Web accounts

What could go wrong for Amazon Web Services?

Amazon (NASDAQ: AMZN) is struggling with its retail business. High inflation is contributing to a slowdown in demand, and rising costs for everything from labor to transportation are reducing profitability. Consumers are not as willing to open their wallets with a potential recession looming.

It’s a very different story for Amazon’s cloud computing business. Amazon Web Services (AWS) increased sales 37% to $18.4 billion in the first quarter, and operating profit jumped 57% to $6.5 billion. Cloud giant friends Microsoft and Alphabet saw similar results. Microsoft’s Azure cloud platform grew 46% in its most recent quarter, and Google Cloud saw 44% growth.

Given this impressive growth in the face of a tough economic environment, it’s not unreasonable to think that the cloud computing industry, and AWS in particular, won’t suffer much during a recession. But there are two risks that investors should not ignore.

A business slowdown

One source of growth for cloud computing giants is as large enterprise customers move workloads from legacy infrastructure to the cloud. This is capable of fueling the industry for many years to come. In an interview earlier this month, Amazon CEO Andy Jassy estimated that 95% of global IT spending still doesn’t go to the cloud. It’s a huge track.

Although the long-term picture is promising, large companies and organizations facing uncertainty tend to cut unnecessary technology spending. It is important to understand that cloud computing is not cheap. Cost savings are not guaranteed when moving from on-premises infrastructure to AWS, and there is the additional cost of the actual migration. What the cloud buys you is agility, flexibility, and scalability.

For a large enterprise faced with declining demand from its own customers and rising costs, it would be easy to delay or scale back a planned migration to the cloud. This is especially true if the goal was never to cut costs in the first place. While companies are happy to tell a “digital transformation” story when things are going well, controlling costs and boosting profits take precedence when the going gets tough.

Image source: Amazon.

A “winter” start-up

Another class of customers driving the growth of cloud giants are start-ups. A start-up is going to overwhelmingly choose cloud computing by default, and if they have venture capital funds, they probably won’t care that much about optimizing their cloud spend.

Venture capitalists pumped money into start-ups in 2021, investing more than $600 billion globally. Hundreds of new unicorns were minted last year, far more than in previous years. It’s a godsend. And it won’t last forever.

Whenever venture capital starts to get harder to find, two things are likely to happen. First, some start-ups with business models that never made much sense will fail, cutting customers out of cloud computing entirely. And second, the start-ups that survive will start to worry a lot more about controlling their costs.

It’s easy to let cloud computing costs slip away from you, and there are countless companies that specialize in optimizing cloud computing bills. While there’s really no risk of start-ups drifting away from the cloud, a widespread effort to reduce cloud computing spending can certainly slow industry growth rates.

A cloud slowdown is not impossible

There is no sign that demand for cloud computing is slowing, but that may not remain the case if global economies fall into recession. Inflation is the highest in decades and interest rates are expected to rise rapidly. It is unlikely that any industry will come out of this without feeling at least some pain.

When you zoom out, the demand for cloud computing is almost guaranteed to increase over time as businesses look to leverage the benefits of the cloud. But in the short term, anyone can guess.

10 stocks we like better than Amazon
When our award-winning team of analysts have stock advice, it can pay to listen. After all, the newsletter they’ve been putting out for over a decade, Motley Fool Equity Advisortripled the market.*

They just revealed what they think are the ten best stocks investors can buy right now…and Amazon wasn’t one of them! That’s right – they think these 10 stocks are even better buys.

View all 10 stocks

* Portfolio Advisor Returns as of April 7, 2022

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a board member of The Motley Fool. Suzanne Frey, an executive at Alphabet, is a board member of The Motley Fool. Timothy Green has no position in the stocks mentioned. The Motley Fool owns and recommends Alphabet (A shares), Alphabet (C shares), Amazon and Microsoft. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.