July 15, 2010 – Clouds: Who Will Get the Silver Lining?

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A brief audio review of this research may be found here: http://live.ssrllc.com/wp-content/uploads/2010/07/July-15-2010-Sagawa-Cloud.wma

Within a decade, we believe that the large majority of Americans will accomplish the large majority of their work and personal computing needs via “cloud” applications hosted on large distributed multi-tenant server systems and accessed over the Internet.  The opportunities in applications, platform software, hardware and hosting are collectively expected to grow 20.5% over the next 5 years to $148B, beginning to crowd out traditional PC investment in the process.  Many consumer cloud applications, led by search, webmail, social networking and e-tail, are already well established, with portable devices increasing their utility and significant new opportunities emerging.  Enterprise adoption has begun in earnest, but will be measured, as IT management struggles with control and security concerns.  The strong scale economies inherent in the cloud concept obviously favor companies able to gain critical mass and establish dominance quickly – e.g. Salesforce.com, Facebook, Google, Amazon, VMWare, Cisco, et al.  We also expect M&A to be active in this area as leaders fill holes and large players without strong positions seek footholds

Cloud computing is simpler than the confusion around it would suggest – the term refers to applications and/or data hosted on a shared system of servers and storage accessed by users via the Internet.   Cloud computing makes use of a technology known as “virtualization” by which a single system of processors can emulate separate discrete computers, each able to run its own operating system and applications.  Enterprises also implement virtualization in their internal systems, to take advantage of economies of scale, increase flexibility, and maintain centralized security and control

Cloud computing is the culmination of the swing back toward centralized processing that began as ‘90’s client/server architectures countered the diaspora of computing resources of the mini-computer and PC eras.  The incremental resources needed to run a cloud application on a large shared server cluster cost far less than on a dedicated server, and far, far less than a single user platform.  Cloud applications have the added benefits of being accessible where, when and how the user chooses, easy scalability and of being maintained and upgraded by a reliable third party.  Moreover, cloud-based apps dramatically increase the practical functionality of portable devices, particularly with the advent of wireless broadband.   The biggest downsides, particularly felt by enterprises, are a loss of control, perceived security threats, and the costs of transition

The cloud is already the primary architecture for the applications most used by consumers.  Web email, social networking, search, on-line shopping, entertainment streaming, mapping/navigation, even securities trading are all cloud-based activities for individuals.  With the rise of on-line productivity suites for the home office – word processing, spreadsheet, calendaring, contacts management, presentation graphics, etc. – that give full access to updated content, in formats compatible with traditional PC-based applications, from almost any internet connected platform, the added utility of home computers is waning.  This is inherent in the rise of smartphones and the enthusiasm for tablet style devices, like the iPad

Enterprise applications vary widely in their cloud appropriateness.  Where benefits of wide and/or mobile access are high, and the importance of tight control and security are low, such as CRM (Customer Relationship Management), a transition to cloud architecture may be worth the cost.  Where system access requirements are narrow and fixed, with need for strong IT control and security, such as ERP (Enterprise Resource Planning), clouds currently offer little benefit that cannot be achieved through in-house virtualization.  Beyond the obvious CRM and disaster back-up applications, we see general productivity apps, like e-mail, calendar, document processing, etc., and vertical applications, such as education or healthcare, to be near term candidates for widespread cloud adoption.    However, we expect most enterprises to be measured in adoption of cloud architectures – if it ain’t broke, don’t fix it, particularly if doing so weakens the control of the IT department

By its nature, much of the cloud opportunity exhibits dramatic economies of scale, giving early leaders significant advantage.  These scale advantages are evident in most aspects – applications, platform software, hardware infrastructure and hosting services – and accrue across business areas.  For example, Google and Amazon.com gain scale and skill in their hosting businesses by virtue of having developed massive distributed platforms to run their own cloud applications businesses.  Other companies with scale advantage in the cloud include Salesforce.com, VMWare, and Cisco.  However, while scale economies are important in established application areas, clear leadership is not established in all of them and new application areas continue to emerge

For some companies, such as Microsoft, IBM, HP, EMC, Dell, amongst others, the opportunity in the cloud is offset in part, by the threat that they face to their traditional businesses, as fewer high-margin departmental servers will be needed in a cloud world.  Some of these companies appear likely to pursue M&A to bolster their technology and market presence in the cloud.  Application plays such as SuccessFactors, and Constant Contact, platform providers like Citrix and RedHat, or leading edge hosts such as RackSpace could be targets

For our full research notes, please visit our published research site.

Member: FINRA / SIPC 

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