Amazon and the Economics of Web Services

What do online retailing and selling web infrastructure services have in common? It's a good question and one that Om Malik posed to Amazon CEO Jeff Bezos at last week's D6 Conference in this very good, impromptu video interview. People often wonder about this aspect of Amazon's web services strategy and if you watch this interview you'll get some good insights. Nick Carr points out some of the key takeaways:

"Four years ago is when it started," [Bezos] says, "and we had enough complexity inside Amazon that we were finding we were spending too much time on fine-grained coordination between our network engineering groups and our applications programming groups. Basically what we decided to do is build a [set of APIs] between those two layers so that you could just do coarse-grained coordination between those two groups. Amazon is, you know, just a web-scale application." As it developed the APIs for its own applications developers, it realized that the interfaces would be useful, as well, to other programmers of web apps: "And so, look, let's make it a new business. It has the potential one day to be a meaningful business for the company, and we need to do it for ourselves anyway."

Bezos goes on to note that Amazon's retailing operation is "a low gross margin business" compared to software and technology businesses, which "tend to have very high margins." The relatively low profitability of the retailing business gave Amazon the incentive to create a highly efficient, highly automated computing system, which in turn could become the foundation for a set of cloud computing services that could be sold at low enough prices to attract a large clientele. It also made a low-margin utility business attractive to the firm in a way that it isn't for a lot of large tech companies who are averse to making big capital investments in new, low-margin businesses.

Earlier when I spoke with Bezos at Web 2.0 about 18 months ago he was making the case that their AWS "pay by the drink" model was a natural, although not obvious, fit for their business: they needed to build that infrastructure anyway just to run their retail business; they have spare capacity; they know how to handle millions of transactions and they can succeed in a low margin business.

As we've seen in these recent news stories from Google, Microsoft and Yahoo, there's going to be some serious competition in this space, and Bezos appears quite ready for that battle.

Be sure to read the next Financial article: The ZayPay API and Global Micro-Commerce