Alphabet (GOOG, Financial) (GOOGL, Financial), Google’s parent company, is still riding on the power of its search engine, its network of sites and the advertising dollars that they bring. Outside of Search, Google’s main successes have been Android, which is the number one operating system in the world in terms of absolute numbers, Gmail, the second most used email client and Chrome, which holds more than half of internet browser market share and Google Maps, the one map that we all depend on.
It’s clear that even its successful products have one thing in common. Their purpose is to drive traffic to Google Search, from where Google can make its money. As a matter of fact, Google Fiber, a highly capital-intensive pet project, started with an aim to dramatically increase the speed of broadband connections and also to goad traditional carriers to increase their speeds. All of this will ultimately end up increasing our search engine usage, which is what Google wants.
With Google being the number one search engine, it's understandable that the company is doing its best to keep the lead by building an ecosystem around it consisting of all the things I just described. But in the world of technology, disruption is the buzzword, and when you are company commanding a more than half-trillion dollar valuation, it's better to have multiple revenue streams flowing into the company. If you can have them coming from different segments, that’s the biggest moat a business could have.
Google Bets is where the company keeps trying for those moonshots, but until now nothing substantial has come out of it. The wildly hyped-up Google Glass, for example, was a spectacular failure; Google Plus didn't manage to excite the crowds; and now they also have the highly ambitious autonomous car project that have other heavyweights like Apple (AAPL, Financial) in the game.
What does Google have that works?
Google has two important businesses that are not designed to drive search traffic: YouTube and Google Cloud Platform.
YouTube is a predictable breadwinner for Google, but the volume still isn’t good enough to turn it into a standalone reporting segment. Moreover, with Facebook poised to take on video in a big way, the number one free video site has something to be worried about. From here on out Google will have to fight just to keep its YouTube ad revenues intact, let alone expect any kind of significant growth.
Google Cloud, however, is a different ball game. Although the company has been sitting on cloud assets for nearly 10 years and most of it has been used up for its own needs, the company finally woke up to the reality that cloud can be a big revenue driver. Unfortunately, only late last year did it get serious about this business unit and get Diane Greene to move from the board to head up the cloud division. With her experience and connections, she’s already brought in names like Home Depot (HD, Financial) to Google Cloud.
But cloud is a tough nut to crack because three large entities sit at the top and are already racing towards the $10 billion annual sales mark - Amazon (AMZN, Financial), Microsoft (MSFT, Financial) and IBM (IBM, Financial). Their robust cloud capabilities have given them double-digit growth for the last eight quarters while Google is still at the $1 billion annual cloud revenue level.
Do they still have a shot at a big cloud business?
Google’s only chance at being a significant cloud player is to quickly get above $10 billion in sales as soon as they possibly can. Not only will it be a significant portion of their $75 billion overall revenue, but it will bring them closer to the leaders of the pack.
The problem is Google will need to be twice as aggressive as Amazon and twice as organized as Microsoft in order to make sure that its closing the revenue gap with these two cloud providers. It may never have the broad offering that IBM has or have an edge in enterprise the way IBM and Microsoft do, but it can certainly go for volume the way Amazon has done.
The top three aren’t going to let Google get an edge without a tough fight. The competition is so fierce now that Microsoft Chairman Don Thomson recently told Bloomberg that he wants Microsoft to grow its cloud unit much faster than the current rate. Microsoft Azure has been growing at three-digit rates for the last few quarters, and if their chairman is saying that’s not enough, you can imagine how critical this is for them.
Google is caught between a rock and a hard place, figuratively speaking. So now the question is: Is there still a long enough growth runway for Google Cloud to catch up to the other three and start growing alongside them instead of way behind them?
What’s the potential for cloud infrastructure?
IDC expects the cloud infrastructure industry to to grow at a CAGR of more than 41%. Considering the growth numbers that Amazon and Microsoft posted in the last eight quarters, the odds are extremely high that rapid growth will continue for the next several years.
“Public cloud infrastructure as a service (IaaS) offerings are rapidly gaining acceptance among enterprises as a viable alternative to on-premises hardware for IT infrastructure. A recent survey of over 6,000 IT organizations found that nearly two thirds of the respondents are either already using or planning to use public cloud IaaS by the end of 2016. International Data Corporation (IDC) forecasts public cloud IaaS revenues to more than triple, from $12.6 billion in 2015 to $43.6 billion in 2020, with a compound annual growth rate (CAGR) of 28.2% over the five-year forecast period.”
- IDC
Gartner, another respected source, predicts that the cloud industry including infrastructure and as-as-a-service products such as Office 365 to grow from $175 billion in 2015 to $204 billion in 2016.
"The market for public cloud services is continuing to demonstrate high rates of growth across all markets and Gartner expects this to continue through 2017," said Sid Nag, research director at Gartner. "This strong growth continues reflect a shift away from legacy IT services to cloud-based services, due to increased trend of organizations pursuing a digital business strategy."
- Gartner
But even at $200 billion, we would only be dipping our toes into this futuristic technology. Cloud adoption has exponentially grown in the last five years, but it is a very real possibility that companies that are being formed now and in the future will never need to set up their own infrastructure because they will have four big companies to choose from.
Enterprises will also slowly move into public cloud as IT costs skyrocket and investors clamor for cost-savings in mission-critical tech areas. Or they could start with a hybrid cloud where they still have their own IT infrastructure but plug that into a public cloud and exploit the cost and convenience benefits.
In fact, the problem is so widespread that Oracle CEO Mark Hurd recently said this:
“CEOs everywhere are under intense pressure to cut expenses, including IT expenses, to boost earnings—and save their jobs.”
Global IT spending runs into trillions of dollars. In 2015, overall IT spending was $3.41 trillion. Though not all of that money will flow into cloud, it's easy to see how the cloud industry can potentially walk away with a lion's share of spending on data center systems (servers), software (CRM, as-a-service products) and other services.
This segment’s growth is far from over, but I expect the three current leaders to stay there for some more time, at least until newcomer Google gives enterprise and middle market consumers enough reason to switch over from their existing providers.
But there are several problems that the company needs to overcome before it is a competitive force in this industry. In the upcoming second article of this series, I’ll cover Google’s challenges, opportunities, threats and weaknesses in its fight to gain cloud market share.
Disclosure: I have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.
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