Cloud Hosting

The cloud infrastructure market today is dominated by an oligopoly of giants that got into the business early and grew their operations quickly: Amazon (AMZN 0.21%), Alphabet (GOOG -0.67%), and Microsoft (MSFT 0.54%). Now, with the benefit of economies of scale, they are positioned to maintain and expand their commanding leads in a market with a long growth runway.

But their stocks are down significantly this year, which some investors may see as an opportunity.

Between them, Amazon, Google, and Microsoft have captured a majority of the $180 billion global cloud infrastructure market. Amazon Web Services (AWS) is the 800-pound gorilla with about a third of the market. Microsoft's Azure and Alphabet's Google Cloud check in at 21% and 10%, respectively.

Image source: Getty Images.

A business that can benefit from economies of scale gains cost advantages as it grows, and in the world of cloud infrastructure, there are a host of size advantages to be had.

For instance, by grouping server farms into massive data centers, companies pay stable costs for the cooling systems those servers require. In the same vein, it takes an enormous amount of electricity to operate a data center. As cloud companies add customers, their revenues grow while their energy costs remain relatively fixed. Their decreasing marginal costs can be passed on to customers, giving the largest cloud players a pricing edge over their smaller peers.

In addition, Amazon, Alphabet, and Microsoft continue to add software and new functionalities to their cloud services, bundling them with their cloud hosting packages and giving their customers the ability to save time and money by only dealing with a single vendor. It's a strategy that harks back to former Amazon CEO Jeff Bezos' famous quote: "Your margin is our opportunity."

Launching a cloud infrastructure hosting service requires massive initial investments in constructing data centers. Today's leading players were able to approach that hurdle from a position of strength because they had strong cash-generating business segments to fund those outlays. For example, Microsoft may have used income generated by its Windows and Office businesses to start its Azure segment. On the other hand, cloud-centric start-ups need to raise those vast sums via equity or debt sales just to get off the ground and compete with the cost-advantaged incumbents.

Interestingly, the legacy business segments that gave these three companies the financial muscle to build out their cloud operations are now in part the causes of their falling stock prices. Alphabet's primary source of revenue and profits is advertising. In 2021, 81% of its top line came from advertising while just 7.5% came from Google Cloud. Advertising is a cyclical business, and fears that a recession is imminent have helped drive Alphabet's shares down by 20% this year.

Similarly, Amazon generated 69% of its revenues from its e-commerce platform, while just 13% came from AWS. Investors mulling the possibility of a slowdown in consumer spending have pushed Amazon's stock down by 34% in 2022.

Researchers at Precedence Research estimate that the cloud computing market -- worth $380 billion in 2021 -- will grow at a compound annual rate of 17.4% through 2030 to reach $1.614 trillion. Due to their dominance and economies of scale, Amazon, Alphabet, and Microsoft should continue to gain market share as that growth progresses. And the roles those companies' cloud segments play in their overall businesses will likely become more prominent too. As such, opportunistic investors may find long-term value in these three cloud stocks while they're down.

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

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Why These 3 Cloud Companies Will Continue to Take Market Share - The Motley Fool