Industry Insight

Cloud Computing

By: Nicolas Ziegelasch

Although cloud computing has been widely talked about for the past decade, we believe most enterprises remain in the very early stages of adoption. Companies are increasingly realising that operating “on-premise” IT infrastructure is inefficient, and they are looking to the cloud to streamline processes and drive product and service innovation. In this piece we look at what cloud computing is, why businesses are moving, the growth potential and the likely winners.

What is cloud computing?

A common misconception of cloud computing is that it is simply the shifting of computing resources from being owned and operated on-premise to being rented from a third party who operates it off-premise. For the renter, this has the effect of converting capital expenditure (large upfront costs) into operating expenditure (smaller, regular costs), whilst eliminating the time, energy and expertise needed to manage computing resources in-house. However, this just describes basic outsourcing of IT services, which is something that has been around for decades. For example, 20 years ago a company could have signed a deal with a large IT services organisation who would build a datacentre, staff it, and then charge a monthly fee for using it.

“Cloud is multi-tenancy and provides “elasticity” for customers.”

Where cloud differs from outsourcing is that cloud is multi-tenancy and provides “elasticity” for customers. With multi-tenancy, the data centre capacity is shared by many different customers. Instead of them each having separate physical servers, they have virtual servers running on top of the same physical servers, effectively sharing the resources. This allows for far greater utilisation efficiency. For instance, a video streaming service may have the bulk of its traffic between 6pm-6am, while a university may have higher demands between 6am-6pm. Using cloud infrastructure, the total computing resources required to run both could be 30-40% less than running them as individual data centres.

This also allows for elasticity, which is an industry term that describes the scaling up and down of computing resources as required. For instance, a retailer may see ecommerce traffic on Black Friday that is several times higher than other days. Whereas with an on-premise data centre, they would need to have physical infrastructure capable of handling that spike (which would then sit underutilised most of the time), with cloud computing they can simply buy extra capacity for Black Friday before scaling back down once the increased traffic has subsided.

IaaS, PaaS and SaaS

There are three main types of cloud computing, depending on how much of your IT stack is covered.

  • Infrastructure as a Service (IaaS) – on-demand access to computing resources such as networking, storage, and servers. You provide the operating system, middleware and applications. This provides a flexible hardware resource that can scale depending on your storage and processing needs.
  • Platform as a Service (PaaS) – on-demand access to a cloud platform with underlying infrastructure and platform software. Platform software is the tools you need to develop, manage, and host applications and includes database, operating system, development environment, cybersecurity and management tools.
  • Software as a Service (SaaS) – on-demand access to cloud-based software. Instead of installing the software application on-premise, you access it using the web or an API. The provider is responsible for the underlying infrastructure and software including maintenance.

Why do businesses move to the cloud?

  • Cost savings – because cloud computing involves the sharing of resources, capacity utilisation is much higher than in on-premise, allowing cost savings to be passed on to customers.
  • Lower capex – because you don’t own the infrastructure and only pay for what you need, it is far more capital-efficient.
  • Scalability – cloud computing gives you the ability to rapidly scale your compute and storage requirements to meet business demands.
  • Security – cloud providers have far stronger security, given the resources they have.
  • Sustainability – using cloud computing is far more energy efficient than on-premise.
  • Data analysis – a cloud provider can offer powerful compute and storage capabilities with built-in analytics to process, analyse, and find value in your data.

“Gartner estimates that global public cloud computing revenue will grow by 25% annually for the next three years.”

Significant growth potential

The move to cloud computing is still in its infancy, with spending on cloud services expected to be c.7% of total spending on technology this year. Looking purely at IaaS & PaaS, based on Gartner’s numbers, penetration is around 13% out of a total addressable market size of over $700bn. Gartner estimates that global public cloud computing revenue will grow by 25% annually for the next three years as more enterprises use it as the foundation for digital transformation. We believe that this secular growth will continue, driven by increased use of artificial intelligence and replacement of on-premise software.

Rise of the hyperscalers

We believe that the IaaS and PaaS public cloud computing market will end up being controlled by a small number of large players driven by three key factors: the scale (tens of billions of dollars) needed to build out a global datacentre footprint; the investment in research and development to build differentiated premium services; and the technical expertise needed to run efficient and secure cloud architectures that will attract enterprise customers and developers. These three factors will provide significant competitive moats in terms of cost advantages and intangible assets that will make it difficult for smaller players to compete.

Market share estimates tend to vary but it is widely agreed that in IaaS and PaaS, Amazon Web Services (AWS) is the largest at approximately double the size of Microsoft’s Azure and quadruple the size of Google and Alibaba. We believe that AWS will remain the market leader given its multi-year head start and broad service offering. We see Azure as a strong number two and growing faster than AWS as it leverages its leading position in enterprise computing and hybrid cloud. Within developed markets, Google will remain number three, closing the gap on the top two having built out its service offering and given its strong history in data analytics and artificial intelligence. Within China, Alibaba is expected to continue to dominate given its current 45% market share and strong position in enterprise computing.

What are the economics of cloud?

The economics of cloud computing are driven by the ability to spread the costs of a data centre in terms of hardware, software, power, heating, cooling, and staffing across large set of customers with a broad workload profile, driving significantly higher utilisation rates than in on-premise data centres. Additionally, the scale of large cloud players allows them to source hardware at lower costs and develop specialised software and AI tools. As a result, cloud providers’ per unit costs have been consistently falling, with a portion of the benefit being passed on in lower prices, unlocking a virtuous circle of more workloads moving to the cloud. We believe that the long-term gross margins of the large players will be very attractive, with IaaS gross margins of 50%-60%, PaaS of 60%-70% and SaaS of 70%-90%. So a combination of strong revenue growth, high margins and wide competitive moats, makes cloud a very attractive business for these long-term winners.

If you would like to discuss anything raised in this article in more detail, please don’t hesitate to get in touch.


This note has been produced by Killik & Co on the basis of publicly available information, and all sources are believed to be reliable, but we have not independently verified such information and we do not give any warranty as to its accuracy. Some of the stocks mentioned in this note are covered by Killik & Co’s Equity Research team and others are not. The mentioning of the stocks does not represent a recommendation to buy or sell any securities, and the note is intended as a marketing communication rather than research. This note does not purport to be a complete description of the securities, markets or developments referred to in the material. All expressions of opinion are subject to change without notice. Nothing in this note should be construed as investment advice or as comment on the suitability of any investment or investment service.  Prospective investors should take advice from a professional adviser before making any investment decisions. There are risks with almost every investment that you may not get back the original capital invested. The value of your investments may fall as well as rise and the past performance of investments is not a guide to future performance.