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Amazon Business Model: Amazon Web Services

It is an almost impossible task to try write about Amazon Web Services
(AWS) without being either unbelievable shallow or unbelievably geeky.
The breadth and depth of AWS’s functionality is so extensive that even it
experts start specialising on certain elements. So, what’s the point
anyway?

Well, I am going to focus on the technicality only to the extent that is

required to explain the business model innovation of it, similar to how we
looked at the business models of the Kindle platform, Alexa
platform and Prime Video. Contrary to those, however, AWS is not fuelled
by the platform business model (which I have covered so extensively) but
by the Infrastructure-as-a-Service (IaaS) model which is similar to the
better known Software-as-a-Service (SaaS) business model.

Users: Everybody
Netflix: 100% on AWS
Netflix is one of the most envied innovators themselves. It speaks volumes
of AWS’s capabilities that Netflix is fully hosted by AWS. (To be entirely
correct, recently Netflix started using Google Cloud for some new features
at small scale.)

In early 2016, Netflix reported having completed their move to the cloud.
We can learn a lot about AWS from Netflix’s Vice President, Cloud and
Platform Engineering about the migration to the cloud:

1. “Our journey to the cloud at Netflix began in August of 2008, when we

experienced a major database corruption and for three days could not
ship DVDs to our members. That is when we realized that we had to
move […] towards highly reliable, horizontally scalable, distributed
systems in the cloud […]
2. We chose Amazon Web Services (AWS) as our cloud provider
because it provided us with the greatest scale and the broadest set
of services and features […]
 3. The Netflix product itself has continued to evolve rapidly, incorporating
many new resource-hungry features and relying on ever-growing
volumes of data. Supporting such rapid growth would have been
extremely difficult out of our own data centers; we simply could
not have racked the servers fast enough. Elasticity of the cloud
allows us to add thousands of virtual servers and petabytes of
storage within minutes, making such an expansion possible […]
4. We rely on the cloud for all of our scalable computing and storage
needs — our business logic, distributed databases and big data
processing/analytics, recommendations, transcoding, and
hundreds of other functions that make up the Netflix
application […]
5. The cloud also allowed us to significantly increase our service
availability […] it is possible to survive failures in the cloud
infrastructure and within our own systems without impacting the
member experience […]
6. Cost reduction was not the main reason we decided to move to the
cloud. However, our cloud costs per streaming start ended up
being a fraction of those in the data center— a welcome side
benefit. This is possible due to the elasticity of the cloud, enabling us
to continuously optimize instance type mix and to grow and shrink
our footprint near-instantaneously without the need to maintain
large capacity buffers. We can also benefit from the economies of
scale that are only possible in a large cloud ecosystem […]
7. Arguably, the easiest way to move to the cloud is to forklift all of the
systems, unchanged, out of the data center and drop them in AWS.
But in doing so, you end up moving all the problems and limitations of
the data center along with it. Instead, we chose the cloud-native
approach, rebuilding virtually all of our technology and
fundamentally changing the way we operate the company.“

Everybody uses AWS

But the list of AWS customers is long and full of innovative companies.
Based on one market intelligence company, these are the (likely) largest
customers of AWS and their annual spend:

1. Netflix – $19 million

2. Twitch – $15 million
3. LinkedIn – $13 million
4. Facebook – $11 million
5. Turner Broadcasting – $10 million
6. BBC – $9 million
7. Baidu – $9 million
 8. ESPN – $8 million
9. Adobe – $8 million
10. Twitter – $7 million

A who-is-who of other large companies using the AWS can be found

here (basically any large company you can name).

There are an estimated total of >2.5m companies using AWS.

(2) The platform – an overview

The building blocks (=services)
One of the strongest selling points for using AWS is its extensive set of
services (I call them building blocks) such as computing, queuing of jobs,
database services, storage, email and notification services and a lot more.
The complete list of AWS products as of Oct 2018 [AWS user console]
You can find an introductory description of each service in this AWS
overview [pdf]:

1. Compute Services
2. Storage
3. Database
4. Migration
5. Networking and Content Delivery
6. Developer Tools
7. Management Tools
8. Security, Identity, and Compliance
9. Analytics
 10. Artificial Intelligence
11. Mobile Services
12. Application Services
13. Messaging
14. Business Productivity”
15. Desktop & App Streaming
16. Internet of Things (IoT)
17. Game Development

Or a different way to represent the services in layers. It distinguishes

between the physical layer, a layer of foundational services, applications
services and management tools.

Categorising the AWS services in layers from the AWS physical

infrastructure up to your application. This simplified list shows an
excerpt of all available services.
Architectures for common problems
How the individual blocks can be put together to solve for common
problems is part of the architectural design. The diagram below shows
Amazon’s recommendation for a media sharing functionality that could, for
example, be part of a social media platform.

Always wanted to create your own social media platform? This is how
you could set up the media sharing functionality of your social
platform in AWS [Source: AWS, pdf]

These architectures can help save tens of thousands of development

manhours of building similar functionality in-house. In the above excerpt,
Netflix was talking about not just “forklifting” their existing applications into
the cloud but rebuilt everything in a cloud-native way (i.e. architecture).
With this massive set of service comes one of AWS’s the challenge of
building the best solution for a given problem. Any complex as-a-service
provider needs to help customers with this. Here are just a few approaches
that Amazon uses:

1. Extensive online documentation of each service and API

2. Videos, webinars, tutorials, blogs, helpful evangelists and more
3. AWS recommends architectures for various types of common
problems
4. A community of practices where others can showcase their solutions
to practical problems (“This is my architecture”)
5. GitHub (a large developer community) enlisting tried and tested AWS
solutions and ongoing projects
6. The AWS partner network of service providers, consultants, etc

As-a-Service: IaaS, PaaS, SaaS

There are three commonly differentiated types of as-a-service architecture.

Differentiating between traditional on-premise IT architectures, IaaS,

PaaS and SaaS
Most of AWS’ services fall under into the Infrastructure as a
Service category.

1. On-premises: this is the traditional architecture where the in-house team

manages everything (though there are again differences depending on
in-house servers or usage of data centres). Most AWS clients would
have a hybrid solution of some on-premises and AWS
2. IaaS (Infrastructure as a Service): This type of service is the one
closest to the hardware level without giving access to the hardware
itself. It gives access to the operating system layer (in AWS you can
choose between Windows or Linux OS) and take care of the layers
between the OS and your applications
3. PaaS (Platform as a Service): With PaaS, users can focus on the
application and data layer only. AWS beanstalk is a service that falls
under this category. It allows users to easily deploy and manage their
applications on AWS without worrying about the layers below
4. SaaS (Software as a Service): SaaS is become increasingly popular,
e.g. Microsoft Office 365 is the SaaS version of Microsoft’s traditional
Office applications. Other well-known examples are Google Apps,
Slack, Zendesk, Dropbox, Salesforce, etc. AWS itself is not an SaaS
service but they have offer solutions for SaaS providers to build their
services on AWS

This famous model shows the various XaaS’s as layers stacked upon
each other (it doesn’t mean that PaaS needs to be stacked on an IaaS
or SaaS on a PaaS)
I will cover Software-as-a-Service in more depth in a number of articles in
the near future as they have become an important part of the IT landscape.

Use cases
What do you do once your services cover a certain amount of foundational
elements and a range of typical application layer elements? You start going
into verticals. That is what AWS has done in recent years.

Example: Vehicle to vehicle communication

An innovative way to increase car safety is vehicle-to-vehicle
communication. It could be used to “look around the corner” or as in the
AWS example below to warn other cars of rainy conditions.

One use case of many is vehicle-to-vehicle communication

The desired functionality can be built by combining a number of AWS
services:

1. Required computing capacity can be scaled up and down quickly:

e.g. more cars transmitting and receiving data in peak hours does not
need to translate into having to own servers for peak demand. AWS
has a few solutions for these situations as we will discuss below
2. The same holds true for increasing the number of cars that are part of
the services which does not need to translate into having to acquire
new physical servers
3. Storage requirements scale up as more cars join and as more data
gets collected over time (AWS S3)
 4. Analytical computing power through scalable machine learning
modules to steadily improve accuracy over time (SageMaker)
5. Routing of data securely between data sources and consumers as
well as defining rules to control the connected devices (AWS IoT
Core)
6. And much more

With over 2.5m customers, the list of use cases is almost endless (you
scroll for a very long time through this list of AWS use cases).

Personally, I find it inspiring to see the opportunities that have been created
for developers within a mere 10 years. Thinking back of my own times of
developing it is exciting how far things have come in such a short time
frame.

It ultimately helps firms to focus more on the customer’s needs than the IT
system’s needs!

Benefits for customers

AWS could not have become the success that it has if it wasn’t for its
tangible and immediate customer benefits. Let’s look at the advertised
benefits of using AWS (and its challenges):

1. Trading Capex for variable opex: Instead of building one’s own data
centres incurring large cash flows upfront, AWS promises that
customers only pay for the computing resources that they actually use
2. Economies of scale: AWS has achieved a scale that no individual
company will achieve by itself. This allows AWS to offer their services
at lower costs than firms could achieve in an in-house solution
3. Flexible capacity: It can be difficult for firms to predict how much
computing or storage capacity they need for new services. Risks are
to over provision (thus sitting on idle capacity) or under provisioning
(e.g. providing a poor customer experience). AWS provides high
flexibility in scaling up or down computing capacity within minutes
4. Agility: Cloud computing services simplify the process of developing
new services/offerings for companies by not having to worry about the
lower level infrastructure considerations
 5. Focus on differentiating projects: By being able to reduce the IT
infrastructure tasks of project teams can focus on the differentiating
parts of a new service/offering
6. Global reach: AWS with its servers across the globe allows their
customers to offer their services worldwide without incurring latency
losses from connecting to servers in one (on-premise) location

IDC reports considerable savings of using AWS compared to more

traditional in-house approaches

Cost control
Costs will be one of the most important factors in evaluating cloud services.
Any as-a-service platform needs to build a strong case. Here is what AWS
does:

 AWS offers a total cost of ownership (TCO) tool so their customers

can build an investment case. (In order to have a good comparison,
prospective clients need to guess the capacity they will be using. Not
having to do was one of the advantages stated by Amazon)
 In an example, that I have run, AWS generated a comprehensive
report (since it’s 2.2 MB I won’t link to it here). It is a useful approach
for an SaaS provider to arm their prospective customers with numbers
so they can to convince decision makers within their organisation
 SaaS, IaaS, PaaS need to be open about costs. Opaqueness about
costs will put off a lot of prospects
 AWS has got a lot of tools and even APIs for cost tracking/control as
well as budgeting, see some of the links below
Challenges
Here are some common challenges of AWS:

 Lock-in effects: bringing things back in-house (if that decision is ever
made) or even to migrate to a different cloud service provider will
come with cost and time efforts. Therefore, there is some exposure to
price increases over time
 Cost control: Many companies seem to have more stringent cost
control requirements to outsourced services than in-house
work (possibly due to the sunk cost fallacy). AWS offers a suite of cost
control tools and even a Budget API to help their customers. Despite
all this, understanding AWS bills is frequently mentioned as a
challenging task for
 Keeping up: Gartner consultancy points out that keeping up with the
changes, enhancements and best practices in AWS requires constant
efforts and that it “may challenge even highly agile, expert IT
organizations, including AWS partners”
 Other: some sources mention security, privacy, availability as
downtime as a disadvantage. Others oppose this view and stated that
AWS will beat most on-premise infrastructures on these dimensions.
The differing opinions may be going back to what Netflix pointed out:
“forklifting” existing applications into the cloud may lead to inefficient
implementations whereas developing a cloud-native approach would
be the best way to take advantage of the potential benefits

Pricing models
AWS uses a number of pricing models:

1. Pay-as-you-go (On-demand): This is the most flexible option but also

the most expensive. It allows ramping capacity up or down as required
without any forward planning. It avoids the risks of buying up too much
capacity that remains unused or under provisioning
2. Reserved Instances (RI): Translate RIs into reserved computing or
storage capacity. By reserving computing/storage capacity upfront, the
user can save somewhere in the vicinity of 35%-75%. The savings
depend on a number of factors including how much the user is willing
to pay upfront. This pricing model is available for a few core offerings
only
 3. Volume discounts: Amazon offers tiered pricing that reduces the
price per unit depending on the volume of the purchase. This too
applies only on certain services
4. Spot pricing: With discounts of 90% off the on-demand price for
purchasing on the spot (similar to commodity spot prices on
commodities markets). This is how Amazon sells unused capacity.
However, AWS reserves the right take away this type of computing
capacity on short notice (2 minutes)

While these principles sound straightforward, looking into the details you
would find an amazing complexity behind these few pricing principles. The
exact price depends on a lot of factors, including the respective service, the
region and more.

Business model
One of the most important customer value propositions is that AWS allows
for high flexibility of capacity usage for their customers. However, if
flexibility was unconstrained it would transfer the risk of getting capacity
wrong from the customer to Amazon. Think of the largest chunk of internet
traffic: streaming. Like many other use cases, streaming is not spread
evenly throughout the day.

Computing capacity is a perishable commodity like hotel rooms, aircraft

seats or food. When unused they expire. Idle sitting processor or memory
capacity makes no money to offset the initial capital costs, the ongoing
operating or overhead costs. If it was a pure on-demand model, AWS
would risk spikes, bullwhip effects and underutilised capacity in the long
term.

Amazon’s pricing models aim to incentivise customer behaviour in a way

that utilises Amazon’s infrastructure evenly while maximising revenue. With
this in mind, here are a few more examples on the above-mentioned pricing
models:

Utilising capacity
 Pay-as-you-go gives customers the most flexibility but they pay for it
with the highest rate by comparison to the other pricing models
  Reserved Instances (RI) (=reserved capacity) sound straight-forward
at first, but as you look into the details, there is complexity behind it in
order to cater for different user needs
 RIs can be reserved for 1 or 3 years. They are most useful
for predictable steady-state usage. Some users may have predictable
capacity needs. Others may have at least a predictable ground
capacity needs for which they can use RIs
 Scheduled RIs can be useful in this context: customers can commit to
using a certain amount of capacity at given time-of-day and/or day-of-
week. E.g. Netflix could reserve a base capacity via RIs and then add
more capacity via schedule RIs for predictable peak hours (e.g.
weekday evenings and then more for weekend evenings, etc). It is a
matter of capturing good usage data
 Convertible RIs can be converted into other RIs (i.e. computing or
storage capacity) of equal or higher value. The discounts on these
types of RIs are still up to 54%
 RIs can be fully paid upfront to get the maximum discount or on
monthly instalments with no further discounts
 RIs can be acquired by 3rd parties (AWS partners) and then sold
onto end customers mimicking the wholesaler approach known in
many other industries
 Spot Instances are an option to get even more discounts of up to
90% off on-demand prices. Amazon reserves the right to take away
the computing capacity from the customer with as less as 2 minutes
notification. The customer can define the interruption behaviour
 Spot instances are not a spot price as you know from commodity
spot markets where the price is determined in real-time based on bids
and asks. Rather AWS spot instance prices are still set by Amazon
based on longer-term supply and demand patterns and differentiating
between regions and computing power, etc

With all the above AWS can incentivise their customers to use AWS
capacity in order to avoid that they sit on excessive unused capacity
themselves which would unravel the whole business model.

The strategic view

Amazon is often described as an economies of scale company that is so
successful and cost-effective because they scale everything up ad infinitum
(or more than others anyway). In reality, however, economies of scale don’t
go down asymptotically as you scale up. They reach an optimal point and
then start increasing like a bathtub. If you scale beyond good utilisation you
have spent Capex at low ROIC and incur unnecessarily high ongoing
maintenance costs.
Thus, economies of scale require a thoughtful management, a healthy
growth of new customer (to cater for churn and then some), useful
functionality for existing customer so they expand their solution, cost
management tools, incentives to achieve optimal utilisation and more.

Gartner’s comparative study (magic quadrant) shows AWS ahead of

other IaaS providers

Among the strategic success factors, AWS is one of the leading

providers (if not the thought leader per se):
  Expand into new markets (industry verticals as well as functionality)
via new services as well as acquisitions
 Fast increasing the portfolio of services
 Low risk with high security, privacy, reliability standards and a high
likelihood of being around in another 10 years
 A strong ecosystem of AWS partners for various services, such as
consulting, development, integration, support

AWS has started as a way to manage Amazon’s in-house IT. They have
then opened it to external customers. This is a very similar pattern to
Fulfilment by Amazon and to Shipping with Amazon. Within 10 years,
AWS has grown to one of Amazon’s biggest revenue streams and the most
profitable one. Not many (if anyone) would have foreseen this level of
success. Whatever you think of Amazon this is inspiring for innovators.