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The Managed Cloud Is Growing, but Risks Commoditization, Margin Compression

Assessing a cloud managed service provider and evaluating their future potential depends on both market growth and unique company capabilities and relationships. While the public cloud market overall is growing rapidly, sales are split between direct and indirect channels, with sales capabilities varying by provider. However, even with direct sales growth and the addition of automated tools by the major cloud providers, the market for resale and value-added services is still expanding at a healthy pace.

While the manager cloud services space continues attractive growth, it is highly fragmented, with service providers covering many niches, from generalist to vertical-specialist, SMB-focused to enterprise-focused. Each provider brings value-added capabilities to the table, in addition to their resale business. With so many provider options to choose from, customers often have a choice to make when selecting their partner. The main criteria that drive customer acquisition and retention are:

  • Price: Customers consistently cite price as a top factor when deciding on a cloud service provider; though price differentiation between comparable competitors is scant, a company’s relationship with the major cloud platform as well as volume can both drive material differences in margin, directly resulting in price differentiation.
  • Cloud platform: Customers often purchase cloud platforms with particular use cases in mind and require a service provider that can cater to that platform; the best-case scenario is a “one-stop shop” service provider with multiple certifications.
  • Capabilities: While breadth of offerings may vary between providers, there is little differentiation in most products; business size determines needs, with enterprises seeking more specialized, hands-on services while SMBs value simple, affordable tools. Tools that optimize purchasing of instances and provide significant savings have now become table stakes, while many companies differentiate by offering high-margin professional services and DevOps.
  • Technical Support: Customers appreciate breadth of knowledge, reliability, and timely responses from support technicians; inability to provide timely support is a deal-breaker.
  • Geography and reputation: Given the highly fragmented market, customers may select and stick to providers for reputation in their local area; cloud providers are likely to refer small to mid-size customers to well-regarded, certified partners.

Once acquired, customers are reluctant to switch providers, as the risk of downtime outweighs most other potential benefits. Though the market for public cloud services is growing rapidly and customer relationships are sticky, there remain a few key risks to the cloud-resale business model:

  • Public cloud providers are developing more robust services that might compete with managed service providers, particularly for SMBs and customers in lower-complexity industries.
  • More companies are bringing expertise in-house to reduce cost, but this is mainly limited to larger enterprises.
  • Value-added services could become commoditized, with constant investment required to stay on-par with competition.
  • Azure’s and Amazon Web Services’ margins are stable but low (<10%) given platform maturity, and Google Cloud Provider’s resale margins are higher but likely to compress as their “land-grab” subsides; thus, the end state is likely relatively unattractive margins on the cloud resale portion of the product portfolio.

While risks exist, the need for managed public cloud will not slow any time soon, especially for mid-market customers and those with complex or vertical-specific needs. In a highly attractive space with a large variety of players, a standout provider must be constantly innovating to meet ever-changing customer needs while constantly delivering stable service from a respected, reliable team.