Amazon Shows Why Investing in the Cloud Is Becoming So Important

NEW YORK (TheStreet) -- Amazon's (AMZN) decision to break out the results of its giant cloud computing business, Amazon Web Services, is a sign that the division is growing up and an indication of just how important investing in the cloud is becoming to tech companies.  

Companies that offer cloud services, where data and applications are stored remotely and accessed via the Internet, spend a lot of money initially trying to acquire customers. That's why traditional metrics, such as revenue and earnings, are not always the best way of determining how well the business is doing. Earnings are likely to be depressed as marketing and sales expenses are inherently higher than a traditional software company.

Many technology giants, including Amazon, IBM (IBM) , Oracle (ORCL) , Microsoft (MSFT) and Google (GOOGL) , offer software and services that provide customers with access to software, platforms or infrastructure from anywhere in the world as long as the customer has an Internet connection. Among them, they have very different cost structures, with some focusing more on acquiring customers at an early stage in order to maintain and win market share.

As of the fourth quarter, there were more than one million worldwide active Amazon Web Services customers making use of Amazon's cloud-computing and data services. On the earnings call, CFO Tom Szkutak said Amazon believes it's appropriate to start looking at AWS by shedding more light on it.

"In terms of AWS, we just think it's an appropriate way to look at our business for 2015," Szkutak said on the earnings call. "And so our plan is... separating it out as of Q1 of this year."

Once a cloud customer is signed, revenue is recognized over the life of the contract, while expenses are recognized immediately. For example, if a contract runs 24 months, the revenue is recognized in 24 equal parts, while the expenses are recognized in one lump sum.

So given that, why would anyone want to invest in a company that's increasingly putting its wares in the cloud?

A really good piece from venture capital firm Andreessen Horowitz explains why:

"Because once a SaaS (software as a service) company has generated enough cash from its installed customer base to cover the cost of acquiring new customers, those customers stay for a long time."

Essentially the reasoning is that once a corporate customer is embedded in a company's software, services and platform, the customer tends not to leave, thus benefiting the vendor down the line.

That's why it's often important to look at metrics such as customer acquisition costs (quarterly sales + marketing expense / number of customers in a time period), churn (the amount of customers leaving in a particular time period), billings (revenue + change in deferred revenue from one quarter to the next) and a few other metrics to see whether the cloud is working for the company in question.

Switching to a cloud-centric model depresses revenue and earnings in the short term (as companies ramp up expenses to acquire customers and forgo the revenue of expensive boxed software), but it creates certainty, ultimately benefiting cash flows for two reasons.

You'll often see Wall Street analysts and company CEOs try to talk up billings as a true measure of the company's growth potential and talk less about revenue, because revenue, expenses and cash flow from operations don't often go hand-in-hand for cloud-based companies.

Aside from the stickiness of a customer not leaving a particular software or vendor, cloud-centric offerings also cut down on the number of versions of a particular piece of software (say for instance, Adobe's (ADBE) Photoshop) that are being used. That reduces research & development costs. It also reduces support costs, as there are fewer error fixes and software updates.

Bloomberg has an  excellent piece on which companies are now breaking out their cloud-centric revenue. The list includes big names such as Amazon, IBM, Microsoft, Rackspace ( RAX) , Salesforce.com ( CRM) and Oracle.

-- Written by Chris Ciaccia in New York

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