Google Inc's Price War is Creating A Headache for Inc

In the last year investors have witnessed an intense price war among top cloud providers like Amazon , Microsoft , Google , and IBM, with prices for many top services being cut in half. Back in March, industrywide price cuts were sparked by Google, thereby forcing market leader Amazon and others to respond. Already, analysts have noticed some revenue growth weakness stemming from these cuts, specifically with Amazon. As a result, Google's decision to once more cut cloud prices might very well cause headaches for Amazon

A valuable business
Amazon's Web Services business, or AWS, accounts for just 5% of the company's total sales, but according to research firm Evercore, it's worth about $50 billion of the company's $150 billion market capitalization. The reason for this enormous valuation lies in what cloud infrastructure and application platforms might eventually become as a service.

While 12-month cloud revenue is estimated at just over $13 billion by Synergy Research, many firms like IBM Market Intelligence believe it could eventually become a $200 billion business. That said, Amazon may have an advantage in this market by owning 30% of the industry, but that doesn't mean competitors like Google aren't causing Amazon major headaches with continuous price cuts to competing services.

Giant competition
For investors looking at the market leaders in cloud infrastructure services, it is filled with some of the biggest service and technology companies in the world. These include Amazon, Microsoft in the number two spot, and then IBM and Google.

There is not much difference between the services of these four companies; Google's cloud storage is just as effective as Amazon's. The only real edge for service providers is pricing, which has launched an aggressive price war throughout most of the last year.

What's happening now?
It has been several months since major price cuts were implemented by the three market leaders. But, on Oct. 1, Google announced yet another price cut to its popular Compute Engine of 10%. While Amazon and Microsoft are yet to respond, it's quite possible that Google's action will create a reaction on behalf of its competitors, as seen historically.

That said, 10% is a relatively low price cut, but in an industry where all cloud storage and application-related services are similar, even the slightest cut can create an edge. With Amazon controlling nearly one-third of the industry, and having a $50 billion valuation tied to its cloud services, a 10% edge is something Amazon can not afford to provide one of its competitors.

Price cuts affecting revenue growth
Google previously cut prices on many of its cloud services, including Compute Engine, by more than 30% back in March 2014. Google's largest cuts came to its Google Drive cloud storage, which was cut by as much as 85%. In response to Google's cuts, Amazon cut the price of its storage service by more than 50%, and reduced the price of other popular services from 28% to 61%. Notably, this marked the 42nd time in six years that Amazon cut cloud prices, according to research firm ISI. Finally, Microsoft then responded to Google and Amazon, cutting prices on Microsoft Azure by 35% and storage prices by another 65%.

As seen, the latest, aggressive round of price cuts started with Google, and then worked its way through the cloud service leaders. While the industry as a whole is growing fast, price cuts of this multitude are sure to be felt. That said, in Amazon's second quarter, its North American Other revenue, largely consisting of AWS, increased just 38% year over year. While Amazon doesn't report exact revenue figures for AWS, Synergy Research estimates that its revenue increased just 49% year over year during the second quarter, down sharply from its 67% increase in the first quarter prior to the cuts.

All things considered, Amazon did note in its second quarter conference call that usage in AWS increased 90% year over year. Therefore, the disconnect between usage and estimated revenue growth shows the impact that price cuts had on the service. It's worth noting that shares of Amazon fell more than 10% after its second quarter earnings were released.

Foolish Thoughts
With all things considered, Google's most recent price cuts combined with the industrywide cuts earlier this year, started by Google, are absolutely a headache for Amazon. It has the most market share in this space and highest valuation relative to its cloud services. Therefore, Amazon has the most to lose, with high expectations for the future. Given what investors have witnessed with revenue growth relative to price cuts, Amazon's days of exceeding the cloud's market growth may be numbered, especially with all of its competitors so quick to cut cloud prices.

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Brian Nichols has no position in any stocks mentioned. The Motley Fool recommends, Google (A shares), and Google (C shares). The Motley Fool owns shares of, Google (A shares), Google (C shares), International Business Machines, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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