There is no doubt that the cloud is one of the most significant platform shifts in the history of computing. Not only has cloud already impacted hundreds of billions of dollars of IT spend, it’s still in early innings and growing rapidly on a base of over $100B of annual public cloud spend.
This shift is driven by an incredibly powerful value proposition — infrastructure available immediately, at exactly the scale needed by the business — driving efficiencies both in operations and economics. The cloud also helps cultivate innovation as company resources are freed up to focus on new products and growth.
However, as industry experience with the cloud matures — and we see a more complete picture of cloud lifecycle on a company’s economics — it’s becoming evident that while cloud clearly delivers on its promise early on in a company’s journey, the pressure it puts on margins can start to outweigh the benefits, as a company scales and growth slows. Because this shift happens later in a company’s life, it is difficult to reverse as it’s a result of years of development focused on new features, and not infrastructure optimization. Hence a rewrite or the significant restructuring needed to dramatically improve efficiency can take years, and is often considered a non-starter.
Now, there is a growing awareness of the long-term cost implications of cloud. As the cost of cloud starts to contribute significantly to the total cost of revenue (COR) or cost of goods sold (COGS), some companies have taken the dramatic step of “repatriating” the majority of workloads (as in the example of Dropbox) or in other cases adopting a hybrid approach (as with CrowdStrike and Zscaler). Those who have done this have reported significant cost savings: In 2017, Dropbox detailed in its S-1 a whopping $75M in cumulative savings over the two years prior to IPO due to their infrastructure optimization overhaul, the majority of which entailed repatriating workloads from public cloud.
Yet most companies find it hard to justify moving workloads off the cloud given the sheer magnitude of such efforts, and quite frankly the dominant, somewhat singular, industry narrative that “cloud is great”. (It is, but we need to consider the broader impact, too.) Because when evaluated relative to the scale of potentially lost market capitalization — which we present in this post — the calculus changes. As growth (often) slows with scale, near term efficiency becomes an increasingly key determinant of value in public markets. The excess cost of cloud weighs heavily on market cap by driving lower profit margins.
The point of this post isn’t to argue for repatriation, though; that’s an incredibly complex decision with broad implications that vary company by company. Rather, we take an initial step in understanding just how much market cap is being suppressed by the cloud, so we can help inform the decision-making framework on managing infrastructure as companies scale.
To frame the discussion: We estimate the recaptured savings in the extreme case of full repatriation, and use public data to pencil out the impact on share price. We show (using relatively conservative assumptions!) that across 50 of the top public software companies currently utilizing cloud infrastructure, an estimated $100B of market value is being lost among them due to cloud impact on margins — relative to running the infrastructure themselves. And while we focus on software companies in our analysis, the impact of the cloud is by no means limited to software. Extending this analysis to the broader universe of scale public companies that stands to benefit from related savings, we estimate that the total impact is potentially greater than $500B.
Our analysis highlights how much value can be gained through cloud optimization — whether through system design and implementation, re-architecture, third-party cloud efficiency solutions, or moving workloads to special purpose hardware. This is a very counterintuitive assumption in the industry given prevailing narratives around cloud vs. on-prem. However, it’s clear that when you factor in the impact to market cap in addition to near term savings, scaling companies can justify nearly any level of work that will help keep cloud costs low.
Unit economics of cloud repatriation: The case of Dropbox, and beyond
To dimensionalize the cost of cloud, and understand the magnitude of potential savings from optimization, let’s start with a more extreme case of large scale cloud repatriation: Dropbox. When the company embarked on its infrastructure optimization initiative in 2016, they saved nearly $75M over two years by shifting the majority of their workloads from public cloud to “lower cost, custom-built infrastructure in co-location facilities” directly leased and operated by Dropbox. Dropbox gross margins increased from 33% to 67% from 2015 to 2017, which they noted was “primarily due to our Infrastructure Optimization and an… increase in our revenue during the period.”