Trillion-Dollar Foes: Does Amazon Web Services Reign Supreme in the Cloud Business?

Amazon (AMZN -0.39%) is one of the few companies -- along with Microsoft (MSFT 0.19%) and Alphabet (GOOG -0.15%) (GOOGL -0.26%) -- with a trillion-dollar market value. Its cloud business, Amazon Web Services (AWS), dominates the industry. AWS is dominant within Amazon as well, recently accounting for nearly 67% of the company's entire operating profit.

As a market leader in this space, AWS has been notching great numbers for nine years in a row, and it's achieved 33% global market share. Its main competitors, Microsoft's Azure platform and Alphabet's Google Cloud, combine to make up about 57% of the market.

Analysts expect a compound annual growth rate (CAGR) of 29.2% for the cloud space between 2021 and 2026. Is there a chance that Amazon's rivals could outpace the leader in the near future?

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The rise of AWS

Amazon was a pioneer and first mover in the cloud industry, launching its initial infrastructure-as-a-service (IaaS) offering in 2006. Its cloud division is made up of several different offerings, as shown in the table below. 

AWS's strength as a market leader comes from the plethora of services it provides to consumers all over the world -- its offerings reach more than 175 countries. In addition, AWS offers scalability for its customers, providing an important economic benefit for companies looking to develop and grow without making heavy investments in technology and operations.

AWS has developed a wide customer base that ranges from start-ups to large enterprises. The latter are especially key to Amazon's business because they make bigger purchases and require a larger amount of tasks than their smaller counterparts. Fulfilling those needs has helped Amazon build its strong reputation as a strategic provider of cloud infrastructure and platform services.

Gritty, or overly ambitious?

That said, AWS does have a few weaknesses, some of which may lead to Microsoft and Google taking market share. Just being a first mover can be a disadvantage -- as the first to release an offering, AWS also becomes the first to deal with any potential bugs or software fixes it may require. 

Microsoft and Google, meanwhile, have ways of taking advantage of their secondary status. For example, Microsoft's Azure may not be the market leader now, but it appeals to enterprises that use Microsoft products across their organization. Microsoft's ability to cater to these strategically committed enterprises means it can sell Azure in combination with other Microsoft products. 

Microsoft also enjoys an advantage over AWS in the hybrid-cloud space, which allows enterprises to store workloads both on-premises and as part of a public cloud. Microsoft was actually the first mover here, releasing its Azure Stack product in 2017; AWS and Google launched their hybrid cloud technologies in 2019, meaning Microsoft currently has the advantage in this area. At a conference in November, Microsoft announced a multi-cloud layer that allows Azure to extend to other platforms such as AWS and Google Cloud. This innovation will help Microsoft stay ahead of its competition and allow more customers to adopt its platform. 

Google, meanwhile, offers services related to analytics and machine learning, with a focus on younger start-ups. The company's approach to attracting enterprise customers differs from Microsoft's focus on companies using Microsoft-centered strategies or AWS's focus on "agile" businesses (those using a type of iterative development featuring cross-functional teams).   Instead, Google it teaches businesses how to run operations through its Customer Reliability Engineering program, which teaches skills similar to those used by Google's site reliability engineers.

Although Google Cloud does focus on the larger market, its particular attention to younger start-ups makes it a bit of a niche player. That's because these partnerships allow for specialized uses for applications for big data and analytics, machine learning projects, and cloud-native applications. Google is working to expand its reach to a larger base of consumers, including enterprise customers; this means a slower buildup of market share compared with with AWS and Microsoft Azure.  

AWS has ambitious plans to expand into new markets, including logistics and healthcare. But this approach has weaknesses that could allow rivals such as Microsoft and Google to win market share. One concern is data privacy; The Wall Street Journal reported on one example in which a breach of Capital One's data led to 100 million records stolen from Amazon's cloud.

And while AWS sometimes seems ubiquitous, there are times when companies push back against its use. A good example is the highly competitive market of retail, where some of Amazon's rivals -- including Walmart, Kroger, Gap, and Target -- all chose Microsoft over Amazon for their cloud needs. Walmart noted in 2017 that it would prefer not to use a competitor's platform because of concerns about privacy in handling the company's most sensitive data. Amazon's rivals also avoid AWS because it is an integral part of Amazon's operating income, and contributing to it would feed Amazon's growth.

AWS may also face some challenges when it comes to specialization -- large companies may prefer a partner with specific experience. For example, while the two companies are technologically equivalent, Volkswagen chose to build on Microsoft's cloud rather than Amazon's because of the former's track record as a software-based company. Businesses aren't just looking for the best services -- they want to see alignment with a strategic vision. 

Who will dominate in the 2020s?

Source: Synergy Research Group

As of the third quarter of 2019, Amazon had the lead in market share. But the recent adoption by the Department of Defense (DOD) of an enterprise-wide  cloud service aimed at modernizing its digital environment is a prime example of where Microsoft could dominate.

The DOD's goal was to award the contract for the Joint Enterprise Defense Infrastructure (JEDI) cloud acquisition program to a single company. After reviewing competing proposals from Amazon, Microsoft, IBM (IBM -1.03%), and Oracle (ORCL 0.33%), the DOD chose Microsoft and Amazon as finalists. In October, it was announced that Microsoft had been awarded the JEDI contract -- and up to $10 billion over the next 10 years. Amazon challenged the decision, and as of Feb. 13, all work related to the contract has been halted until the legal issues are resolved.

The ultimate resolution of the JEDI contract has the potential to change the landscape between Amazon and Microsoft. The former generated $35.1 billion in cloud revenue for 2019, while the latter generated $38.1 billion. The JEDI contract could mean $1 billion a year for the ultimate winner. If Microsoft is the victor, it would be poised to expand its global presence through the pairing of cloud services with artificial intelligence or machine learning. This could increase revenue and potentially expand its market share, perhaps even putting the company ahead of Amazon on revenue. 

What to watch going forward

Microsoft's focus on the hybrid cloud, its approach to customers already using Microsoft products, and its more specialized offerings to businesses (such as artificial intelligence and machine learning) may give it a leg up on Amazon in the long run -- and the JEDI contract could also be a huge win. A potential $1 billion per year from the 10-year JEDI contract could put Microsoft's revenue at roughly $40 billion per year -- or more -- over time. 

Over the long term, investors should expect a highly competitive battle for market share between Microsoft and Amazon. Google may also end up pulling some market share from AWS, thanks to its focus on niche markets and its efforts to gain more enterprise customers through its training program. The resolution of the JEDI legal challenge will be important for investors to watch, as it could break the run of success in the cloud that AWS has had since it was first launched in 2006.

When it comes to the cloud, Microsoft looks like a better buy for the longer term than Amazon or Google. It can take advantage of AWS's weaknesses, and it seems well-positioned for growth thanks to its hybrid-cloud technology and the specialized products and services it offers along with its cloud offerings.