One clear theme has come across from big tech's first quarter earnings: the plan to invest in yet more computing. Amazon (US:AMZN), Microsoft (US:MSFT), Meta (US:META) and Alphabet (US:GOOGL) may have cut thousands of jobs in the past year to reduce operational costs, but all will be increasing capital expenditure (capex) on computing further still in the coming 12 months.
This year, Meta is promising total capex of $30bn (£23.9bn) to $32bn. Alphabet said it is going to spend “modestly” more than the $32bn it spent in 2022, but with a focus on investing in the drivers of its cloud division. Meanwhile, analysts are expecting Microsoft to increase its total spending by 13 per cent to $27bn.
Amazon said it expects its capex to be lower than the $58bn spent last year. However, the cuts will be made in ecommerce fulfilment investment, not in computing. “We’re continuing to invest in infrastructure to support AWS customer needs, including investments to support large language models and generative AI,” chief financial officer Brian Olsavsky told analysts at the end of last month.
These capex numbers are truly massive. People usually think of technology companies as operating in the digital space, and when investors consider their assets they often think of intangibles. However, all these technology companies are spending around as much as the world’s largest oil company: Suadi Aramco (SA:2223) spent $37.6bn last year.
Big tech didn’t always spend this much. As the chart below shows, these companies have ramped up spending in the past three years. In part, this is because they have more to spend. In 2021, the pandemic drove people online, which meant more digital advertising revenue for Meta and Alphabet and more ecommerce business for Amazon.
The problem for competitors is that this very size makes it easier to expand. Microsoft has said it receives a 30 per cent discount on its hardware purchases compared with smaller companies. Electricity costs make up 20 per cent of the costs of servers, but the largest tech companies have signed agreements with energy companies to bring the per-unit cost down.
The ‘big three’ dominate
A survey conducted on behalf of Ofcom by Context Consulting found that companies choose the three main cloud services: Google Cloud, Microsoft’s Azure and Amazon Web Services – because they provide “peace of mind”. They have fewer outages, better cyber security and are cheaper. “It has never occurred to us to look at smaller players because whenever we need something Microsoft has a good product,” said one survey respondent.
In the UK, the ‘big three’ has 78 per cent of the cloud market and this is unlikely to change soon. Aside from the above factors, it is difficult and expensive to change suppliers. Microsoft also doesn’t make its services interoperable, so if your data is stored on its servers, it can be difficult to transfer it to a different platform.
This dominance is, clearly, good for the incumbents. Among the UK survey respondents who faced price rises when renewing contracts, the average increase was 20 per cent. Extrapolate that globally and the effect of these hikes can be seen in companies’ reported results. In the last quarter, Microsoft Azure revenue grew 31 per cent year on year, while Google Cloud was up 28 per cent and AWS 16 per cent. This growth was significantly faster than their wider businesses: Amazon's group revenue was up 9 per cent, Microsoft's 7 per cent and Alphabet's 3 per cent. In fact, Alphabet’s revenue would have shrunk without its cloud business. Meanwhile, Amazon would have recorded an operating loss of $349mn last quarter without AWS’s $5.1bn in operating profit.
Computing used to be a niche part of these businesses: Amazon initially designed its cloud services just for its own use. It only started selling the server space externally in 2006, and at the time many investors thought it would be a waste of money. It has long since proved its worth, and now Amazon is cutting employees and fulfilment centre investment to keep the cash flowing into data centre capacity.
Computing will keep growing
Big tech is expecting computing needs to keep ramping up. The Context Consulting survey found that 79 per cent of respondents expected to increase cloud spend in the next 18 months, and this is only those that already use cloud services. Most companies are yet to transition at all. “People sometimes forget that 90 per cent of global IT spend is still on-premise,” said Olsavsky.
Originally these cloud systems were just used for data storage and everyday computer processing. However, now artificial intelligence is driving a new wave of demand. Central processing units (CPUs) are the semiconductors used in a typical computer. Graphics processing units (GPUs) are used to train the massive large language models – such as ChatGPT – and big tech companies are now intent on getting their hands on as many GPUs as possible.
AWS, Google Cloud and Azure have all signed partnerships with generative AI companies; in exchange for equity they are giving them access to their AI servers. Microsoft is partnered with OpenAI, Google with Anthropic and Amazon with StabilityAI. Meanwhile, Meta is using servers to improve its own AI capability to drive user engagement. “AI recommendations have driven a more than 24 per cent increase in time spent on Instagram,” chief executive Mark Zuckerberg told analysts last month.
It will be difficult for any company to catch up with these three. As we noted in our recent feature (‘Big tech's AI winners’, IC 28 April 2023), two-thirds of all GPUs purchased last year were acquired by either Microsoft, Google, Meta or Amazon. This has been great business for GPU designer Nvidia (US:NVDA). In the fourth quarter of last year, its data centre revenue was up 41 per cent year on year. Its share price is up 91 per cent in the year to date.
Big tech’s core businesses are now slowing down or reversing. Last quarter, Microsoft Windows revenue fell 28 per cent year on year. The PC market has reached its peak, and consumers are now pulling back on personal electronics spending. At Amazon, online store sales were flat for the year, while Google’s search revenue was up just 2 per cent. Management teams are not giving up on their legacy products, but their capital commitments show where they think their future advantage lies.
Ofcom is aware of the potential issues. Last month it called for a probe into Microsoft’s and Amazon’s dominance of the UK’s cloud computing market. It is “particularly concerned” by the pair, which have an estimated UK market share of 60 to 70 per cent. Whether it is possible to have healthy competition in a market that requires such large capital expenditure is up in the air, but it is right for regulators to be asking the questions.
From a user and consumer perspective, the lack of competition is concerning. However, investors in these companies will be welcoming the next act. Dominance of digital platforms generated an unprecedented amount of cash flows for these businesses over the past decade. This time, it is their head start in hardware that is looking dauntingly unassailable.
