Follow the CAPEX: Separating the Clowns from the Clouds

In previous installments (2017, 2018) of Follow the CAPEX (merch store opening soon!), we’ve looked at the capital expenditures behind the three hyper-scale public clouds. Now, we turn our attention to two vendors who often tell us they also belong in that group: IBM and Oracle. While I have written about their CAPEX spending before (IBM, Oracle), if derisively due to the paltry sums involved, in this post we will look at their investments systematically and compare them to the hyper-scale cloud players. Because, unlike marketing, CAPEX doesn’t lie.

CAPEX spending on cloud infrastructure is both a leading indicator of the ability to compete at hyper-scale and also confirmation of success with customers. In cloud computing, CAPEX is the ultimate form of putting your money where your mouth is, because no amount of jawboning alone will conjure up data centers or pack them with millions of servers.

As with previous analysis, the goal is identify an inflection point when a company started investing materially in cloud infrastructure and get a sense of their trajectory and cumulative investment.

IBM

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Alas, IBM’s CAPEX spending is not the picture we expect from a rapidly (or even modestly) growing hyper-scale public cloud. There is no (positive anyway) inflection point, just protracted decline. Where on IBM’s cash flow statement are the vast data centers, much less transoceanic cables? In the cloud era, IBM’s CAPEX is shrinking in both absolute and relative terms. Even as IBM’s topline has plummeted by almost $28 billion since 2011 (equivalent roughly to today’s combined annual revenues of Adobe, NVIDIA and Salesforce), their CAPEX spending has plunged even faster.

In the absence of any clear upward inflection point, it is hard to make any estimates of IBM’s cumulative CAPEX spending on cloud, which is tantamount to saying they haven’t even started to compete. The multi-year, $1.2 billion CAPEX announcement from 2014 might actually be a real number, despite IBM’s long history of vacuous “billion dollar” announcements. To update Number Two from Austin Powers for the cloud: “A billion dollars isn’t exactly a lot of money these days.”

Oracle

Oracle’s fiscal year ends in May, so their annual spending has been normalized to a March through February year. When compared to the other cloud companies in this analysis, they get to pull in two months of spend from the following year. Stay tuned to see how this little advantage pays off.

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Oracle’s chart is much better than IBM’s. It is up-and-to-the-right as we expect from cloud providers and there is a discernable, if late for the overall cloud market, inflection point in 2014. This is a much more precise way to figure out when Oracle started to take cloud seriously versus trying to figure out which of their annual OpenWorld proclamations over the last decade to take seriously.

While there is some CAPEX in here for various SaaS acquisitions, Oracle’s cumulative spend on cloud CAPEX looks to be about $3.5 billion. However, that’s about what each of the big three public clouds spend in a quarter.

Stepping into the Big Leagues

Now let’s examine how our two challengers stack up with the hyper-scale clouds (trigger warning: it isn’t pretty):

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We see IBM’s CAPEX slowly trailing off, like the company itself. IBM has always spent a lot on CAPEX (as high as $7 billion a year in their more glorious past), from well before the cloud era, so we can’t assume the absolute magnitude of spend is going towards the cloud. The big three all surpassed IBM’s CAPEX spend in 2012/13. In resisting the upward pull on CAPEX we see from all the other cloud vendors, IBM simply isn’t playing the hyper-scale cloud game.

That red line you may mistake for the x-axis is Oracle’s CAPEX spending. While they have finally separated themselves from the axis in the last couple years, they’re still by far the smallest spender of the bunch. Amazon, Google, and Microsoft each spent more on CAPEX in 2017 than Oracle has in its entire history.

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While the big three have converged to spending about 12% of revenue on CAPEX, IBM and Oracle are eerily similar at 4.8%. It is interesting to compare Oracle to Microsoft, as both were asset-light software companies at the dawn of the century. They had similar CAPEX/Revenue ratios until 2005, when Microsoft started putting its software in data center-sized boxes.

On Magical Thinking

One explanation for lower CAPEX spending, and one advanced by Oracle in particular, is that their technology stack is just so much better than anyone else’s that they don’t have to spend nearly as much on CAPEX. Oracle Co-CEO Mark Hurd:

“We try not to get into this capital expenditure discussion. It’s an interesting thesis that whoever has the most capex wins. If I have two-times faster computers, I don’t need as many data centers. If I can speed up the database, maybe I need one fourth as may data centers. I can go on and on about how tech drives this.”

James Hamilton at AWS debunks this completely and the Register recaps the smackdown with even more snark than I can muster.

But more alarming for Oracle is they don’t seem to know that when they think they’re bragging about their cloud scale, they’re actually demonstrating how hopelessly far behind they are. Deploying dozens of racks a week may sound good if you don’t realize the hyper-scale clouds do orders of magnitude more every week. These kind of data points just reinforce that Oracle is falling ever further behind with every passing week.

End Game

As I keep repeating, CAPEX is both a prerequisite to play in the big boy cloud and confirmation of customer success. Both IBM and Oracle are tens of billions of dollars in cloud infrastructure CAPEX behind Amazon, Google, and Microsoft. Oracle’s spending has at least ticked up, but their spending is not enough to keep pace, much less to have any hope of catching up to the infrastructure of the big three.

Both IBM and Oracle (like many vendors) make it difficult to do apples-to-apples comparisons across different parts of their cloud businesses, but we can draw some conclusions from their reported growth rates. For the first quarter in 2018, IBM claimed their cloud business at the broadest level (which includes both SaaS revenue and – literally hardware — the proverbial kitchen sink) was up 22%, while their “as-a-service” cloud business was up 25% (which is less than half the size of their “not-cloud cloud business”, whatever that is). Oracle claimed their overall cloud business was up 32% (again, a lot of SaaS) while IaaS and PaaS lagged slightly at 28%. Contrast this to first calendar quarter 2018 reported growth for AWS of 48% and 89% for Microsoft Azure (Google doesn’t report growth or break out Google Cloud Platform revenue). Both Amazon and Microsoft are growing much faster than IBM or Oracle on dramatically larger revenue bases. Given vastly smaller CAPEX investment and a fraction of the revenue growth on an at least one order of magnitude smaller base, it is next to impossible to see how IBM or Oracle ever really are competitive with the hyper-scale cloud vendors.

Maybe they are reconciled to sitting at the children’s table of cloud, but the problem for both IBM and Oracle is cloud is eating their existing businesses. It has eaten the server business and now starting to feast in earnest on software infrastructure, including the database, which is the profitable heart of these companies. IBM’s revenue implosion has been on display quarterly for years. Oracle likes to point out Amazon runs their e-commerce business on Oracle database, and there are a lot of other legacy Oracle customers out there. But there just aren’t very many new customers for Oracle’s database. New software license revenue is down to 14% of total revenue in the most recent quarter and that number continues to decline. And be sure that when Amazon.com gets off Oracle (and they’re hard at work on this), they’re going to show the whole world how to do it. AWS already has a booming migration service for Oracle (and other) databases. The need to replace the database business and/or move it to the Oracle cloud will only become more acute.

The problem for both IBM and Oracle is their sticky, high margin platform businesses are being eroded, and their customers are migrating to other cloud platforms. Both companies have acquired a number of SaaS applications, which will bolster their sense of self-worth and belonging in the cloud,  but there is little to no platform leverage associated with these apps (and platform leverage = profits!!!). Meanwhile, the big clouds will leverage their platforms and move up from the infrastructure layer to take an ever larger bite out of overall IT spend, i.e. IBM and Oracle’s customer bases.

IBM at this point has greater self-awareness about their predicament than Oracle (and perhaps that is why they’re not making any incremental CAPEX investment because they know they can’t win this game). I’ve expressed some skepticism about IBM’s prospects in the cloud era for a while. After a cringe-inducing campaign claiming to be bigger than AWS (which reinforced IBM doesn’t really understand the difference between hosting and cloud), they have mostly moved on to making preposterous claims in other areas (Watson which is in serious contention to be the biggest “overpromise and underdeliver” in tech industry history, now blockchain as they try to save humanity from our looming existential tomato provenance crisis, and as that founders in its absurdity,  they are moving onto quantum computing). IBM has been better at storytelling than delivering technology in the 21st century. They still tell Wall Street ridiculous things with Watson-esque bravado about their “position as the leading enterprise cloud provider”, but it seems half-hearted at best. IBM’s biggest investment in cloud seems to be “convincing” (perhaps using monetary inducements) a boutique analyst firm to define cloud as cloud plus whatever it is that IBM does (“private hosted cloud” ¯\_(ツ)_/¯ ) in a way that lets them claim to be a “Big Four” cloud provider (Synergy’s numbers are ridiculous, but that is a post for another day).

At the most basic level, IBM has a product problem and a customer problem. The product problem is they can’t build competitive technology any more. As Gartner delicately puts it: “IBM has, throughout its history in the cloud IaaS business, repeatedly encountered engineering challenges that have negatively impacted its time to market.” And their customer problem is who their customers are at this point: the disrupted. You may not get fired for buying IBM, as the old saying goes, but it is increasingly likely your employer will go out of business if you’re in an industry where technology matters.

Oracle finally understands the threat cloud poses, and have aggressively responded, but don’t yet seem to have a realistic view of their prospects. Their traditional strategy of picking a verbal fight with the leader in a new market isn’t going to work when they haven’t actually spent the money to build out a cloud to back up the rhetoric. Oracle doesn’t suffer from IBM’s product development problem. They’re throwing tons of money at people in Seattle and, like a bank, making every employee a vice president. But they’re way behind, need to spend tens of billions to have a competitive global cloud infrastructure, and have a much more severe customer problem than IBM: their customers hate them.

No one is looking to electively increase their dependency on Oracle (and embracing cloud takes vendor dependency to a whole new level). Oracle has always been very aggressive on the sales side, and their desperation around cloud appears to be taking it to new heights. Gartner, who are otherwise inexplicitly inexplicably upbeat about Oracle’s cloud efforts, says, “Oracle sometimes uses high-pressure sales tactics to sell its cloud IaaS offerings, including software audits or threatening to dramatically raise the cost of database licenses if the customer chooses another cloud provider.” The risk for all existing Oracle customers, as the company’s cloud ambitions collide with reality, is the company will get even more aggressive in monetizing its non-cloud installed base in order to sustain its revenue. If you think their maintenance fees and audits are bad now, just wait until they start waterboarding customers (or maybe they already do?).

TL;DR: Thanks for playing IBM and Oracle.

Rumor has it IBM's hat seen here was designed by Watson
Clown-1-1” (CC BY-SA 2.0) by americanbulldogbully007

17 thoughts on “Follow the CAPEX: Separating the Clowns from the Clouds”

  1. What a stupid report of course paid by Microsoft.
    Please do not talk about things you do not know just because Microsoft pays. Totally unnecessary…

  2. Can we expect a look into Alibaba Cloud in your next roast? Can the dragon puff up to compete or is there no magic that can help you reach Microsoft (and see Amazon)?

  3. Charles,
    This is an interesting article. I’m curious where you have received your CAPEX figures from? Have these been taken from annual reports and if so, are they delineated from all CAPEX amounts each company has spent? Without reference to specific cloud related spend data points I guess we have to take your word for it. Also, IBM had the most CAPEX spend until 2012, 11 years worth in your chart. Does this not account for something? One last point, anytime you compare a person or group of people, namely a corporation, to clowns I believe discredits your position. I get your trying to “stand out” by naming calling but calling IBM (specifically) a clown when they have led patents for the past 20+ years is ridiculous.

  4. CAPEX data is all from the companies’ SEC-reported cash flow statements. See earlier posts in this series for discussion of all the things that might be in this line item beyond cloud infrastructure.

    IBM has been spending a ton on CAPEX for a long time. To believe IBM is keeping up in cloud, you’d have to believe they’ve had hyper-scale cloud data centers for a long time (implausible) or they’ve pretty much zeroed out everything else they spend CAPEX on (also hard to believe). The lack of any inflection point upwards, unlike everyone else running this race, suggests not much is going on at IBM when it comes to cloud infrastructure.

    Given the absurd things IBM (and Oracle) say publicly about their cloud efforts, calling them clowns is kinder than calling them liars. The first paragraph in IBM’s quarterly earnings press release is invariably full of whoppers about cloud and more recently AI.

    IBM’s patent numbers show the complete disconnect between patent quantity and innovation. If IBM’s patents represented actual innovation, they would not be in the situation they are in. I’ve written about this before:
    http://www.platformonomics.com/2007/10/patently-nonsense/
    http://www.platformonomics.com/2007/10/ibm-beats-hasty-retreat/
    http://www.platformonomics.com/2007/10/still-more-ibm-patent-tomfoolery/

  5. This and some of the articles would be better if some nuances are addressed; it doesn’t necessarily detract from the main thrust of the article but would nevertheless make it more accurate.

    Here are a few things that are different for each company in my mind:

    1) I think Amazon has started delineating the CAPEX spend from Amazon vs. AWS – but obviously the initial investments were not specific to AWS – although I am sure the datacenter expertise helped. It is not clear from the article if the CAPEX spend is specific to AWS or is for all of Amazon.

    2) It is not clear if there is a clear delineation that Microsoft provide between CAPEX for search (Bing, etc) vs. their cloud efforts. I am sure their work on Bing, etc helped them in their cloud efforts esp. as it relates to datacenter expertise

    3) Similarly it is not clear if there is a clear delineation that Google provides between CAPEX for search vs. their cloud efforts.

    4) Amazon, Microsoft, Google have a different strategy than Oracle in that they are trying to own the Datacenters vs. Oracle which is going with a co-location strategy and so is not owning the datacenters. Not clear how IBM is approaching things.

    5) Another difference between Oracle/IBM and Amazon, Microsoft, Google is that both Oracle/IBM have a hardware division. Now much this results in reduced costs is anybody’s guess – but if we could account for this then that would the article more insightful.

    6) Given Oracle at this point is more of a SaaS player than in IaaS/PaaS – it would be interesting to also compare the spend of Oracle vs. other SaaS players – esp. Salesforce, SAP, Workday – this will probably a get a better perspective on how much CAPEX is for SaaS vs. IaaS/PaaS

  6. At a general level, see some of my previous CAPEX posts for details and limitations of each company’s reporting.

    Amazon called attention to their use of capital leases in addition to traditional CAPEX spending. We think these leases are for AWS but they have not explicitly stated that as far as I know. The CAPEX numbers shown here include both their CAPEX spending on the cash flow statement and the capital leases. When I estimate AWS overall spending, I assume it is mostly the capital leases.

    Microsoft CAPEX is in some ways the cleanest but they don’t distinguish between search (which is the biggest app around). There is no doubt Microsoft is where they are in the cloud game because they overbuilt for search starting in 2006.

    Google has by far the biggest investment in infrastructure, but GCP is a small client. Search and YouTube are enormous and GCP has to build on top of that infrastructure which is not built for them. I think this in part explains Google’s reluctance to embrace non-container approaches seriously/on a timely basis.

    Oracle and IBM are both primarily co-lo (Oracle has a decent-sized datacenter in Utah). This limits their scale and keeps them from achieving economies of scale.

    Amazon, Google and Microsoft all have non-trivial hardware businesses (Echo, HTC/Pixel, Surface, HoloLens, etc.) as well that consume CAPEX. You can see how much Oracle managed to squeeze the CAPEX they inherited from Sun, so don’t think they have a lot. What IBM spends all that CAPEX on is a mystery, but pretty sure it is in’t data centers.

    The SaaS guys in general have pretty minimal CAPEX requirements relative to revenue (unless they are storage companies). Oracle has bought a bunch of SaaS companies and each will have their own CAPEX. Whether they can consolidate those onto Oracle Cloud remains to be seen. But the fact Oracle is out bragging about deploying “dozens of racks a week” gives a real sense of just how miniscule their IaaS infrastructure is.

  7. I really like your breakdown of the CAPEX spend. As a customer, this is a great background for strategic planning. As an investor, I’m unmoved until I see organic or margin growth that proves every employee with a 16 page whitepaper isn’t slowly flushing that CAPEX down the toliet over 4 and 7 year increments.

    The balance of expenditures associated with Saas revenue at Oracle brings some comfort. I know they aren’t writing huge checks against vast capabilities their not good at delivering or selling. They’re playing to their customer base.

    After this read I’m not sure I can break the image of the Oracle customer as the sorry man buying the used car in Fargo, getting lectured about that factory clearcoat while he cries to his wife to get the check book out.

  8. Great insights, Charles – CapEx is indeed a leading indicator of continued growth.

    One question though – from Amazon’s financial statements, how were you able to separate their CapEx on AWS from their retail business – e.g. warehouses, planes, trucks, drones ….?

  9. Look at the first Follow the CAPEX post – I try to break down different types of CAPEX based on available info and cumulative cloud infra spend. I think the capital leases for Amazon are a pretty good proxy for AWS infrastructure spending.

  10. IBM and Oracle are portfolio management companies specializing in high tech industry. Amazon, Microsoft, and Google ARE tech companies.

    A tech companies builds products and spends on data centers. A portfolio manager is focused on financials and is risk averse. Innovation like cloud and AI is risky. Therefore they acquire companies instead.

    That explains why most of their spending is on acquiring companies instead of building data centers and products.

  11. IBM and Oracle are serving their customer base so they don’t lose them in the transition to the cloud.

    Neither Amazon nor Google make production technology for enterprises. One is aiming to become the logistics provider and the other is aiming to become the salesperson, and both are on their way to becoming them for all the small businesses on the planet. Moore’s Law causes economies to polarise, so there will be, at various dimensionals, sets of the small and the large; with the small being very well served by these two.

    Microsoft, IBM and Oracle, as before but only differently now, are positioning to serve the polarised market. Microsoft’s job is to substitute the cpu/mem of all the personal computers it has helped install in the last thirty years, hence those fast large capex before the market fragments too much. You don’t get fired for buying IBM and that will remain true for the foreseeable future; they do basic computing science that perhaps only Google, and some of Microsoft, might arguably claim to be doing too. Oracle has made its database business a cashcow long ago and is focused on SaaS and the PaaS to support the SaaS as it eventually goes head to head with Microsoft who are aiming to come from behind quietly.

    Capexes don’t lie. The truths that they do say are various and not trivially comparable, for a planet of 7 billion humans and 500 million businesses.

    Might you describe what it is that you think the world of businesses and humans are expecting from the hype/r of the cloud. People around the world wake up in their mornings to go to some work and they plan, not merely expect, to be doing so for the foreseeable century, no?

    Thanks for the article.

  12. Only a part of Amazon’s business is cloud. Are their CAPEX figures total CAPEX, or just the AWS component? (Bear in mind that AMZN paid $13.7Bn cash for Whole Foods last year.)

  13. This is all-up CAPEX. See the first post in this series for an attempt to tease out what is cloud and what isn’t. Cloud is a minority of Amazon’s overall CAPEX at this point.

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