Current Business Model of Cloud Computing Providers: Financial Aspects

In this post, I want to tell you how the cloud computing providers generate profit and how they can improve their profitability in the future.

Current State

Let's start with the financial aspects of the current business models of cloud computing providers. There are three components that are important in the business model.

• Value Proposition
• Pricing Mechanism (Revenue Model)
• Cost Structure

The diagram below shows how business model of cloud computing is described by Osterwalder, A. in 2004. (http://www.hec.unil.ch/aosterwa/PhD/Osterwalder_PhD_BM_Ontology.pdf) 

As I understand it, the value proposition of a particular provider would determine what the provider's cost structure would be and what kind of price the provider can demand from its customers. Thus a short discussion of the current value chain is necessary to understand the cost structure and pricing mechanism. 

Value Chain

The diagram below( http://www.happiestminds.com/services/it-services/cloud-business-solutions) describes the cloud computing value chain and was developed based on the work of Jaekel and Luhn (2009) titled "Cloud Computing – Business Models, Value Creation Dynamics and Advantages for Customers", Leimeister et al. (2010) titled "The business perspective of cloud computing: actors, roles, and value networks", and Zhang et al. (2010) titled "Cloud computing: state-of-the-art and research challenges". 

By now, you probably understood that firms choose to serve any number of components of this value chain according to their capabilities and long term strategies. Moreover, firms form strategic relationships, technical alliances and consortium memberships to integrate functions so that they can deliver a value added service to the consumers. 

Pricing Mechanism

Osterwalder, A. in 2004 (http://www.hec.unil.ch/aosterwa/PhD/Osterwalder_PhD_BM_Ontology.pdf) developed the probable pricing strategies for cloud computing providers which I have summarized in the diagram below. If you want to read the detailed discussion on each type of pricing, you can consult this article: http://www.intertic.org/Policy%20Papers/Jaatmaa.pdf, page 27-28.

 Most of the current cloud providers offer fixed pricing and volume dependent pricing. Some of the industry giants provide some customization as most of the consumers are SMEs and look for little to no customization. Thus you can find some differential pricing in the market mainly because of volume dependent pricing. The market pricing category, in my opinion, would be relevant mainly for big enterprises which are yet to move their entire ICT need to Clouds. As I discussed in the previous post, providers need to innovate more to offer additional value added services to attract big enterprises. 

Cost Structure

 In the Service Delivery Book, Office of Government Commerce (2001) lists hardware, software, people, accommodation, external service and transfer as traditional ICT cost types. Because of the presence of elastic resource utilization and virtualization, cost structure in the cloud computing paradigm differs significantly from that of the traditional ICT. In the article titled "The Method and Tool of Cost Analysis for Cloud Computing (2009)", Li et al. listed two cost types that are to be included while calculating the accounting cost of cloud computing for the providers. 

• Total cost of ownership (TCO): Its the fixed cost of providers that they incur to build the cloud infrastructure and to operate the cloud. 
• Cloud utilization cost: Its the variable cost that is incurred by the users depending on extent of usage. 

Li et al. developed the following diagram to depict the cost structure of cloud computing:

Greenberg et al. have come up with four cost elements in their article titled "The cost of a cloud: research problems in data center networks". These elements are summarized below (http://www.intertic.org/Policy%20Papers/Jaatmaa.pdf):

Because of automation, operational staff cost is below 5% are thus is not included in the cost calculation.
Depending on the existing capabilities and long term strategies, providers design their value propositions. Cost structure and pricing strategy or revenue model are direct dervatives of the value propositions. Thus ROI of the providers depends how attractive their value propositions are. 

Recommendations

I believe that in the near future, cloud service providers would have to come up with more customization and value added services either by themselves or by collaborating with other firms that possess different capability sets to convince big enterprises to move their ICT capabilities and need to clouds. Here is a video that emphasizes the important of product differentiation in cloud computing paradigm:

An analogy can be drawn from Citibank's e-business strategy (Citibank's E-business Strategy for Global Corporate Banking, HKU797, October 24, 2008). I have came across this case study in my Digital Marketplace class at Carey Business School. The case describes how Citibank developed and consolidated its e-business strategy according to the customers need. Citibank targeted big corporations for whom it not only offered a truly global e-banking service that provided transaction services, corporate finance services and treasury market services, but also offered to perform back office tasks for the corporations. Thus Citibank offered a complete solution package along with consultancy to integrate customers' need while developing a consolidated global e-business strategy. 

The cloud service providers should follow a similar strategy while formulating their service offerings. The companies that are already in the cloud computing sector or are contemplating entering this sector, have already been in the ICT field offering other ICT related services. Firms such as IBM and Cisco have established themselves in the IT consulting arena and can use this capability to work with both SMEs and big enterprises closely to provide a complete solution package. Such solution package should include a road map for the clients complete ICT need including infrastructure, platform,  softwares and applications and storage, agility consideration, data monitoring, risk assessment, measures against failures, data monitoring and security. To enable such offerings, the providers should built capabilities to accommodate customization and develop their strategies accordingly. 

New entrants should have some advantages because they do not have an existing cloud and thus can built one that is scalable and agile and can accommodate customers's need. Last but not the list, every cloud provider should address the issue of security which seems to be the main concern of the consumers and some experts in the field. Many companies hesitate to move their ICT needs to cloud because of the security issue. As I described in my post titled "Critical Notes on Cloud Computing", scientists and engineers are producing extremely promising research in this arema. Cloud computing providers should pay close attention to new finding in this area and should facilitate such research to come up with innovative ways to ensure security in the cloud. Here is a video that discusses efforts of Professor Ken Birman in this area:

Thus to ensure economy of scale and economy of scope, cloud computing providers should ensure security in the cloud, innovate more to offer customization and should provide a complete solution so that enterprises can move their entire ICT needs to cloud. These are the ways by which cloud can reach its full potential and can prove to be a disruptive innovation to change the face of ICT industry.

In my next post I am going to introduce cloud's effect on semiconductor industry which has been one of the most important facilitators of traditional ICT industry.