Azure vs. AWS: Can Microsoft Catch Up to Amazon in the Cloud Competition?

By Markets Fool.com

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A report from IDC estimates that public cloud spending will increase from $70 billion in 2015 to $140.1 billion in 2019 -- that's a lot of potential business up for grabs for service providers. As security continues to improve and enterprises increasingly move from on-premise data centers and infrastructure to the cloud,Amazon.com (NASDAQ: AMZN) and Microsoft (NASDAQ: MSFT) are positioned to soak up the largest shares of the unfolding market.

Amazon currently has a big lead in the space thanks to its multi-year head start, but Microsoft's Azure offers comparable service and is growing at a faster pace. Can Microsoft continue to make gains and ultimately catch the cloud leader? What would such a progression depend on?

Background on AWS vs. Azure

Gartner ranks Amazon Web Services (AWS) at the top of the overall cloud infrastructure-as-a-service model in its most recent "Magic Quadrant" analysis, with Azure ranked a close second.For customers who already depend on Microsoft software and are interested in a hybrid cloud platform that also interfaces with on-premise infrastructure, Azure offers advantages. However, AWS is still broadly viewed as the superior service.AWS currently offers functionality advantages compared with Azure, though Gartner notes that these differences are narrowing.

First-mover advantage has paid off greatly for Amazon in the cloud, with AWS estimated to have roughly 30% market share, while Microsoft's roughly 11% share gives it the second biggest position. Launched in 2006, roughly four years before Microsoft's Azure, AWS has secured a place as the dominant cloud infrastructure-as-a-service (IaaS) provider. For perspective on how much bigger Amazon's cloud is than its competitors, the total storage capacity of AWS is reported to be greater than all other cloud infrastructures combined.

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The cloud competition by the numbers

AWS is on track to do more than $10 billion in revenue in the current fiscal year. The company's last recorded quarter saw its public cloud platform generate roughly $2.89 billion in revenue, representing a roughly 59% increase over sales in the prior-year quarter and putting the cloud business on track to surpass a $10 billion run rate even faster than the company's retail business.

The service's operating margin for the quarter came in at roughly 25%, up from 23.5% in the prior quarter and representing a substantial increase over its second-quarter 2015 operating margin of roughly 16.7%. These profitability increases have come even as the company has implemented significant price cuts for some of its services.

Microsoft doesn't currently give Azure-specific sales figures, but Microsoft's July quarterly report saw Azure revenue grow 103% from the prior-year quarter. The company's server products and cloud services revenue grew $253 million, roughly 5%, year over year in the last quarter, with much of the increase attributed to Azure gains.Merrill Lynch estimates that Microsoft's margin for Azure is somewhere between negative-10% and negative-20%, but it also thinks the platform could achieve profitability in 2017 with margins between 5% and 10% on annual revenue of roughly $4.1 billion. Taking a look at another estimate, Goldman Sachs formulates that Azure will be profitable this year, with a margin or 9.2% on revenues of $3.46 billion.

Microsoft looks to sacrifice profitability to continue winning cloud share

Mapping the progression of cloud market share remains difficult, because the market will be shaped by new app offerings and integration with emerging technologies such as the Internet of Things, as well as to what extent the enterprise market breaks for hybrid versus pure cloud solutions. However, it appears that Microsoft and other challengers will have a hard time wrestling market leadership away from Amazon.

With such a substantial size, customer base, and revenue difference, it would be no small feat for Microsoft to catch up to Amazon's cloud infrastructure -- doing so would depend on developing long-term position over realizing near-term profits. Amazon is currently setting the pace for price reductions, and while Microsoft has stated that it will match Amazon's cost discounts, AWS looks to enjoy continued benefits from being the larger, more established offering. Amazon's lead in the cloud is very large, though not necessarily insurmountable.

Microsoft's ingrained position in the enterprise infrastructure and software is one of its big advantages in securing future cloud business, and it should help the company continue to grow business at a rapid pace and expand market share.That said, with the already sizable market for cloud services growing at a fast pace, Microsoft still has substantial opportunity with Azure, even if it never wrests cloud IaaS leadership from Amazon. Its cloud infrastructure should become a meaningful contributor to the company's bottom line within the next several years, though propelling cloud growth will continue to eat into profitability as it directs business from higher margin on-premise enterprise businesses and bundles the sales of other services with Azure.

Companies are scrambling to establish dominant positions in the future of the cloud, and Microsoft is likely to continue forfeiting margins in other business segments to continue strengthening its cloud position. Regardless of how market share plays out in the long run, both companies have big futures in cloud technologies, but Amazon is currently realizing holistic gains from AWS, while Microsoft is enduring some cannibalization to ensure future relevance.

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Keith Noonan has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Amazon.com. The Motley Fool owns shares of 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.