Opportunities Abound in the Cloud

Innovative cloud computing companies offer investors multiple options for long-term growth

October 29, 2019

It wasn’t long ago—maybe a decade—that the idea of companies accessing software from the internet or storing important data on a remote server was a perplexing concept. Why would a successful business trust technology located in the so-called “cloud” to meet its critical needs when it had abundant and reliable computers, software, and support staff on-site?

The concept isn’t confusing anymore. Cloud revenue at companies offering these services—known as cloud service providers (CSPs)—totaled approximately $200 billion in 2018 and is expected to reach $331 billion by 2022.1 Cloud computing is commanding an increasing share of information technology (IT) budgets, as companies in nearly all industries take advantage of the lower cost, higher speed, stronger security, and ability to deliver uniform IT resources at multiple locations that the CSPs provide.

On top of all these advantages, the sheer volume of available data is necessitating increasingly frequent software updates to better analyze and respond to the information. The planet is generating 2.5 quintillion bytes of new data every day2. If you lined up 2.5 quintillion pennies flat on the ground, they would cover the earth five times. Also, 90% of the world’s data was created in the past two years, but less than 1% has been analyzed.2 This disconnect has created opportunities for companies to interpret and store this data, adapt business models, and quickly deliver customer solutions.

Cloud computing is a key component of a revolutionary trend in what we define as the NEXT—or New EXceptional Technologies—economy. Along with e-commerce platforms and digital payment processors, cloud-based technologies are being used to deliver a host of disruptive products and services that customers are demanding. Although cloud computing is currently dominated by a few tech giants, the young industry is changing rapidly and opportunities to innovate abound, making it challenging for investors to identify the long-term winners.

To better understand this industry, it helps to learn more about the various cloud computing segments and how they are deployed to customers.

Cloud segments

Source: Statista, Gartner; CAGR = compound annual growth rates from 2018-2022.

  • Software as a Service (SaaS) – SaaS is the largest cloud segment, accounting for more than half of the cloud market’s revenue and close to half of users’ cloud budgets.3 It offers clients access to software and databases, usually through a subscription, with the infrastructure and platforms managed by the CSP. Customer relationship management (CRM) and enterprise resource planning (ERP) software are two popular SaaS applications. Microsoft is the overall SaaS leader while Salesforce tops the CRM segment and Oracle dominates in ERP.
  • Infrastructure as a Service (IaaS) – This segment provides clients with off-site support through storage, servers, virtual machines, and networking. Amazon, the segment leader, commands a third of the market, which is greater than the collective share of the next three largest providers—Microsoft, Google, and Alibaba.3
  • Platform as a Service (PaaS) – This segment helps customers develop apps via testing environments that include operating systems, web servers, databases, and programming languages. With a 25% market share, Amazon dominates the space, although Salesforce and Microsoft hold sizeable positions.3

 

Cloud deployment

  • Public cloud: In this model, the CSP owns the cloud resources, such as data centers, and is responsible for management and maintenance. It makes these services available to the general public via the internet, typically through a pay-per-use model. This approach appeals to companies seeking a cost-effective solution that helps them deploy new products quickly, as well as increase or decrease their services based on storage needs.
  • Private cloud: With this option, the cloud resides on a company’s internal data center or is hosted on a center owned by a third-party provider. In both cases, all of the company’s data is protected by a firewall. While this solution delivers high security, it’s also expensive as the company is responsible for managing and maintaining the data centers.
  • Hybrid cloud: Because a one-size-fits-all model doesn’t work for many companies, hybrid clouds are gaining popularity. Combining public and private clouds, hybrid solutions allow companies to share data between their on-site data centers and public centers owned by third parties. This option helps companies better manage their computing resources by providing greater flexibility, computing power, and cost efficiency.

 

While the cloud computing industry is young, it already has grown considerably, with a few major players dominating the market. Amazon is currently the cloud king, although the cloud businesses of Microsoft, Google, and Alibaba all grew faster in 2018.3 As demand continues to grow and evolve, industry participants continue to seek new ways to expand and enhance their platforms, which helped contribute to the massive increase in cloud acquisitions in 2018.

Consolidation often is a sign that an industry’s growth is slowing, but that’s not the case with cloud computing. Cloud platforms are diverse and provide different benefits to a wide variety of companies that likely will need to deploy multiple platforms to meet their various business needs. Innovative companies making disruptive products such as autonomous driving vehicles and surgical robots will need new cloud-based technologies. This trend gives both the CSP industry heavyweights, as well as small and nimble CSPs, an opportunity to develop new services and gain market share.

Successfully investing in CSPs and the companies using their services requires a deep understanding of technological developments, industry dynamics, and growth potential. Experienced, active managers with a strong historical track record can offer useful insights about complicated industries like cloud computing.

For 50 years, Jennison Associates has identified companies developing cutting-edge technology and invested in them early to optimize long-term returns. Learn more about Jennison’s investment process and other compelling secular themes in Where are the best growth opportunities today?


 

1 Source: Statista, Gartner
2 Source: DOMO, U.S. Chamber of Commerce; IDC Digital Universe Study, 2016
3 Source: Statista

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Certain information in this commentary has been obtained from sources believed to be reliable as of the date presented; however, we cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. The manager has no obligation to update any or all such information; nor do we make any express or implied warranties or representations as to the completeness or accuracy.

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