenters and servers is being open sourced and shared - Facebook has opened up its designs through Opencompute.org, where its cloud-computing peers and enterprises can freely benefit from best practices. We highlight the key aspects of cloud computing’s disruptive impact on the technology industry:  A wholesale economic model disrupts a bespoke industry. We point to the 2006 introduction of Amazon’s EC2 as the turning point where scalable compute and storage became available on a self-serve, pay-per-use model. Even the design of datacenters and servers is being open sourced and shared Spending on the cloud is expected to increase as a proportion of IT budgets There is growing evidence that cloud-computing adoption has experienced an inflection Businesses are investing in IaaS, but backing off PaaS until technologies mature The emerging cloud- computing architecture benefits from resource abundance
  9. 9. Section 1: Vaporizing IT Global technology 20 September 2013 ed.maguire@clsa.com 9  Open-source alternatives to proprietary technologies gain ground. The shift to cloud computing occurs as open source is increasingly viable for the enterprise.  Native cloud architecture commoditizes infrastructure hardware and software. A mature PaaS layer decouples the application logic from the underlying infrastructure and makes infrastructure components increasingly interchangeable and subject to the forces of commoditization. Cloud computing facilitates a range of new use cases around social computing, mobile services and high-performance analytics, all of which have potential to create new economic value. Cloud computing reflects the industrialization of information technology. While this has disruptive effects on certain providers of infrastructure components and services, there are many beneficiaries of broad-based adoption of cloud computing.  Businesses benefit from lower costs for technology, IT staff and overhead, while gaining benefits of agility. Lowering the marginal cost of failure accelerates innovation and allows for rapid value creation. The extensible aspects of cloud computing allows businesses to scale online operations far more quickly than possible on their own, for less capital, with less risk.  Consumers benefit directly and indirectly from the availability of cloud- enabled applications. Cloud-enabled search, entertainment, information services, location-based services and applications democratize access to culture, knowledge and commerce. Dematerialization of physical goods (for instance, the digitization of books, music and video) into cloud- delivered services reduces friction around information flow. Further elevating applications to the top of the IT food chain In our February 2010 report Compubiquity, we argued that applications are the top of the software food chain (as software itself is the top of the IT food chain). Applications are the raison d’etre of technology; compute, storage and connectivity are all in the service of applications. Applications are where ultimate value resides, by automating business processes, facilitating communications and collaboration, entertaining and informing users and enabling business models - the value to the users is defined by their utility. Cloud computing provides an essential enabling role in the delivery of business value, allowing applications to be developed and deployed with speed, flexibility and cost efficiency. It’s a broad generalization, but it’s our view that the higher the vendor operates up the stack, the better cushioned from forces of commoditization. Applications can be deployed both as SaaS and on-premise offerings, and broadly include enterprise and consumer applications as well as the proprietary code powering ecommerce and internet sites. Latency and data gravity considerations inform the choice to deploy on premise or in the cloud. Figure 4 Value moves up in stacks Source: Jonathan Murray (Murray's First Law of Platform Economics) Application Platform Infrastructure Value Cloud computing provides an essential enabling role in the delivery of business value Cloud computing enables social computing, mobile services and high- performance analytics Value migrates from infrastructure to platform to application
  10. 10. Section 1: Vaporizing IT Global technology 10 ed.maguire@clsa.com 20 September 2013 In many respects, infrastructure becomes a commodity. The interchangeability of compute, memory and storage changes industry dynamics for providers of infrastructure technologies. There are broader implications for the adoption of hybrid cloud strategies with a fully realized PaaS layer as this commoditizes higher levels of the software stack. There is increasing focus on the characteristics of the next generation of applications, which differ from the prior generation given the use of new languages and frameworks (such as Node.js, Spring, Rails and Python). These new applications are often social or location-aware, primarily accessed by mobile devices (smartphones and tablets). In fact, a new acronym has emerged to describe the new generation of apps: SMAC, which refers to social, mobile, analytics and cloud. What characterizes the new generation of applications?  Social - Socially enabled applications need global scale, ability to perform multiple real-time operations, relatively low latency and a distributed architecture.  Mobile - With mobile applications, more of the application logic resides in centralized datacenters, delivered as a service to mobile endpoint devices. There’s an increasing importance of location-based services.  Analytics - With the immense proliferation of data, the opportunities to deliver context-aware, real-time analytics demand scalable data- management systems with intelligent filtering capabilities.  Cloud - Application architectures that incorporate the principles of next- generation PaaS and IaaS have requirements of massive scalability. The flexible architecture accelerates the forces that commoditize underlying infrastructure components. Figure 5 Catching the fifth wave of corporate IT Source: Cognizant Technologies Cloud computing hastens existential threats for certain industries Looking at the potential for competitive threats, a study by Cognizant Technologies likened the decoupling of business process from underlying technologies from the cloud to the impact that rising temperatures have upon different elements. Businesses that have been disrupted so far include information-based businesses with products subject to digitization, such as classified ads, movie rentals and maps. Next-generation applications embrace social, mobile, analytics and cloud The SMAC stack represents a new wave of corporate IT Decoupling of business process from underlying technologies increases competitive pressures
  11. 11. Section 1: Vaporizing IT Global technology 20 September 2013 ed.maguire@clsa.com 11 Figure 6 Information technology drives “melting points” for cloud-based disruption Source: Cognizant Technologies Over time the rising temperature from cloud computing will increase pressure on industries to advance competitive advantages through technologies, which leads directly to software development. Custom software development becomes a strategic weapon The adoption of cloud computing can help accelerate how businesses develop, test and deploy applications. There is growing awareness of the competitive advantages of software development as effective use of development can translate to competitive outperformance. According to a 2012 survey of over 435 IT and business executives by the IBM Institute for Business Value, successful organizations are increasingly using effective software development and delivery to disrupt business models and shift industry paradigms. Fifty-four percent of respondents believe that software development is critical, but only 25% leverage it effectively today. Of the businesses that leverage software development effectively, 69% outperform their peers from a profitability standpoint, 25% are average and only 6% underperform. Figure 7 Industries identifying software as crucial to competitiveness ¹Industries were classified as “more software intensive” where more organizations identified software as crucial to competitiveness as compared with the average for all industries. Source: IBM Institute for Business Value (The software edge: How effective software development and delivery drives competitive advantage) Industries that place a premium on software development are not surprisingly in information-intensive sectors: financial services, retail, telco, travel, pharma/life sciences and public sector/government. 76 65 64 64 62 62 54 54 48 46 38 32 Financial Services Retail Telecommunications Travel and Transportation Pharmaceutical/Life Sciences Public/Government Automotive Industry average¹ Professional Services Consumer Products Industrial Products Energy and Utilities (%) More software intensive Less software intensive Softwareintensity Companies that successfully leverage custom development outperform peers Delivering custom apps rapidly becomes a competitive advantage Information-intensive industries feel the impact of the cloud first
  12. 12. Section 1: Vaporizing IT Global technology 12 ed.maguire@clsa.com 20 September 2013 The emergence of public cloud services like Amazon, Google AppEngine and others has also seen growing adoption of new programming languages and frameworks to support the next generation of applications. EMC, in a presentation in March 2013, forecast the number of applications built on the next-generation cloud architecture to increase from 6m in 2012 to almost 50m in 2016, while traditional applications will grow far more in absolute terms. It’s the new generation of applications that are poised for the most robust growth. Figure 8 Next-generation cloud applications set to surge Source: March 2013 EMC presentation citing IDC, Gartner, AWS Workload estimates In a generational shift, traditional languages like C++, Java and JavaScript are being supplanted by Perl, Python, Ruby, Node.Js, Erlang and others. A notable aspect of the evolution of cloud stacks - the software that enables infrastructure as a service - is that leading technologies are mostly open source. OpenStack (a consortium of roughly 200 vendors spearheaded by RackSpace), CloudStack (purchased by Citrix and open sourced to the Apache Foundation), Eucalyptus and Amazon’s Elastic Beanstalk are open source. VMware remains the proprietary enterprise standard for cloud infrastructure. A key consequence of adoption of the new cloud-computing architecture is that we will see more organizations elevate the importance of the software development function. We are seeing large investments pour into the development platforms for next-generation architecture. GE has invested US$100m in the EMC/VMware Pivotal spinout, which has brought together people (the Pivotal Labs development organization) with new technologies (the Spring framework, HAWQ database processing technology and Pivotal HD Hadoop distribution). One of the most important players in the new paradigm is GitHub, a collaborative site for developers with over 3.4m users. The company has received US$100m from venture-capital firm Andreesen Horowitz, its largest single investment to date. GitHub was designed to make the processes around software code management (SCM) into a social, collaborative service. The site provides repositories and sharing functions that allow programmers to upload and download shareable open-source code that can be used to build and enhance applications and services. It is a cloud-based SCM service that helps teams of developers with the complexities and challenges of aggregating code, tracking changes and managing collaboration. Over the past couple of years, the site has become de riguer for startups and GitHub accounts are becoming the preeminent means for developers to show off their coding chops to the world. With a GitHub account, engineers have access to a cornucopia of open-source software, which when combined with low-cost cloud services provides a compelling catalyst for accelerating innovations. It’s notable that leading cloud technologies are mostly open source It’s the new generation of applications that are poised for the most robust growth New generation of applications poised for growth One of the most important players in the new paradigm is GitHub More organizations elevate the importance of the software development function
  13. 13. Section 2: PaaS - Key to the hybrid cloud Global technology 20 September 2013 ed.maguire@clsa.com 13 PaaS - Key to the hybrid cloud The Platform-as-a-Service market is far smaller than SaaS and IaaS, but size understates its strategic consequence. PaaS promises code portability, the ability to swap out infrastructure components as a commodity. It decouples applications and data from underlying infrastructure software and hardware, eroding the effective differentiation between vendors at lower levels of the stack. The market is highly fragmented, but has attracted growing focus from IT giants. Microsoft, Pivotal, Google and Salesforce.com lead this highly fragmented landscape and we expect consolidation of smaller vendors to accelerate mainstream adoption. First-generation public clouds from Amazon, Google, Rackspace, Salesforce.com and Microsoft Azure have helped to validate viability of the model. Now traditional hosting companies, outsourcers and service providers target cloud-infrastructure services as a way to retain customers and drive new revenue growth. There is currently a battle over standards, as PaaS vendors battle for leadership in the critically important layer of the technology stack. Salesforce.com, VMware, Red Hat, Microsoft, Google, Amazon, IBM, Oracle and a host of private companies are all angling to capture a share of PaaS users, while ongoing debate and evolution of standards seek to balance ease of interoperability with “vendor lock-in.” The distinction between public and private clouds has been meaningful in the early stages of the market, as most of what investors and users think of when they hear the term cloud computing is public clouds like Amazon’s EC2. Privately operated clouds that take advantage of the same architectural characteristic of extensibility, dynamic pooling of resources and massive scalability are the province of the largest, most leading-edge companies for now. Purely public or private cloud models can lend themselves to vendor lock-in because application code typically runs on a single IaaS. Code portability defines the hybrid cloud Users and vendors are increasingly emphasizing the hybrid cloud model as the preferred model for businesses. The term applied loosely refers to deployment of applications on both public and private cloud infrastructure, but, in our view, the critical distinction of a hybrid model is the portability of application code to run on the private or public cloud with minimal modification. When the application code can be shifted easily from across public clouds and into private clouds, this renders IaaS interchangeable. This commodifies the technology components that comprise IaaS, altering competitive market dynamics. A fully realized PaaS layer will be the key technology that renders IaaS a commodity, and it is here that we believe the most important (and most interesting) dynamics are at work. Investors should pay increasing attention to the merging PaaS market, with dynamics analogous to the application server/middleware wars at the early part of the last decade. We highlight the critical role we believe PaaS will play in furthering the commoditization of infrastructure hardware, software and services. Investors may not fully appreciate the extent to which the competitive battles between PaaS vendors mirror prior battles over the application server. PaaS advances the decoupling of application logic from the underlying infrastructure - the benefits of PaaS include faster innovation, more efficient use of resources (developer, software and hardware) and better consistency across applications. A critical distinction of a hybrid model is the portability of application code Purely public or private cloud model can lend themselves to vendor lock-in PaaS is a small but important catalyst for technological disruption First wave of public clouds sets the stage for new battles
  14. 14. Section 2: PaaS - Key to the hybrid cloud Global technology 14 ed.maguire@clsa.com 20 September 2013  PaaS is the least mature and most highly fragmented of the cloud “layers” with over 150 vendors offering basic functionality.  PaaS for application development and deployment will play an essential role enabling hybrid clouds.  Increasing preference for hybrid cloud architectures will elevate the importance of PaaS offerings that allow application code to be deployed on public and private clouds with minimal modification.  The relatively small size of the PaaS market belies its strategic importance to the rest of the tech ecosystem.  Adoption of mature PaaS will accelerate commoditization of infrastructure - hardware, storage, operating system, database, various flavors of middleware, application servers and IaaS as well. Interest in PaaS adoption is gaining ground. In a September 2012 survey of 554 organizations with over 500 employees, Gartner found that roughly two out of five respondents have evaluated and planned to use PaaS for integrating applications, managing application portfolios and developing new applications. We expect the battle lines to become more distinct with IBM, Oracle, Microsoft, Red Hat, Salesforce.com, Google and Amazon, as well as newer entrants Pivotal, Apprenda and CloudBees. EngineYard, Stackato and others seek to command share of the market. It’s too early to handicap the likely winners, and public PaaS should continue to be a vibrant market. PaaS: Revenue may be small but impact is big So far, cloud computing has seen the most momentum at the top and bottom layers of the stack. SaaS application vendors including Salesforce.com, Workday, NetSuite, Concur and others have seen impressive growth, disrupting incumbents and carving out new market segments. IaaS vendors such as Amazon, Google and Rackspace have experienced rapid growth from supporting a range of startup companies and projects and increasingly assuming a role as core infrastructure providers for companies of all sizes. It’s our view that the PaaS layer is strategically the most important in the cloud stack, far more significant than the relative size of the market would suggest. At present, the market for PaaS is broadly fragmented with over 150 vendors tracked by Gartner. This is a sign of a young market, where there is no single, obvious answer to users’ needs. PaaS commonly refers to a type of framework that enables the deployment of SaaS applications on a common platform, taking advantage of common services, resources and quality controls. The predominant vision of PaaS is to provide developers an environment that accelerates creation and deployment of applications, which share common services such as authentication, billing and database integration while benefiting from scalability and resilience. Benefits of the PaaS approach include cost reductions due to the ability to re- use services (eg, security and transactional capabilities), run applications on shared infrastructure with scalability and failover capabilities and support geographically disparate development teams, as well as the quality controls associated with a specifically proscribed development and runtime environment. Developers can get around capacity constraints dependent on PaaS addresses the needs of users to better support cloud-based applications Interest in PaaS adoption is gaining ground The PaaS layer is strategically the most important in the cloud stack
  15. 15. Section 2: PaaS - Key to the hybrid cloud Global technology 20 September 2013 ed.maguire@clsa.com 15 having to forecast requirements accurately. Benefits include better utilization of infrastructure, significant reductions in hardware costs, notably improved uptime and the ability to leverage common components. SaaS applications address horizontal disciplines (eg, sales or service), specialized functions (eg, expense management, HR, elearning or IT functions) or industry-specific needs (of which numerous examples abound among public and private vendors). SaaS applications are effectively a natural combination of the application and hosted-services market, but their value to customers lies in the efficacy of the solution based on business needs. As such, the complete value proposition is inextricably linked with business process and domain specialization. SaaS vendors manage all of the aspects of the technology stack for the customer, who accesses application functionality over the internet. PaaS provides developers a centralized, self-service platform that can manage the development and deployment of applications on a common architecture. The platform provides access to a set of services and components that accelerate the ability of developers to build, test and place applications into full production. Figure 9 Traditional packaged software versus the cloud layers Source: VentureBeat PaaS manages access to underlying datacenter resources, allowing compute and storage to be managed as a pool with defined policies that allow developers to access and consume memory, storage and compute on a self- service basis. Applications Data Runtime Middleware O/S Virtualization Servers Storage Networking Youmanage Managedbyvendor Managedbyvendor Managedbyvendor Packaged Software Infrastructure (as a Service) Platform (as a Service) Software (as a Service) Applications Data Runtime Middleware O/S Virtualization Servers Storage Networking Applications Data Runtime Middleware O/S Virtualization Servers Storage Networking Applications Data Runtime Middleware O/S Virtualization Servers Storage Networking Youmanage Youmanage SaaS applications address horizontal disciplines, specialized functions or industry-specific needs PaaS provides developers with a centralized, self- service platform PaaS leaves everything but applications and data to someone else
  16. 16. Section 2: PaaS - Key to the hybrid cloud Global technology 16 ed.maguire@clsa.com 20 September 2013 Figure 10 Characteristics of IaaS versus PaaS IaaS PaaS Virtual machines (VMs) and storage Middleware in the cloud Rapid datacenter resource provisioning and delegated hardware management Rapid application development, deployment and change; fully delegated datacenter responsibility Coarse-grained elasticity and payment Fine-grained elasticity and payment Developer responsible for platform and application stack as well as his code Developer is responsible only for his code Shared-hardware multitenancy Shared processing, shared database or shared-everything multitenancy Portability at the VM level Little or no portability You can run anything you want within VM (provided it is technically feasible and you can get a cloud license) What you can run is restricted to what the PaaS provider offers Source: Gartner PaaS setups tend to sit on top of IaaS offerings. These can be maintained on platforms from the likes of Amazon, Google or Microsoft or on IaaS platforms like VMware’s VSphere or OpenStack. Figure 11 Conceptual view of cloud-computing architecture Source: Microsoft An advantage of decoupling the application platform from the underlying infrastructure is that businesses can use different vendors for platform and infrastructure in many cases. For instance, Heroku and EngineYard run on AWS, while CloudFoundry and CloudBees enable developers to run their apps on either OpenStack or VMware VSphere despite being priced on a per-use basis. The cloud-computing models abstract resources and automate many of the functions that would previously require custom coding. PaaS can provide self service, services management, orchestration and management PaaS offers higher level functionality than IaaS, with more restrictions on what runs on the platform Businesses can use different vendors for platform and infrastructure
  17. 17. Section 2: PaaS - Key to the hybrid cloud Global technology 20 September 2013 ed.maguire@clsa.com 17 Developers are the key to the PaaS market In contrast to SaaS (which targets end users and business) and IaaS (which targets datacenter/infrastructure managers), the PaaS market targets developers. We see significant growth in the category as users seek to leverage increasing capabilities to support cloud-based applications, while providers (both IaaS and SaaS) seek to engage customers more deeply, achieving the practical objectives of lock-in without the negative implications. Businesses are using PaaS in order to simplify the processes involved with managing hardware and software, so that they can develop and bring to market applications and innovation more quickly. Speed to market is the most important benefit of PaaS; companies that use PaaS are able to save time managing infrastructure and basic services to bring applications live in a fraction of the time. A diverse, shifting landscape Gartner identifies over 150 vendors with offerings that directly or indirectly target different categories of PaaS. Gartner tracks over a dozen segments. These functions include application platform services, application lifecycle management services, integration services, analytic services, managed file transfer services, database services and others. Cloud application platform services (aPaaS) offer functions similar to application servers, which intermediate between application logic and infrastructure (server, storage and database). We are primarily concerned with application platform services that support custom applications. Gartner estimates that worldwide PaaS revenue reached US$1.2bn in 2012, an increase from US$900m in 2011. It forecasts the market to reach US$3.5bn by 2017, a Cagr of 24%. Figure 12 PaaS forecast, 2011-17 Note: AD - Application Development; AIM - Application Infrastructure and Middleware; BI - Business Intelligence Platform; DBMS - Database Management Systems. Source: Gartner The number of vendors and fragmentation are an indication of a young market as there’s no obvious answer to the market need. At this point, the market for PaaS consists of a number of smaller subsegments including application development/application lifecycle management PaaS; application PaaS, business process management PaaS, integration PaaS and other 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 2011 2012 2013 2014 2015 2016 2017 (US$bn) AD AIM BI DBMS The PaaS market targets developers Gartner identifies over 150 vendors with offerings that target different categories of PaaS Gartner estimates that worldwide PaaS revenue reached US$1.2bn in 2012 Shakeouts and consolidation likely to characterize the market in the near term
  18. 18. Section 2: PaaS - Key to the hybrid cloud Global technology 18 ed.maguire@clsa.com 20 September 2013 functions. Over time we expect PaaS to be subsumed into broader offerings, which is likely to include PaaS suites and hosted development platforms. Leading players in traditional application PaaS remain Salesforce.com (both Force.com and Heroku), Microsoft’s Windows Azure Services Platform and Google’s App Engine. There are also privately held providers including CloudBees, EngineYard, Stackato (based on Cloud Foundry), Apprenda (primarily .NET focused), Appistry (Hadoop analytics), AppFog (recently acquired by Savvis) and others. We would expect shakeouts and consolidation to characterize the market in the near term, as a crowded landscape typical of nascent markets is unsustainable over the medium term. We expect competition to remain fierce as cloud stack providers seek their own ways to lock in customers. Users expect hybrid cloud model to predominate According to the North Bridge/Giga Om 2013 Future of Cloud Computing Survey, public cloud use is expected to decline relatively from 39% to 32% in five years, while hybrid clouds increase as a proportion of all uses from 27% to 43%. Today, public clouds account for 39% of usage, with 27% hybrid and 34% private, but in five years hybrid should be the most prominent model at 43% versus 32% public and 25% private. The expectation that enterprises will increasingly prefer a hybrid cloud model over pure public or private approaches has a few key implications. Application portability (the ability to run applications on a public or private cloud depending on business requirements) will become a critical capability for hybrid PaaS offerings. This may leave public-IaaS-only vendors such as Heroku and Google App Engine at a modest disadvantage. Public PaaS versus private PaaS - Towards hybrid PaaS The first generation of PaaS offerings was predominantly public - Heroku and Force.com (Salesforce.com), Engine Yard and Google App Engine all offered developers the ability to write applications without worrying about the underlying infrastructure. However, public PaaS failed to address enterprise concerns over security and governance, and hence did not see significant adoption. Deploying applications on a hybrid-enabled PaaS middleware layer allows users to move applications as they see fit - from one public cloud to another, or behind the firewall on a cloud-based architecture. According to David Linthicum of GigaOm, advantages to private PaaS include:  A common self-service application development platform allows developers to design, test and deploy applications within an environment that provides consistency, control and quality assurance.  Developers can access datacenter resources more effectively. PaaS handles server utilization by helping to abstract the application logic from the underlying server and storage. This improves utilization and efficiency of hardware and results in more effective operations.  Developers can utilize their existing skill sets while taking advantage of new management capabilities around application management and datacenter resource services. Initial PaaS products primarily supported application server capabilities, but the market has broadened to encompass other middleware functions. The conditions are in place for accelerating innovation in custom applications, as increasing sophistication and ease of use of development tools and backend The barriers to develop, deploy and scale custom applications have dramatically decreased Hybrid clouds are expected to increase as a proportion from 27% to 43% in five years Applications on hybrid- enabled PaaS can more easily move between public and private cloud
  19. 19. Section 2: PaaS - Key to the hybrid cloud Global technology 20 September 2013 ed.maguire@clsa.com 19 services available from PaaS providers obviate the need for developers and startups to invest in their own IT infrastructure. Programming languages and tools continue to evolve and are more accessible. Various ROI studies for PaaS (most notably an IDC analysis of Force.com) have shown up to 75% reduction in development time and four-five times improvement in payback from hosted development and deployment models. Balancing control and openness, focus and heterogeneity Among the various approaches to PaaS, users must weigh the benefits and disadvantages of closed versus open models. Salesforce.com’s Force.com leveraged the company’s underlying infrastructure and services, which included vetting of code to run on the platform (analogous to Apple’s AppStore process). The limitation was that developers had to use Salesforce.com’s Application Exchange (APEX) programming language, a variant of Java but a specialized skill set nonetheless. While the vision of an application exchange built on the Force.com platform was sound, the APEX requirements limited adoption by developers, leading Salesforce.com into a short-lived partnership with VMware to harness the Java developers that used its open-source SpringSource framework. The alliance fizzled; Salesforce.com bought Heroku, a Ruby-based platform that has since extended to other languages (eg, Java, Python, Node.js and others), while VMware launched CloudFoundry, an open-source platform that supports several languages. Battle to control the platform - Legacy versus cloud native It is critically important to control the platform - the infrastructure, standards, etc. Every application is written to the middleware, and the PaaS layer is evolving to be a high-stakes battle for developer share. Figure 13 On-premises application platforms - Magic Quadrant Source: Gartner In the late 1990s and early 2000s, there was a life and death battle between Microsoft, BEA Systems, IBM, Sun and others for the platform architecture. Microsoft had .NET and everyone else had a mix of Java, CORBA and object- request brokers. These vendors united around Java Enterprise Edition (JavaEE) to successfully build a common front against Microsoft. Users must weigh the benefits and disadvantages of closed versus open models IBM, Oracle, Microsoft and Red Hat are on- premise application platform incumbents It is critically important to control the platform
  20. 20. Section 2: PaaS - Key to the hybrid cloud Global technology 20 ed.maguire@clsa.com 20 September 2013 A new generation of innovation goes cloud native There is a subtle, but distinct difference in PaaS offerings between cloud based (where existing technologies are deployed on a cloud underneath) and cloud native (where middleware is designed for the cloud). Cloud-native technologies are engineered to be elastic, to use in-memory computing and other capabilities. Customers are migrating to the cloud because they expect high productivity and ease of use. However, existing languages like Java and C# programming have lower productivity in the cloud. Most of the innovation is no longer going to JavaEE or .NET, but these skill sets are still in short supply among traditional enterprises. Initially the cloud-native platforms are all proprietary. Force.com. Rollbase and Zoho Creator are key examples of this. One vendor, LongJump, was similar to Force.com and has been acquired by Software AG. Rollbase is another cloud- native PaaS vendor acquired by Progress Software. Both LongJump and Rollbase are cloud-native platforms currently in the hands of vendors with more resources. They now have sales channels. Tibco is also moving in this direction, moving through organic development. IBM has been working on a strategic project with WebSphere to create a new technology stack designed specifically for the cloud, and in the interim has launched its own BlueMix project focused on building solutions around CloudFoundry and OpenStack. Google and Red Hat created a partnership around a project called CapeDwarf, which is focused on creating a standard for cloud-native platforms. This project aims to provide on- premise software running on JBoss with application program interfaces (APIs) compatible with AppEngine that can be modified to become more cloud native. Cloud-enabled (and backward compatible) versus cloud native Over the past year, all of the major enterprise Java platform vendors have launched versions of PaaS. IBM, Oracle, SAP, Red Hat and VMware (through its Pivotal spinoff) have all launched cloud application infrastructure services based on core Java technologies. Oracle, SAP and Red Hat use Java and JavaEE as primary models, while CloudFoundry uses the Spring framework. Red Hat’s OpenShift and Pivotal’s Cloud Foundry are squaring off to compete directly in the market as independent PaaS offerings. We see one of these two projects emerging as a potential challenge to the proprietary offerings seen elsewhere. Red Hat’s OpenShift is a PaaS offering that supports Java, Perl, PHP, Python and Ruby. The technology is not yet open sourced, but there are plans to open up the platform. For now, OpenShift is focused on public clouds, though there are plans to support on-premise deployments. VMware’s Cloud emerged from the company’s SpringSource acquisition, has been open sourced and currently supports Java, .NET, Ruby, Scala, Node.js, PHP and Python. At this point Cloud Foundry appears to be seeing the strongest momentum among the independent PaaS projects, but Red Hat is investing in technology and partners around its own project. The key consideration for the Java-leading vendors (as well as Microsoft’s .NET-based Azure Platform Services) is backward compatibility, and this is largely a defensive measure. The leading vendors will be able to benefit from a “long tail” in business usage of Java, .NET, JBoss and WebSphere - these technologies will not go away before the CIOs retire. Is backward-compatible PaaS the equivalent of “screen-scraping”? Our discussions with industry analysts reveal the view early on that cloud adoption is “radio on TV” – like old wine in new bottles. Older applications are in an introductory stage, like screen scraping, so backward compatibility is Red Hat’s OpenShift and VMware’s Cloud Foundry are squaring off Initially the cloud-native platforms are all proprietary Existing languages like Java and C# programming have lower productivity in the cloud
  21. 21. Section 2: PaaS - Key to the hybrid cloud Global technology 20 September 2013 ed.maguire@clsa.com 21 essentially an emulation. It’s likely that over time we will see backward compatibility give way to a new architecture. According to Gartner, PaaS vendors that are locked into supporting JavaEE will be challenged. IBM has four big customers, Oracle’s PaaS is now just generally available and the company’s focus is more on hosting, and Red Hat just recently became generally available. In terms of consolidation, it’s likely that the smaller companies will be acquired on the merits of their technology. The big vendors like HP, Dell and the telecoms will be acquirers of PaaS. Clearwire/Savvis acquired AppFog, which was reportedly close to a fire sale. Cloud agnostic or integrated stack? Still evolving PaaS providers are distinguished by whether they are locked into an underlying IaaS platform (as is the case with Force.com, Google AppEngine, Amazon’s Elastic Beanstalk and Windows Azure) or cloud agnostic (in the case of VMware/Pivotal’s CloudFoundry, Red Hat’s OpenShift and independent providers such as CloudBees and others). There are advantages to each approach: offerings tied to an underlying platform provide better integration with underlying compute, management and storage services, while the cloud- agnostic platforms theoretically provide users the option to choose the most appropriate IaaS provider. Even more so than with IaaS, lock-in concerns around PaaS are top of mind for users. In many respects, there is no way to get around reliance on proprietary programming languages or service interfaces; this is inherent to the nature of applications. Additionally, the ability to shift applications between platforms is limited in many cases. That said, this dynamic is not that much different from the on-premises development model (where .NET and Java development platforms have competed). However, the cost and reliability benefits offered by leading PaaS providers nevertheless provide an attractive solution in light of the economic downturn. ISV success will determine the winners in PaaS Success with independent software vendors (ISVs) will be a key indicator of traction. To be a leader, the PaaS provider needs a healthy SaaS ecosystem and one of the predictors for success is the ability to attract a healthy ecosystem of partners and applications running on the platform. Salesforce.com was early to the market with Force.com and its proprietary platform. We note that Salesforce.com already has several companies running on its platforms that are writing large checks, with management alluding on recent earnings calls that some may potentially be considering IPOs. However, we’d note that Salesforce.com’s technology does not work on premises and this could limit relevance as a broad platform provider. AWS currently supports a broad range of startups and established companies running on its services, including FourSquare, Pinterest and Netflix. An emerging concern over PaaS is potential for vendor lock-in Success with ISVs will be a key indicator of traction PaaS vendors that are locked into supporting JavaEE will be challenged
  22. 22. Section 3: The cloud as an economic catalyst Global technology 22 ed.maguire@clsa.com 20 September 2013 The cloud as an economic catalyst The cloud-computing model alters the economic calculus of information technology. In our view, the transition from products to services, from capex to opex, parallels the electrification of industry in the 19th Century as widespread access to distributed power catalyzed massive value creation and innovation. The benefits that cloud computing delivers to users and organizations translate into innovation, job creation and economic growth. The cloud-computing impact is multifaceted. The adoption of cloud computing creates new competitive challenges as well as shifts in the business model for vendors, and this impacts spending on traditional IT, which can be bucketed into capital and operating costs:  Capital expenditures - Areas potentially impacted include middleware, database, operating systems, storage, server, networking and IT consulting. The cloud-computing wave impacts capital expenditures in several ways: shifting consumption of on-premise purchase of hardware and software to public cloud services; substituting of free open-source software licenses and hardware designs for proprietary offerings; subsuming previously distinct infrastructure-management-software functions into a platform layer; and improving utilization of server and storage hardware through virtualization and other ways.  Operating expenditures - Potentially impacted areas include maintenance and support for software and hardware, corporate IT staff and support, real estate, heating, ventilation & air conditioning (HVAC), energy and third-party IT services (support and helpdesk). Cloud computing can potentially reduce the need for software maintenance and support (as well as third-party IT services) through standardization of infrastructure architecture, while reductions in overhead costs come from consolidation of facilities into more efficient design or use of outside providers. Scope varies, but robust growth expectations concur Industry analyst forecasts differ in terms of scope and definition of what is characterized as cloud, but concur in expectations for healthy growth. Gartner forecasts cloud computing to grow from US$93bn in 2011 to US$237bn in 2017, a 17% Cagr. Gartner sizes the global information and communications technology (ICT) market at US$3.6tn, with telecom services making up the greatest portion of overall spend. Adoption of cloud computing drives demand for all major categories of spending, although changes afoot in technology, business models and customer priorities will give rise to new winners and losers. Figure 14 ICT spending by category, worldwide (US$bn) 2011 2012 2013 2014 2015 2016 2017 Cagr (%) 2012-17 Devices 610 676 695 740 788 828 863 5.0 Datacenter Systems 138 140 143 149 155 160 165 3.4 Enterprise Software 273 285 304 324 346 370 395 6.7 IT Services 888 906 926 968 1,018 1,071 1,127 4.5 Telecom Services 1,653 1,641 1,655 1,694 1,732 1,769 1,803 1.9 Overall IT 3,560 3,648 3,723 3,875 4,039 4,198 4,354 3.6 Source: Gartner A disruptive force as well as a net-positive economic catalyst Industry analyst forecasts differ in scope, but concur in expectations of healthy growth Cloud-computing impact is multifaceted Software is forecast to grow faster than other technology categories
  23. 23. Section 3: The cloud as an economic catalyst Global technology 20 September 2013 ed.maguire@clsa.com 23 If we exclude telecom services, Gartner’s 2013 forecasts for total IT spending would be US$2.1tn, of which over US$300bn comes from software alone. We estimate that roughly 13% of total spending will be impacted negatively in some way by cloud adoption. Figure 15 Worldwide end-user spending on IT by technology segment and subsegment, 2013 US$bn As a % of segment (%) As a % of total IT spend (%) Impact from cloud computing PCs 202.0 29 5 Not meaningful Tablets 56.6 8 2 Neutral Mobile phones 386.3 56 10 Neutral Printers 49.8 7 1 Modest negative All devices 694.6 19 Servers 55.9 39 2 Negative External controller-based storage 29.3 20 1 Modest negative Enterprise network equipment 42.1 29 1 Neutral Enterprise communications applications 16.0 11 0 Modest negative All datacenter systems 143.3 4 Enterprise application software 132.0 43 4 Neutral Infrastructure software 171.7 57 5 Modest negative All software 303.7 8 Business IT services 773.0 83 21 Neutral IT product support 153.1 17 4 Modest negative All IT services 926.0 25 Mobile voice services 613.0 37 16 Neutral Mobile data services 430.6 26 12 Neutral Fixed voice services 298.4 18 8 Neutral Fixed data services 313.1 19 8 Neutral All telecommunications services 1,655.1 44 All IT spending 3,722.7 Source: Gartner, CLSA Public cloud services are a small subset of overall ICT spend, representing just 3% of the total US$3.6tn spend in 2012, increasing to 5% of a US$4.4tn market by 2017, according to Gartner forecasts. Figure 16 Public cloud services market and annual growth rate Source: Gartner 93 109 129 152 177 205 237 16 21 19 18 17 15 0 5 10 15 20 25 0 50 100 150 200 250 2011 2012 2013 2014 2015 2016 2017 (US$bn) Growth (%) Public cloud services represented just 3% of total 2012 ICT spend We estimate roughly 13% of IT spending will feel some negative cloud impact Cloud services growing at a rapid pace
  24. 24. Section 3: The cloud as an economic catalyst Global technology 24 ed.maguire@clsa.com 20 September 2013 Cloud application services (SaaS) will continue to be the largest proportion of public cloud services, forecast to grow from US$16.2bn in 2012 to US$27.8bn in 2017. CRM, enterprise resource planning (ERP) and collaboration applications are the largest SaaS segment, with the most robust growth expected from digital content creation, office suites and business intelligence platforms. As the most mature segment of cloud services, SaaS in 2012 accounted for 69% of the public cloud services market; Gartner expects this to decline to 53% by 2017 as IaaS becomes a larger portion of the market (and custom-build applications increasingly go into production). Figure 17 Market-size forecast for IaaS, PaaS and SaaS Source: Gartner Gartner expects cloud application infrastructure services (PaaS) to grow in line with the market, increasing from US$1.2bn in 2012 to US$3.6bn in 2017, a Cagr of 23.5%. Overall PaaS is likely to remain roughly 5% of public cloud services through 2017. Cloud system infrastructure services (IaaS) should grow at the most robust rate, increasing from US$6.2bn in 2012 to US$30.6bn in 2017, a Cagr of 37.8%. IaaS should jump from 26% of public cloud services in 2012 to 43% by 2017. Measuring return on the cloud Quantifying the economics of cloud computing is an inexact discipline; there are so many variable inputs that defining payback is necessarily situation- specific. Calculations need to incorporate not just cost factors, but also the creation of incremental value (whether in the form of additional revenue, new innovation, competitive advantages, etc). Nonetheless, there are a few key measures that businesses in particular must assess to determine the economic rationale for a cloud investment. According to CDW’s 2013 State of the Cloud Report Survey (comprising 1,242 IT professionals including 479 organizations implementing or maintaining cloud computing), respondents are currently saving an average of 13% of their organizations’ IT budgets using cloud resources and applications, with savings expected to increase to 17% in one year and 25% in four years. The Business Impact of the Cloud, a March 2012 report by Vanson Bourne, found benefits from cloud computing ranging from 15% for quantifiable reduction in IT spending to a 21% acceleration in time to market for new 0 10 20 30 40 50 60 70 80 2011 2012 2013 2014 2015 2016 2017 (US$bn) IaaS PaaS SaaS SaaS is the largest portion of the market, forecast at an 18.5% Cagr through 2017 Quantifying economics of cloud computing is an inexact discipline CDW survey respondents cite an average 13% IT budget savings from cloud, increasing to 25% in four years SaaS, PaaS and IaaS to grow from US$23.6bn in 2012 to US$72bn in 2017, a 25% Cagr
  25. 25. Section 3: The cloud as an economic catalyst Global technology 20 September 2013 ed.maguire@clsa.com 25 services. On average, respondents had an average of 17% reduction in IT maintenance costs and 16% reduction in operational costs. Figure 18 Estimated quantifiable benefits from cloud computing Source: The Business Impact of the Cloud – Vanson Bourne survey based on interviews conducted with 460 senior European enterprise IT decision makers When asked what cost factors are considered when comparing cloud alternatives to traditional IT offerings, 65% of respondents to CDW’s survey cited software management costs, 63% cited software licensing costs, 52% cited IT labor costs, 41% cited cost of capital with electricity costs (21%) and real estate (12%) rounding out the survey. Total cost of ownership (TCO) considerations are complex . . . Traditional on-premise technology infrastructure includes servers, storage, networking and software (operating system, middleware, database, systems management, security, data integration). These components are purchased or leased typically with a useful life. Related operating expenses include maintenance and support, full-time employee labor cost, energy and facilities. There are challenges to calculating specific ROI as components within the datacenter may have disjunct life cycles because useful lives of servers, storage and networking equipment are not coterminous. There are also differences in the useful life of datacenter hardware and the facilities housing them. One of the most effective measures of IT performance is availability, which is typically expressed in terms of downtime. Five “9s” (99.999% availability) translates to around five minutes of downtime per year, while four “9s” is around 53 minutes. Availability for revenue-producing applications can have a direct and quantifiable cost attached, while for non-revenue production apps there are costs to productivity and employee downtime. Time to market represents how long it takes for an organization to bring products or services to market; opportunity costs are alternative uses of resources or opportunities against which initiatives can be measured, while productivity is a measure of output per employee. All of these measures can impact the cloud-computing ROI equation. 15.07 16.18 16.76 16.96 18.04 18.80 19.63 20.66 Average quantifiable reduction in IT spend Average quantifiable reduction in operational costs Average quantifiable reduction in IT maintenance costs Average quantifiable reduction in M&A integration costs Average quantifiable increase in employee productivity Average quantifiable increase in process efficiency Average quantifiable increase in enabling fast growth Average quantifiable increase in getting new products/services to market faster (%) Benefits range from 15% reduction in IT spending to a 21% faster time to market for new services There are challenges to calculating ROI as components may have disjunct life cycles Uptime/availability is a key factor in determining financial impact
  26. 26. Section 3: The cloud as an economic catalyst Global technology 26 ed.maguire@clsa.com 20 September 2013 . . . and cloud ROI is an inexact science The Economics of Cloud Computing by Bill Williams provides a framework for calculating the ROI of cloud-computing projects. Line items that can be measured include disk storage, disk maintenance, server hardware, server maintenance, firewalls and load balancers, network switches, software licenses, software maintenance, facilities and full-time equivalent (FTE) labor. A business calculating the ROI of SaaS versus traditional on-premise IT (or PaaS or IaaS) would need to calculate the costs of all of the prior components over a period of several years (typically three years) then compare this to the cost of a SaaS subscription. Once annual costs have been calculated, then multiyear costs should be reflected. Typically, a documented payment on a cloud investment in less than a year is respectable. ROI = (gains from investment less costs of investment)/costs of investment. Net present value (NPV) uses a discount rate applied to cash inflows and outflows starting in the first year. If the NPV is high enough (and positive), that would suggest a project makes economic sense (if assumptions are correct). Will cloud computing reduce or increase aggregate IT spending? An ongoing investor concern is that the deflationary aspects for IT - declining cost of computing, emergence of free open-source software and the shared efficiencies from cloud architecture - will ultimately dampen IT spending. We would concur with author Simon Wardley’s view that cloud computing is subject to the Jevons Paradox, the theory that technological progress that increases the efficiency with which a resource is used will increase the rate of its consumption. Figure 19 Cloud computing has parallels with the Jevons Paradox Source: Wikipedia English economist William Stanley Jevons first described this paradox in his 1865 book The Coal Question. At that time, there were concerns that British coal reserves were dwindling, and some experts believed that improvements in efficiency would reduce coal consumption. The Jevons Paradox was the argument that fuel-efficiency improvements would actually increase fuel use, not reduce demand, as greater output per unit of coal would actually Improved technology doubles the amount of Work produced with a given amount of Fuel Demand for Fuel rises Elastic demand Costs falls by half Price 0 Quantity Quantity demanded more than doubles ROI is commonly calculated over a period of three years We believe cloud computing reduces costs, which will accelerate demand As prices of a commodity decline, demand elasticity significantly boosts consumption The Jevons Paradox was first observed with UK coal consumption in the 19th Century
  27. 27. Section 3: The cloud as an economic catalyst Global technology 20 September 2013 ed.maguire@clsa.com 27 stimulate demand. Jevons observed that coal consumption grew dramatically after James Watt introduced the coal-fired steam engine, given its efficiency over Thomas Newcomen's prior design. It’s our view that cloud computing and related technologies such as open- source software and higher-level programming languages are a parallel to James Watt’s steam engine, with compute power substituting for coal. As such, disruption within the infrastructure is likely to continue along a path of “creative destruction” as proprietary infrastructure hardware and software providers see their ability to charge premium “rents” and enjoy attractive profit margins steadily erode. The commoditization of computing, bandwidth and storage has proven to be a continuous dynamic. The principle of Moore’s Law, which holds that processor performance can double every 18 months, has held fast since the 1970s, while price performance of Dram continues to improve along a similar dynamic. It’s a fair assumption that these dynamics will continue for the medium term, but over the next decade it’s likely we may reach the physical limits of processor density. This in turn could have longer-term ramifications on resource- consumption considerations in software architecture, but for the foreseeable future the emerging cloud-computing architecture continues to factor in declining cost of compute. We’d highlight our colleague Mark Heller’s CLSA U Blue Book Moore no more? The future of IC manufacturing, which explores the implications of reaching the end of Moore’s Law. Figure 20 Moore’s Law Source: Wikipedia In fact, the dynamic of exponential cost and performance improvement is occurring across a broad range of technologies. While improvement occurs at different rates, the consistent historical trend remains a common dynamic across different hardware technologies. Cost of computing, bandwidth and storage continues to decline Moore’s Law has held fast since the 1970s Open-source software and higher-level programming languages parallel James Watt’s steam engine
  28. 28. Section 3: The cloud as an economic catalyst Global technology 28 ed.maguire@clsa.com 20 September 2013 Figure 21 Time to double (or half) Dynamic Ram memory “half pitch” feature size 5.4 years Dynamic Ram memory (bits per dollar) 1.5 years Average transistor price 1.6 years Microprocessor cost per transistor cycle 1.1 years Total bits shipped 1.1 years Processor performance in MIPS 1.8 years Transistors in Intel microprocessors 2.0 years Microprocessor clock speed 2.7 years Note: MIPS = millions of instructions per second, a measure of processing capacity. Source: Ray Kurzweil, KurzweilAI.net Sizing the broader economic impact of cloud computing A May 2013 report from McKinsey Global Institute estimates the potential economic impact for cloud technology between US$1.7-6.2tn in 2025, of which US$1.2-5.5tn could come from surplus from the use of cloud-driven services, while US$500-700bn could come from productivity improvements in enterprise IT. The McKinsey report assumed 20-30% productivity gains from reduced infrastructure and facilities footprint, with 10-15% productivity gains from standardization of application environments and packages as well as faster experimentation and testing. A 2012 report from KPMG Australia estimated that adoption of cloud services across 75% of relevant ICT spending, achieving opex savings of 25% and capex savings of 59% after 10 years, would result in an increase of long-run GDP of 0.23% per year or A$3.32bn. The economic benefits can be grouped into three broad categories, according to the report: direct cost savings, productivity improvements and innovation. A positive force for economic growth There has been some debate about the impact that ICT and cloud computing in particular is having on job creation. A natural process of “creative destruction” comes from automating manual processes and enabling tasks to be performed in geographically dispersed locations (at lower cost). There is a growing number of studies that seek to quantify the beneficial impact of cloud computing. A 2009 study by Federico Etro on the Economic Impact of Cloud Computing on Business Creation, Employment and Output in Europe found that cloud computing would contribute between 0.05-0.3% to the annual growth rate in Europe. The Centre for Economics and Business Research in 2010 found that cloud computing would improve the efficiency of an average employee by an average of 2.1%, and would generate 1.6% of total GDP for UK, Germany, France, Italy and Spain from 2010 to 2015. A white paper by Harvard Business School Professor Marco Iansti and Gregory Richards of Keystone Strategy found that cloud computing would increase US GDP by 0.83-0.99% per year. A March 2012 study commissioned by SAP and published by the Sand Hill Group cited several findings:  11 cloud companies added 80,000 jobs in the USA in 2010 alone.  Companies selling cloud services are forecast to grow cloud-based revenue an average of US$20bn per year, which could generate as many as 472,000 jobs in the USA and internationally over the next five years. There is a natural process of “creative destruction” from automating manual processes Companies selling cloud services are forecast to grow cloud revenue an average of US$20bn/year McKinsey estimates the potential economic impact for cloud between US$1.7-6.2tn in 2025 Exponential cost and performance improvement occurs across technologies
  29. 29. Section 3: The cloud as an economic catalyst Global technology 20 September 2013 ed.maguire@clsa.com 29  Over the next five years, US$30bn in cumulative venture-capital investments in cloud computing is expected, which could add another 213,000 new jobs in the USA and abroad.  Cloud computing could save US businesses as much as US$625bn over the next five years, much of which can be reinvested in new business opportunities and additional jobs. Microsoft in March 2012 sponsored a study with IDC - Cloud computing’s role in job creation - that estimated that in 2011, IT cloud services helped organizations of all sizes in all sectors globally generate more than US$400bn in revenue and 1.5m new jobs. As a result of the new study, IDC estimates:  Increased business revenue from cloud-enabled IT innovation could reach US$1.1tn a year by 2015 globally.  Spending on public and private IT cloud services could generate nearly 14m jobs worldwide by 2015.  Over 50% of new cloud-related jobs will come from small- and medium- sized businesses. Over 1m jobs will be created in banking, communications and discrete manufacturing. The majority of these jobs will come from emerging markets like India and China because of their large workforce. An innovation accelerator There is increased focus on cloud-fueled business incubation and we believe we are at the beginning of enterprise adoption of the cloud to fuel business innovation. A February 2012 study from the IBM Institute for Business Value and the Economist Business unit found that 72% of the leaders were piloting, adopting or had substantially implemented cloud computing; this is expected to reach 90% in three years. Out of the top seven objectives cited for cloud adoption, only one was related to cost reduction; other objectives include increased partner collaboration, new channels/markets, new revenue streams, competitive differentiation, flexible pricing models and rebalanced mix of offerings. This same study found that only 16% of respondents were currently using the cloud for innovation, such as entering new lines of business or industries, while 35% plan to rely on the cloud for business- model innovation in the coming three years. Initial beneficiaries of public cloud IaaS customers have been web-based startups, departmental application projects, “burst” or overflow hosting for ecommerce applications for the medium term. Concerns over security, integration and governance keep the most mission-critical enterprise applications on premise. We believe continuous pricing deflation of cloud IaaS favors scale over the long term. Smaller entrants and traditional service providers will be forced to differentiate into higher-value services. Providers will seek to achieve vendor lock-in through proprietary offerings (such as PaaS), but open-source initiatives such as OpenStack will help preserve openness. Internet/ecommerce businesses are direct beneficiaries of virtually unlimited compute, storage and network bandwidth offered and managed as a service. Examples include Google, Facebook, NetFlix, Amazon, FourSquare, Pinterest and many more. Cloud-enabled IT innovation could reach US$1.1tn/year by 2015 globally We are at the beginning of enterprise adoption of the cloud to fuel business innovation Smaller cloud IaaS vendors will be forced to differentiate into higher- value services
  30. 30. Section 3: The cloud as an economic catalyst Global technology 30 ed.maguire@clsa.com 20 September 2013 Who benefits? As we’ve discussed before in our writings on innovation, the combination of cheap, accessible and scalable compute and storage allows users to create, innovate and experiment with applications - to bring the marginal cost of failure towards zero. Startups and entrepreneurs benefit from cloud services. Many of these are small, but a number has reached significant scale. We would aggregate beneficiaries into several segments:  Cloud-service providers - Infrastructure-as-a-Service providers benefit from growing secular demand for their services. Competitive dynamics are fierce. Service providers win on scale, transparency, ease of provisioning, security and governance. We’d distinguish these providers from beneficiaries who happen to be users. Amazon’s non-AWS businesses are an example. Microsoft’s Bing and Office365 benefit from the underlying cloud infrastructure platform. Leading cloud-service providers include Amazon (AMZN), Salesforce.com (CRM), Microsoft (MSFT), Google (GOOG), Rackspace (RAX), Joyent (Private), Softlayer/IBM (IBM), Terremark/Verizon (VZ), Savvis/CenturyLink (CTL), Navisite/Time Warner (TW), Dimension Data/NTT (NTT) and others. Amazon remains the dominant leader in this segment by virtue of massive scale, aggressive feature expansion and low cost. We are seeing incumbent technology vendors, including Oracle and VMware, launch their own public clouds as part of their own strategies. At this stage, we see most vendors as playing defense against Amazon’s dominance and would expect smaller competitors to seek differentiation through vertical or process-related services.  Internet and ecommerce companies - Then there are internet and ecommerce businesses that operate on a cloud-architected infrastructure. Google, Facebook, LinkedIn and Yahoo all benefit from scale, cost and flexibility advantages that come from modern cloud architecture. The cloud delivery model affords a variety of business models: advertising, information services (accessed through API calls) and various ebusiness strategies. If one examines the essential IP that differentiates internet companies from one another, it’s clear that the value resides in the software. Google Search, Facebook, OpenTable, Yelp, Twitter and LinkedIn - these are all applications at the core, with different constituencies and models. Where they all benefit is from the ability to scale rapidly and efficiently, leveraging low-cost and commodity hardware. It’s important to distinguish that not all internet/ecommerce companies run on a cloud- based architecture. Some are just delivering applications written to a multitier architecture and delivered over the internet. Conversely, applications written on a cloud-based architecture can be delivered behind a corporate firewall. Leading internet and ecommerce companies include Amazon (AMZN), Facebook (FB), Google (GOOG), NetFlix (NFLX), LinkedIn (LNKD), Yahoo! (YHOO), Baidu.com (BIDU), Sohu.com (SOHU), Pandora (P), Yelp (YELP), Zillow (Z), Angie’s List (ANGI), Zynga (ZNGA), BlueNile (NILE) and others.  Software-as-a-Service vendors as “cloud natives” - We’ve already seen the emergence of highly successful SaaS companies that deliver their applications over the internet, with business models based on subscriptions, transactions and business outcomes. SaaS vendors benefit both from running on top of PaaS and IaaS, while reducing the cost and Internet and ecommerce companies are cloud applications SaaS vendors benefit from running on top of PaaS and IaaS Cloud computing brings the marginal cost of innovation failure towards zero
  31. 31. Section 3: The cloud as an economic catalyst Global technology 20 September 2013 ed.maguire@clsa.com 31 overhead required to maintain infrastructure and at the same time delivering real business value from application logic. There are numerous publicly traded SaaS vendors that benefit from operational efficiencies derived from delivering a service based on shared resources. Not all employ a true cloud-based architecture. We note that Salesforce.com has architected its Sales Cloud and other applications on its own Force.com PaaS, while its other PaaS offering Heroku runs on Amazon Web Services. Leading SaaS vendors include Salesforce.com (CRM), NetSuite (N), Workday (WDAY), BazaarVoice (BV), BlackBaud (BLKB), Carbonite (CARB), Concur (CNQR), Cornerstone OnDemand (CSOD), Demandware (DWRE), LogMeIn (LOGM), LivePerson (LPSN), ServiceNow (NOW), RealPage (RP), Responsys (MKTG), Marketo (MKTO), ServiceSource (SREV), DealerTrak (TRAK), Ultimate Software (ULTI) and Vocus (VCUS).  The nimble startups - It is axiomatic that software startups seeking venture funding need to be running on a public cloud like AWS, Azure or AppEngine. There are thousands of pure-play internet and mobile companies running on AWS, with FourSquare, Instagram and Pinterest among the most prominent. Salesforce.com has disclosed that its own ecosystem of third-party ISVs on Force.com has reached critical mass, with at least one potential IPO in the wings. The rise of the “API economy” Cloud infrastructure is also giving rise to a generation of companies with business models built on APIs. Entertainment, sports, news, maps and location services can be delivered as part of application “mash-ups” with revenue based on the number of times the services are accessed. Web APIs are more than technology, they facilitate new revenue opportunities and give rise to new models. As the role of data becomes increasingly important, the economic power of APIs will become increasingly apparent. An API is a simple concept in programming terms, a protocol intended as an interface for software components to communicate with each other. The term “web API” refers to a web service, which is an always-on software function accessible via a network address over the internet or in the cloud. Essentially, a web service is a way to access functionality over the web as a component. Providers of web services, sites and brands publish their APIs, and what has evolved is a broadly open architecture that allows sharing of data and content between applications. This allows content that is created in one place to be updated and posted in different locations across the web. The interoperability is critical because it allows applications to be treated like services - and services like applications. Web APIs are behind what is known as “Web 2.0” functionality, where multiple services can be embedded into web-based applications. Various uses include:  Photo sharing - Photos from sites like Flickr and Photobucket can be shared via social sites like Facebook.  Content embedding - This enables content to be embedded, such as a slide presentation from Slideshare or Scribd to a LinkedIn profile or blog. Video content from Vimeo or YouTube can be embedded as well.  Dynamic content sharing - This allows comments or content created in applications like Twitter, Facebook or TripAdvisor to be shared on Facebook, LinkedIn or other sites. Transforming the app economy into the API economy An open architecture has evolved that allows sharing data and content between applications Web APIs are behind what is known as “Web 2.0” functionality Fostering a surge of startups
  32. 32. Section 3: The cloud as an economic catalyst Global technology 32 ed.maguire@clsa.com 20 September 2013  Identity sharing - This functionally allows user information to be shared from web communities to outside applications. The Facebook application platform allows users of third-party applications to create IDs and log into apps via an open API. This creates value for the app by allowing it to access user information, while offering new functionality to the web community. Unlocking value by connecting businesses to the world In many ways, the app economy is being replaced by the API economy. APIs are building blocks for the next generation of applications, a way to embed a plethora of different services into composite “mash-ups”. The website Programmable Web tracks over 9,900 commercially available APIs, and we are seeing steady growth of private companies whose business models are purely based on API calls (requests for the underlying service). Notable are privately held Factual (an information directory service) and Alohar Mobile (a geo-location API). Other firms like Pipl and SportsData are openly indicating plans to charge for the use of their APIs. Others such as Dun & Bradstreet, Klout and BestBuy are finding ways to monetize their APIs. In April 2013, Intel purchased API aggregator Mashery for over US$180m, reflecting the broad strategic importance of API services. API business models are increasingly important sales channels
  33. 33. Section 4: Ripples turn to waves Global technology 20 September 2013 ed.maguire@clsa.com 33 Ripples turn to waves Cloud-computing architecture recasts the dynamics of infrastructure hardware and software. Incumbent technology vendors must navigate dual threats from ascendant open-source alternatives and transition to service models. Below the PaaS layer, providers of middleware, database, operating systems and hardware must reckon with the forces of creative destruction. As value accrues up the stack, it gravitates towards SaaS and solution services. Our top software picks are Salesforce.com, Akamai and Microsoft. As infrastructure transforms into a service, on-premise models are disrupted. Open-source alternatives undercut pricing power for proprietary infrastructure offerings. This doesn’t mean there aren’t good business opportunities around open source, rather it means that rules change. High- margin hardware and infrastructure-software vendors will see revenue and margins pressured, whereas low-margin, high-volume players can do well exploiting economies of scale. Cloud infrastructure service providers are likely to win on scale. We expect Amazon, Google and Microsoft to be long-term winners, while Rackspace appears at risk. EMC is positioned to benefit from ongoing datacenter buildout, along with Delta and Quanta. Proprietary infrastructure vendors at risk include Intel, HP, VMware and Oracle. Dual vectors of disruption The adoption of a cloud-based architecture brings to bear two primary vectors for disruption on providers of technology infrastructure:  Open-source software/commodity hardware. The next generation of cloud architecture is heavily based on open-source software. Once considered the province of IT geeks, open-source software is fully in the mainstream and there are more viable alternatives to proprietary software than ever.  “Everything as a service”. A defining characteristic of cloud-infrastructure services is the ability for customers to purchase compute, storage and other services per use on a subscription or metered basis. This is a profound shift (and challenge) for incumbent technology providers, financially, organizationally and culturally. Open-source alternatives mature for software layers Open-source software is a key vector for disruption, particularly for cloud computing since so much of the infrastructure in the new cloud-based architecture is based on open-source components. Open-source principles inherently enable innovation, not just in software, hardware and services, but through the derivative benefits to technology users in any endeavor. There are over one billion lines of freely available open-source code that developers and business users can access to create applications and new businesses. Free open-source software reduces costs for startups as well as new projects within IT organizations. Even with paid technical expertise and support, the ROI tends to be overwhelmingly favorable for open source. Over the past decade, Linux has made significant inroads into the Unix and mainframe markets. Since 2009, Linux server shipments enjoyed a 17% Cagr, well ahead of Windows Server’s 7% and Unix’s 11% decline. IT spending to grow in aggregate, with plenty of “creative destruction” Open source has been critical to enable innovation, not just in software Value migrates upwards, commoditization pushes downwards; PaaS is the pivot point
  34. 34. Section 4: Ripples turn to waves Global technology 34 ed.maguire@clsa.com 20 September 2013 Figure 22 Server shipments by OS (units) 2009 2010 2011 2012 % Cagr 2009-12 Linux 1,792,929 2,119,427 2,472,226 2,875,927 17 Unix 439,804 403,346 366,426 314,472 (11) Windows 5,212,754 6,252,158 6,570,900 6,382,128 7 Source: Gartner However, the economics of open source illustrate the disruptive impact on business models. Revenue associated with Linux is based on subscriptions for support and services, not for the software (which can be downloaded for free). From 2009 to 2012, Linux increased from 24% to 30% of server shipments, while the proportion of revenue increased from only 9% to 12%. Figure 23 Revenue share for server operating systems Source: Gartner There are increasingly viable open-source alternatives to proprietary software all the way up the stack from OS (Linux, FreeBSD) to database (MySQL, MongoDB, Cassandra), Big Data/data-warehousing management (Hadoop, Talend), content management (Drupal), application server (JBoss), analytic tools (R language, Pentaho, Jaspersoft), CRM (SugarCRM) and many more. In fact, it is not unusual for startups, particularly in the internet or ecommerce arena, to avoid the use of proprietary software entirely. “X”-as-a-Service models upend equipment capex SaaS vendors have disrupted the existing on-premise enterprise software applications landscape. While this is partly due to the online delivery model and subscription basis of the business, the advantage that SaaS vendors have is the ability to develop and push innovations into the market more quickly. Salesforce.com in application software uses periodic, rolling version releases (summer 2013, winter 2012) that can be launched several times a year rather than monolithic versions of on-premise applications that saw annual or even less frequent updates. The market for public cloud IaaS is Amazon’s to lose as the company’s momentum outpaces all other competitors. Its self-service model has proven extraordinarily effective in growing the business to a US$2bn-plus annual run rate. “Gorilla game” dynamics (by which disproportionate benefits and market share accrue to the leading vendor in the space) are in full effect, as Amazon’s APIs and conventions have increasingly become the de facto standard in the cloud. 6.5 7.6 8.4 9.3 9.9 10.5 11.7 37.6 34.9 32.2 30.0 29.9 27.3 24.4 55.9 57.5 59.4 60.7 60.2 62.2 63.9 0 20 40 60 80 100 120 2006 2007 2008 2009 2010 2011 2012 (% of total market) Linux Server UNIX Server Windows Server The leading cloud platforms, including Google and Amazon EC2, are built on open source Linux now accounts for 30% of server shipments Amazon is pushing the cost curve down . . . while the proportion of revenue increased from only 9% to 12% Linux increased from 24% to 30% of server shipments . . .

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