Cloud computing is a powerful and disruptive technology that is now breaking out into the mainstream economy, more than a decade after launching in 2006. Millions of companies are using some form of cloud computing, often from Amazon Web Services (AWS), Microsoft Azure, Google Cloud, or other providers. Successfully adopting cloud computing will be a key determinant of which countries will prosper in the global economy. Cloud computing lowers costs, creates technical and business agility, and enables innovation and digital transformation. In 2020, the global market for cloud services was $270 billion and cloud companies listed on U.S. markets had more than $1 trillion in capitalization. Hundreds of new cloud services are being introduced and thousands of new venture-backed cloud companies are being formed.
Yet, cloud computing is still in its early days, given more than $3 trillion in annual global information technology (IT) spending and decades of accumulated investment in traditional IT infrastructure. In short, cloud adoption is more broad than deep. Most companies use the cloud for only a small share of their IT needs, and spending on cloud computing is just 7.2 percent of annual global IT spending. It’s early in this disruptive shift, and it’s important to better understand cloud computing’s successes and challenges. Cloud computing is important not only for individual companies’ success, but also for economic growth and global competitiveness. It’s what economists call a “general-purpose technology” that is pervasively used across most sectors. The cloud is becoming a platform that drives innovation and productivity across the broader economy. It represents the digital equivalent of the electric grid, only one that is more capable and dynamic.
Cloud computing is important not only for individual companies’ success, but also for economic growth and global competitiveness.
After a brief introduction to what cloud computing is, this report focuses on the economic impact of cloud. It addresses why cloud computing matters for a country’s economic success—which has not received as much focus as the cloud’s technical and business impact. It then analyzes the economics of the cloud sector, including industry structure and market dynamics. The report recommends five areas where cloud computing excels and five challenges that need to be met to fully capture the benefits of the cloud. It concludes with a policy agenda for cloud computing. Governments will inevitably address cloud-related policy issues as cloud’s reach and power expand. Recommendations for policymakers include accelerating adoption with a federal cloud-modernization moon shot; improving security and resilience; preserving competition by encouraging application portability; strengthening governance and enabling cross-border data flows; and building workforce skills and inclusivity.
Cloud computing is a powerful technical architecture for IT, driven by technologies such as software virtualization. Just as important, cloud architecture enables new operating and business models. As a starting point, cloud computing provides IT resources (e.g., compute, storage) as a pay-only-for-what-you-use service delivered over the communications network by a third party. This is in contrast to the predominant model in which users directly “own and operate” on-premises physical IT equipment. The U.S. National Institute of Standards and Technology (NIST) states “cloud computing is a model for enabling ubiquitous, convenient, on-demand network access to a shared pool of configurable computing resources … that can be rapidly provisioned and released with minimal management effort or service provider interaction.” An important capability of the cloud is that IT resources can be scaled up when demand increases, or scaled down and turned off, delivering agility gains and cost savings. We break down the cloud’s defining characteristics in figure 1.
Figure 1: What is cloud computing?
Three Layers of the Cloud: IaaS, PaaS, SaaS. Cloud computing is typically broken into three major parts, each covering a collection of services. Infrastructure as a service (IaaS) provides the underlying IT infrastructure such as compute, storage, and networking. Platform as a service (PaaS) provides middleware, databases, and developer and management tools to build and support applications. Software as a service (SaaS) provides a fully managed application that customers directly use such as email, financial applications, or supply chain management. While all three layers operate together, each represents a different scope of adoption of the cloud by the user (see figure 2). Each involves a different technical part (often called a “layer of the stack”) of the technology solution. As users move from IaaS to PaaS to SaaS, they shift more responsibility for IT to the cloud provider. This typically provides lower costs and more agility, but entails less control over individual IT resources. Users can and do adopt different services independently, as each user takes their own journey of cloud adoption. This reflects different customer priorities and skill levels. There is no one right starting point for adopting the cloud.
For example, at the IaaS level, customers store data, run web servers, and provide back-up and recovery services in the cloud. At the PaaS level, customers often run databases in the cloud for high scalability and availability, while also shifting database maintenance to the cloud. At the SaaS level, customers run applications such as email and collaboration, human resources management, and accounting systems in the cloud. In practice, the lines between these approaches and services blur, and cloud providers’ offerings overlap across markets. There are also new so-called “XaaS” markets emerging such as Function as a Service (FaaS). These XaaS markets are important, but mostly smaller markets in earlier stages of adoption.
Figure 2: Different approaches to the cloud have different scopes of adoption
Another distinction is between public and private clouds, which use similar technology. The major difference is public clouds offer services to the general public and the same cloud infrastructure is shared by many different entities, whereas private clouds are typically limited to a single organization. Private clouds are usually smaller in scale and can trail the cost and performance of public clouds. “Hybrid cloud” refers to combining traditional on-premises IT with public clouds. We discuss the benefits and limits of hybrid cloud.
This paper focuses on public cloud IaaS and PaaS. The primary providers of IaaS and PaaS are the same. IaaS and PaaS also share similar characteristics: Both are underlying technical resources that support the application, and both are predominantly used by IT managers and software developers rather than end-users. The IaaS and PaaS markets are moving closer together as providers offer services that combine their functionality. In contrast, SaaS is led by a different set of software providers (e.g., Salesforce, Workday, ServiceNow), and end users interact directly with the application. While SaaS takes advantage of and runs on top of IaaS and PaaS infrastructure, SaaS’s core value added is the application itself.
This paper also focuses on enterprise cloud markets that serve businesses, governments, and organizations—rather than individual consumers. While companies such as Facebook and Twitter use similar cloud technologies and run, in part, on top of enterprise cloud providers, they are consumer-focused companies. For the most part, they do not offer their services “wholesale” for other businesses to build on, but rather effectively offer SaaS applications to consumers. The consumer cloud companies also have different business models, often driven by advertising spending. This is not to say only enterprise providers define the cloud; there are a wide array of services offered by many others that compose the cloud. For the purposes of this paper, enterprise and consumer raise different issues.
IT is the foundation of a modern economy. IT underpins the operations and workflows across every facet of an organization. Companies in every industry use IT to develop products, orchestrate supply chains, drive the selling process, run operations, and manage every step of the business. Every government uses IT to provide citizen services, from health care to education, and to manage back-office operations. In fact, 28 percent of U.S. business investment is in IT, and the U.S. federal government spends over $100 billion annually on IT.
Cloud computing is an emerging technology architecture that is driving growth, productivity, and innovation. New computing architectures come in waves. The mainframe dominated in the 1960s and 1970s, the PC in the 1980s, client-server in the 1990s, the Internet in the 2000s, and cloud computing took off in 2010 and is now gaining scale. Previously, new technology waves drove productivity gains and economic growth. Each new architecture builds on the prior one and delivers lower cost and more capability. Each wave deepens IT penetration of the economy, reaching more users and integrating IT with more economic activity. While cloud computing technology is new, it builds on a past technical lineage that includes network computing, grids, and distributed computing. Further, cloud computing is integral to new IT-driven business developments that have broad economic impact. For example, technologies such as artificial intelligence and machine learning (AI/ML) and Internet of Things (IoT) depend on robust computing and are being built directly into the cloud infrastructure and offered as cloud services. The cloud will become the platform for AI/ML.
Cloud computing is a better economic model for IT. It’s the digital equivalent of the electric grid—and is more powerful. Cloud computing finally delivers on the promise of IT by shifting the hard work of operating IT infrastructure to the cloud—with lower costs and better performance. It represents the industrialization of IT wherein cloud effectively standardizes and outsources the IT infrastructure to a cloud service provider. Cloud computing applies modern statistical process controls to IT similar to modern manufacturing. Customers no longer need to buy, deploy, operate, maintain, and own their IT infrastructure. The public cloud operates IT better, so customers don’t have to.
First, cloud computing has lower costs. An International Data Corporation (IDC) study sponsored by Amazon Web Services (AWS) shows cloud infrastructure has 31 percent lower operational costs than comparable on-premises infrastructure, and has even greater savings when people and downtime costs are included. Greater scale and technical innovation lead to rapid quality-adjusted price declines, according to economists Byrne, Corrado, and Sichel, of 7 percent per year for computing power, 12 percent per year for database, and 17 percent per year for storage. The cloud is also more automated, enabling new capabilities and whole IT infrastructures to be deployed and managed with only a few key strokes. IDC estimated, in an AWS sponsored report, that IT staff efficiency is 62 percent greater in the cloud, while developer productivity is 25 percent greater. Second, cloud has better capital efficiency. It drives greater capacity utilization by aggregating demand across many customers and sectors, which each have their own usage profile. On-premises servers are typically used 20 percent of the time, whereas in the cloud, utilization typically well exceeds 50 percent. This reduces server over-provisioning and drives better asset efficiency. Third, the cloud has better energy efficiency and a lower carbon footprint. Google says its data centers use about six times less overhead energy for every unit of IT equipment than the average data center does. This progress is increasing.
On an operating level, even large, sophisticated organizations have challenges implementing and upgrading IT. IT is not most companies’ or governments’ core competency, or even purpose. Each customer has to implement and operate their own IT system. For large mission-critical systems such as finance, customer records, and supply chains, implementation can take years. For example, HP implemented an application upgrade in 34 systems around the world, but the 35th failed, causing the company to miss its quarterly financial goals and its stock price collapsed. In another example, the U.S. Department of Veterans Affairs initially spent $1.1 billion over five years on an electronic health record system that it was not able to implement. In large part, this is because each enterprise’s IT environment is different, complicated, and brittle. Over $1 trillion globally is spent on people-based IT services each year to make these complex systems work. Even when successfully deployed and operated, traditional on-premises IT rapidly becomes out of date, causing a build-up of “technical debt” that needs to be modernized and replaced. Users then have to re-implement IT all over again. And IT implementation and operations are the easy part, relative to the challenge of getting real business value or government-mission value from IT. As discussed in more detail below, cloud computing is simply a better way for most of IT.
Cloud computing drives specialization and the division of labor, enabling the business, operations, services, and everything that uses IT to become much better. The cloud is not only a cheaper and better way of operating IT, it enables businesses and governments to focus on their customers, their core business, and the value added of satisfying needs. One of the most powerful ideas in economics is specialization and division of labor. The cloud takes specialization and division of labor to a new level in IT, wherein the cloud provider specializes in the IT infrastructure so users doesn’t have to. The JPMorgan Chase bank has stronger IT capabilities than most, but it requires an army of 40,000 people in its IT organization with a $9 billion annual budget. As an apt historical analogy, in the early industrial revolution, manufacturing mills were built on rivers to provide water power. Each manufacturer had to generate, distribute, maintain, and own their power, similar to how most enterprises today own and operate their IT. However, after electric-power technology became good enough, manufacturing mills began outsourcing electricity to the power grid, so they could focus on running their core manufacturing processes. They specialized in what they were good at boosting economic productivity.
Cloud computing drives innovation across the economy. Because cloud is a variable cost that can be turned on and off when needed, it lowers the cost of experimentation and failure. This reduces risk and enables faster time to market for new products. The entire economy benefits, but this is especially important for smaller companies that may not be able to afford larger up-front capital purchases. The cloud also drops barriers to company formation, a key source of innovation and job growth. Indeed, start-ups were some of the first users of the cloud. Most of the new Internet-based companies are cloud-native and, because they are starting fresh, their entire businesses are built on top of cloud IT infrastructure.
The larger significance of cloud computing is it’s becoming the IT platform on which the economy is built. The distributed electric grid enabled the creation of hundreds of new products such as consumer appliances, and whole new industries such as radio and television broadcasting. As we will discuss, companies today (e.g., Twitter, Snap, Netflix) are building their whole business on the cloud, and large enterprises (e.g., Bosch, Providence Health, Procter & Gamble) are migrating existing IT to the cloud. We’ll show how cloud lowers cost, boosts productivity, and shifts scarce talent to higher value-added applications and business processes. It enables enterprises to move faster and be more agile. Cloud computing is spreading across every industry, providing flexible enabling technologies from basic computing to ML. The cloud enables businesses to reinvent each step of the business, including marketing, product development, manufacturing, selling, and financial management. Cloud computing is more than just the latest IT innovation. It underpins the broader economy directly enabling the “digital transformation” of the economy. The digital economy is powered by the cloud.
Cloud Adoption Is in Early Stages—Adoption Is More Broad Than Deep
The market for cloud services is developing quickly but is still in the early stages. IaaS officially started in 2006, and in the last 10 years, adoption has accelerated beyond early adopters and is now breaking into mainstream users. Millions of organizations are using the cloud for specific applications and workloads. By number count, cloud computing is crossing over into the mainstream. However, measured by share of total use, market penetration is low, especially for new or advanced services. AWS CEO Andy Jassy recently pegged overall cloud adoption at 4 percent of global IT spending, and Gartner data shows 7.2 percent. The latest National Science Foundation (NSF) business survey data shows similar low penetration.
SaaS ($103 billion globally in 2020) and IaaS ($74 billion) are the two largest markets by revenue, with PaaS the smallest ($46 billion). The SaaS market scaled first, building on the prior Application Service Provider model. SaaS adoption is much higher than PaaS or IaaS, exceeding 25 percent of the software application market, led by cloud-native companies such as Salesforce.com, Workday, and ServiceNow. Most traditional software companies such as Microsoft, Oracle, SAP, and Adobe are moving from traditional licensed, on-premises software to the SaaS model. All three markets are growing significantly faster (32 percent combined global growth rate) than is global IT spending (approximately 4 percent growth). As customers become more skilled at using the cloud, adoption grows, in turn increasing the spending, scale, and number of services used. Most customers use foundational services such as compute and storage. However, more advanced services such as ML, Internet of Things, and specialized databases still have low adoption.
Figure 3: Spending on global cloud computing, 2015–2020
There Are Multiple Market Segments With Different Customer Needs
Different customers are at different stages of adopting the cloud and have reached different levels of cloud maturity. The key buying factors and customer needs vary across customer maturity and market segments. Some of the earliest cloud adopters were start-ups that valued the speed of near instant provisioning of IT, cash-conserving pay-as-you-go pricing, and access to world-class technologies. For some users, core capabilities such as lower cost, business continuity, and remote access matter most. For others, the ability to outsource IT at global scale and achieve granular management and security is key. While for advanced users, cloud-native architectures and software development practices enable them to rapidly test products, innovate, and achieve superior business agility. Ultimately, cloud computing is integral to organizational change and culture, becoming a source of competitive advantage. This is most identifiable in start-ups that built cloud-native architectures from the start (Airbnb, SmugMug, Pinterest). Yet, established firms are also going all in on the cloud in sectors ranging from banking, where Capital One has closed eight data centers, to education content providers such as Blackboard, Ellucian, and Instructure.
Cloud Providers Have Large Economies of Scale and High Fixed Costs
Large economies of scale are a defining characteristic of the cloud computing businesses. IDC tracks $74 billion of investment in global cloud infrastructure in 2020, and the leading cloud providers each spend billions annually. Microsoft and Amazon each have dozens of geographic regions and more than 150 data centers globally. They don’t disclose cloud-only CapEx data but it takes tens of billions of dollars to build cloud data centers globally, provision gigabit networks, and develop the software infrastructure. Opening a new region is typically a >$1 billion investment. The competition for scarce technical talent is also fierce.
Once providers incur this big fixed cost, the average cost for each unit of compute and storage declines as volume and utilization grows (figure 4). Cloud infrastructure is heavily automated, and providers have developed proprietary knowledge about design and management. Providers scale to millions of computing cores and petabytes of data without adding people, blowing past traditional industry benchmarks for the number of system administrators per server or database. This ultimately results in lower prices for users. Cloud providers also have greater economies of scale in purchasing, becoming the largest buyers of storage, memory, and compute. For example, the cloud is one-third of the global server market, up from just single digits a few years ago. In addition, there are large soft costs such as compliance, which take years to achieve for the dozens of security and compliance regimes needed. All of these create substantial entry barriers for IaaS platform providers. However, lower-cost, large-scale IaaS providers reduce entry barriers for PaaS and SaaS, which can more quickly and cheaply leverage the massive cloud IaaS infrastructure. PaaS and SaaS can run their products on top of IaaS, choosing to buy IaaS rather than build it.
Figure 4: Cloud computing economies of scale
Customers Benefit From Declining Prices and Improved Price Transparency
Compute, storage, and database are the largest segments of the market and show large price declines. AWS alone has cut prices over 70 times across services and regions since launching. Economists Byrne, Corrado, and Sichel analyzed published AWS prices from 2009 to 2016 and found that quality-adjusted prices fell rapidly (see figure 5).
- Compute prices (EC2) fell on average by 6.9 percent a year from 2009 to 2016 and, more rapidly, by 10.5 percent a year on average from 2014-2016 once Microsoft and Google started publishing prices publicly in 2014.
- Storage (S3) pricing fell on average by 17.3 percent a year from 2009 to 2016 and on average 25.1 percent a year from 2014 to 2016.
- Database (RDS) pricing fell on average by 11.6 percent a year from 2010 to 2016 and on average -22.6 percent a year from 2014-2016.
Falling prices are driven by 1) cost declines from economies of scale and technical innovation, 2) competition to win over customers from traditional on-premises providers that capture >90 percent of IT spending, and 3) competitive rivalry among the major cloud providers. For example, in a six-month period in 2012–2013 when cloud adoption started to pick up, AWS, Microsoft, and Google made over 20 price cuts.
Figure 5: Declining prices for cloud computing
Cloud service pricing has become more complicated as the number of services and pricing models have grown. But this comes with greater choice and visibility. Prices for specific services are publicly published on cloud provider websites. Pricing differs by type of service (e.g., compute) and within a service (e.g., size and mix of computing power, memory, and networking optimized for different workloads). Cloud providers also offer a growing number of pricing models in addition to the standard no-up-front-charges, pay-only-for-what-you-use model. Customers achieve even greater discounts for committing to larger volumes and longer time periods, and pre-paying. There is even a “spot market” for computing power and a secondary market with cloud brokers and resellers. As users get more confident and capable managing their cloud spending, they are able to shift their mix of usage to even lower cost “reserved” capacity, thereby reducing their overall costs even further than standard price discounts. These pricing options are more transparent than most traditional software licensing. However, with more pricing choices, customers must know both their usage patterns and how to use cost management tools to get the most benefit.
The Top Three Providers Have 60 Percent Global Market Share
Synergy Research data measuring the combined IaaS, PaaS, and hosted private cloud revenues for Q4 2020 shows that Amazon has 32 percent share, Microsoft has 20 percent, Google has 9 percent, followed by Alibaba and IBM each at around 5 percent, and then Oracle. This concentration reflects the large economies of scale previously noted. Our estimated Herfindahl-Hirschman Index (HHI)—a measure of market concentration—is around 1,600, which is at the low end of “moderately concentrated” markets, according to Justice Department guidelines. Note, HHI is a static snapshot and doesn’t capture market dynamics. The top three market share leaders have stayed in the same order. AWS invented the market for public cloud computing, is the leader measured by revenue, and has led the Gartner magic quadrant for 10 successive years. Microsoft is number two, gaining 10 points of share from 10 percent to 20 percent from 2017-2020, as it pivoted to the cloud. Google and Alibaba are also making smaller share gains. Providers outside the top 10 are consistently losing share, and are down to a combined 20 percent share. We examine switching costs in the next section. Each company has its own focus:
- AWS emphasizes technical performance, customer-driven product roadmap, and offers unmatched breadth and depth of its services. It has led the push into new cloud services from analytics to satellite data.
- Microsoft has built out its cloud service portfolio to narrow the gap to AWS. It leverages its existing relationships with customers, installed base of Office/Office 365 and Windows operating systems, and extensive go-to-market ecosystem of sellers and partners.
- Google Cloud has technical strengths, including its heritage in data and analytics. Under CEO Thomas Kurian, Google is improving its enterprise selling and support capabilities, and targeting vertical sectors.
- IBM emphasizes hybrid cloud computing, leveraging its large on-premises customer base. Especially with its Red Hat acquisition, IBM is focusing on multi-cloud and hybrid cloud management.
- Oracle is focused on large enterprises and mission-critical workloads. It leverages its proprietary and widely deployed database and enterprise application (ERP) software.
- VMWare runs on top of AWS, Azure, Google, IBM, and other clouds but no longer offers IaaS data center hardware infrastructure. VMWare leverages its leading position in on-premises virtualization and offers a common solution across the private cloud, the hybrid cloud, and the public cloud.
- Major telecoms (VZ, AT&T) and legacy IT providers (HPE, Cisco, Sun (now part of Oracle)) have exited the market, unable to keep up with the large investments required in services and infrastructure. Telecoms still have a presence in “hosting” customer IT equipment.
- China’s state-led economy has systematically nurtured and protected Alibaba, Tencent, Huawei, and Baidu. Alibaba dominates in China and is a major player in Asia. Tencent is growing rapidly too. The Chinese government requires non-Chinese cloud providers to operate through a Chinese partner in China.
- Europe is trying to build its own European data infrastructure. The EU is driving the GAIA-X project and the European Cloud Initiative, in which it expects to invest €2 billion.
Figure 6: Cloud provider market share and growth rate, Q1 2021 (IaaS, PaaS, and hosted private cloud)