A couple of months ago, the talk was about IBM looking to make a major cloud acquisition, likely SoftLayer or Rackspace. The intent was to expand Big Blue's hosting and service capacities, giving it a bigger footprint in the cloud.
Today, Rackspace remains independent, and rumours about a pending acquisition are nil. Also gone is its earning strength, which has been eroding for a few quarters.
Following last week's earnings report, which missed targets and reflected slow performance, Rackspace saw its value halved.
What is happening at Rackspace is nothing less than the accelerated forces of commoditisation. As more companies enter the cloud market, the gold rush for customers is forcing down prices, making it harder for providers to earn money.
For the channel, the trend is telling.
The VAR community is two years behind the rest of market in cloud development. Even so, resellers have a hard time making money on cloud services and complain the margins provided by vendors are too thin. As commoditisation takes over, margin pressure on vendors will make it harder to extend profitability to their channel partners.
Rackspace is defending its poor earnings showing, blaming the transition in its core business from bare-metal hosting to the OpenStack development architecture. Since its launch in November, OpenStack has won solid reviews, but few companies use the platform for application development.
Transition is only part of the story, though. Pricing pressure and increased competition are the real issues.
Rackspace CEO Lanham Napier acknowledges fierce price-cutting by rival Amazon.com's Amazon Web Services, the market leader, is affecting sales and slowing growth.
"We obviously observe what others are doing in the market, but we are a cost-plus shop," said Napier, in a conference call with analysts last week. "We price at a premium. We believe this premium reflects the fact that we have a differentiated service that we call Fanatical Support. So we will always be at a premium to other people out there because we are the best service, we're the best customer outcome. You have to pay the most for that."
The position makes sense, but is probably indefensible.
Cloud computing is disrupting traditional hardware and software sales. The development of cloud services, such as those provided by Rackspace and AWS, are seen as the future of the IT industry – at least for those who can make the transition.
The challenge is that cloud computing is barely a replacement revenue source for the lost sales of disrupted products, much less an incremental growth engine. Products from companies such as Rackspace and AWS were once seen as immune to the transition issue, as they were built in the cloud.
Growth in cloud computing is entirely dependent on volume sales. It is not enough to convert existing accounts, but rather continually expand utilisation to keep revenue ahead of operating expenses.
When sales slow, revenue grinds down and expenses eat into profitability. This phenomenon is seen in the Rackspace earnings. Even as sales trend down, Rackspace must invest in new datacentre capacity to meet current and anticipated needs.
The last-quarter earnings were dampened, in part, by the expense of building a $1.8bn (£1.2bn) datacentre.
Cloud computing is a volume sales game, one that will only get tougher as more vendors enter the service-provider market. IBM, Google, Microsoft, Cisco Systems, HP and Dell – companies that need cloud computing to be a success for their future viability – are investing heavily in capacity expansion and sales.
The effect is a continual drop in prices, which attracts more customers but makes it harder for the supply side to make money.
This trend is directly translated to the channel. The 2112 Group's channel profitability report reveals managed and professional services have consistently high profits. Conversely, hardware and software sales have low profit potentials.
Cloud computing profitability, however, is spread across the spectrum; some services have already been commoditised and earn cloud vendors and resellers little income.
Rackspace believes OpenStack is the value-add element that will maintain its premium pricing and, potentially, restore previous operating margins.
It could be a tool for enabling partners to make money. The question is whether or not such platforms will evolve fast enough to defeat the commoditisation beast.
Larry Walsh is president and chief executive of Channelnomics
As part of our special editorial partnership, CRN is republishing this article from Channelnomics
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