Shares of Alphabet , Google's parent company, recently surged toward an all-time high after reporting robust third-quarter earnings that beat analyst estimates. Its tech peers Amazon and Microsoft also soared after crushing expectations.
But despite Google's strength in advertising, which accounted for 90% of its top line last quarter, the company's cloud business is actually much smaller than Amazon or Microsoft's. Unlike those two companies, Google doesn't report its cloud revenues separately. However, Forrester Research recently estimatedthat Google will generate just $2.1 billion in total cloud revenues (less than 3% of its total projected revenues) in 2015.
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By comparison, Microsoft reported that its commercial cloud revenuehad an annual run rate of $8.2 billion last quarter. During a developer conference in early October, Amazon reported that its AWS (Amazon Web Services) cloud computing platform had an annual run rate of $7.3 billion. So, why is Google trailing so far behind those market leaders?
Not all cloud businesses are created equallyGoogle's cloud business is diversified across SaaS (software as a service), IaaS (infrastructure as a service), and PaaS (platform as a service) solutions.
Google Drive is a SaaS solution, which is designed to be easily used by mainstream customers and businesses. Google's Compute Engine is an IaaS platform, which gives businesses extra computing power from virtual data centers. Google's App Engine is a PaaS solution, a cloud-based environment where developers can create apps and IT administrators can remotely manage computing infrastructure.
The majority of Microsoft's cloud revenues come from SaaS services like Office 365 and Dynamics CRM. Azure, its hybrid IaaS and PaaS platform, generates around $1.6 billion in annual revenues, according to Forrester. Over 80% of Amazon's AWS revenues come from IaaS and PaaS platforms instead of SaaS ones. Google's cloud business resembles Microsoft's more than Amazon's because 86% of its estimated cloud revenues come from SaaS solutions. The other 14%, or just $300 million, comes from IaaS/PaaS solutions.
Growth rates aren't everythingThe SaaS market is expected to grow at a CAGR (compound annual growth rate) of 33% between 2013 and 2018, compared to 21% growth for PaaS and 13% growth for IaaS.
While that sounds like Microsoft and Google are invested in the faster-growing part of the cloud market, the SaaS market is also a crowded one. Microsoft has a massive advantage in this market since Windows is installed on nearly 90% of all PCs worldwide. As a result, many mainstream and enterprise customers choose Microsoft SaaS products like Office 365 or OneDrive as a default choice.
Google's Android dominates mobile devices, but Google Drive probably won't gain ground unless Android devices are taken seriously as productivity devices. The majority of Google Drive users also use the free tier, which makes monetization tough.
Google Drive/Apps for Work. Source: Google.
Google recently claimed that Google Drive for Work, a beefed version of the service for businesses, had over a million enterprise customers. But that service is dwarfed by Microsoft's Office 365, which had 18.2 million subscribers at the end of last quarter.
Other major challengesGoogle's weakness in SaaS doesn't give it much clout in the IaaS/PaaS market, where Amazon reigns supreme. As Amazon expanded its e-commerce site, it let other companies and organizations host their websites and services on its servers. That foundation evolved into today's AWS. Google lacks that first mover's advantage.
Another challenge for Google is its desire to mine data for targeted ads across its entire ecosystem, including Google Drive. This makes the service a tough sell to larger corporations or government agencies. In a blog post weighing the pros and cons of Google Drive, Web development agency Hallnet promised to keep clients' "sensitive data" off Google Drive and stored on its own servers. Since Microsoft and Amazon don't generate much direct revenue from targeted ads, there's much less suspicion regarding their cloud-based services.
Cutthroat competitionThe intense cloud race between Amazon, Microsoft, Google, and other companies has forced the competitors to pile on more features while slashing prices. In this so-called "race to zero," Amazon has slashed its cloud service prices nearly 50 times in just nine years, forcing other rivals to do the same. As a result, only players with established footholds, like Amazon and Microsoft, have a chance of growing.
In early October, Piper Jaffray analyst Gene Munster predicted that Googleand other rivalswould fall behind in the IaaS/PaaS market as Microsoft and Amazon surge ahead. That defeat wouldn't cripple Google, but it would represent a missed opportunity to diversify its top line away from advertising.
The article Is Alphabet Inc.'s Google Being Left Behind in the Cloud Race? originally appeared on Fool.com.
Leo Sun has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and 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.
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