I spoke on “Overcoming the Barriers to Building Great Products” at this year’s Silicon Valley Product Camp. In this presentation, I look at how great products generate superior financial returns even though they have equivalent or lesser functionality to their competition. I then present a hypothesis that building a great product requires making decisions that run counter to the quantifiable ROI requirements that almost every business endorses.
Google cut prices dramatically last week on it’s Infrastructure as a Service (IaaS) offering, Google Cloud Platform. Amazon followed suit on Amazon Web Services the next day and cut prices to match Google’s price cut. What business strategy lessons can we learn from these prices cuts and what can we predict about the future prices?
Commodity Products Compete On Price
Even though it takes both access to a large amount of capital and a high level of technical capabilities to run a large scale cloud provider, the cloud computing services especially compute and storage are a commodity as one providers offering is equivalent to another’s in the purchasers mind. There’s little difference in a virtual machine from Amazon, Google or Microsoft Azure.
As cloud resources are undifferentiated products, it’s not surprising that Google is choosing to compete on price. As a smaller player (in terms of cloud market share) hoping to take share from Amazon, Google needs to compete on price. Other attributes such as reliability surely matter but there’s not enough difference for Google to effectively compete on those.
As is frequently the case when when one player cuts prices, the other players respond with their own price reductions. Amazon responded by cutting prices to match Google for on-demand instances. Interestingly, there’s a significant difference in pricing structure for heavy usage. Google gives automatic discounts at 70% and 100% usage in a billing cycle. Amazon is cheaper when using reserved instances but they require up front payment and thus the buyer loses the option to terminate or reduce usage with out penalty. The reserved instance approach helps Amazon when comes to capacity planning but is less buyer friendly.
The other piece to note is that Amazon cut prices only on services where Google competes with them. Amazon left prices alone on services that do not have a Google equivalent such as Dynamo DB or the RedShift data warehousing service. Services where the competitors do not have competitive offering are differentiated and not a commodity.
What to Expect For Future Prices
For both compute and storage, we can expect costs to fall due to Moore’s law for processing and that hard drives get denser over time. Even if data center costs stay flat, providers being able to get more yield for a given amount of rack space and power means costs will continue to fall. The other question is will competition force lower margins over time? If so, prices could fall faster than costs as competition drives margins and thus prices provider lower.
As providers show no signs of being able to differentiate offerings in cloud storage and compute, I expect prices to continue to fall. With prices likely to fall, Amazon three year reserved instances become on a gamble since as realized price for Google’s offering may fall over enough over the next 3 years where it’s a better deal to use Google’s pay as you go price especially considering the flexibility to change or reduce consumption as needs change.