Winning in the Cloud: Charting a path to...

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Winning in the Cloud: Charting a path to success

Darren Pleasance – Principal, McKinsey & Company

Some fun facts to get us started

47%

11B

4M

1/2

27M

11B

47%

4M

1/2

27M

• Small and medium businesses accounted for 47% of worldwide IT spending in 2010, and

their share is projected to grow through 2015

• Expected annual spend by SMBs in the APAC region: $11B

• 4M servers are installed in data centers annually (50% of annual server sales)

• Roughly 1/2 of small businesses are DIY when it comes to managing their IT; the other

half need a higher-touch level of support

▪ Over 27M search results for “cloud computing” on Google

Some fun facts to get us started

Today‟s Discussion

Follow the growth

Size is not destiny

Playing to win

First, let‟s make sure we‟re all speaking the same language

Cloud computing is a computing paradigm in which...

Leverages ultra- high-scale distributed computing technologies pioneered by consumer Web firms

…dynamically scalable and multitenant…

… are provided as a service

Underlying technologies and operations abstracted from the user

Users typically billed or charged back on an ongoing basis (as variable opex)

…resources…

Three models:

• laaS (Infrastructure as a service)

• PaaS (Platform as a service)

• SaaS (Software as a service)

“Public” (off premise) or

“Private” (on premise or

dedicated host)

First, let‟s make sure we‟re all speaking the same language

Small and medium businesses are defined as…

Number of employees

<100

>1,000

Small

100-1000

Medium Large

SOURCE: Gartner, IDC, Deloitte, BoA-ML, In-Stat Cloud, Team analysis

SMBs will drive public cloud services over next 5 years

Worldwide public cloud services market size

$ Billions

Enterprise

SMB

2015

40-50

2010

9 14-18

26-32

2 7

Percent of

WW IT spend ~1 ~6

~10% by 2020

~4-6X

Total cloud market

(private and public)

~$65-85B by 2015

54

41

SOURCE: McKinsey CIO/CTO Cloud Online Survey, Gartner, Team analysis

Worldwide cloud market by region

Percent

% of CIOs surveyed on application migration

Percent expecting migration to public/hybrid cloud by app

Customer-facing and employee productivity

applications will lead the cloud migration

Growth won‟t be even – go where the market is…

Cloud is a global phenomenon;

strong growth in all regions

Average 21

Tier 1 LOB 10

Dev / Test 18

Others 1 19

Supply chain 22

Collaboration 35

eComm/Web 42

CRM 46

10 13

8 9

= 100%

2015

N. America

Western

Europe

Japan

Rest of World

30

~$65-85B

2010

~$11B

48 58

24

CAGR (%)

50

55


Follow the growth

Size is not destiny

Playing to win

Landscape of cloud players has become increasingly diverse

Hyperscale

providers Telcos/

service providers Managed hosting

providers Mass market

hosting providers

Cloud solution

providers Cloud

resellers

Infrastructure investments

http://www.clearpathsg.com/

http://www.appirio.com/

http://www.cloudsherpas.com/

$1-3B

$1-3B

$1-3B

$3-5B

$5-6B

$6-8B

Cloud investment, 2000-09

$600M in 4 tier 3/4 DCs in the US with >100K sq. feet (2007); PUE of individual data centers of 1.10 (2010)

$1.5B over 5 years for EMC to expand R&D facility (2009)

$500M in 700K sq. feet Chicago DC and $500M in Dublin DC (2009)

$373M capex for tech infra. and new products (2009);

553K sq. ft. DCs in US; 197K sq. ft. non-US DCs (2009);

$100M on 134K sq. ft Australia DC (2010);

$250M agreement with Microsoft over 3-yrs in cloud tech (2010)

$362M on 100K sq. ft. DC in North Carolina (2010)

Examples

SOURCE: Press releases, Analyst reports

Will this market be “winner takes all?”

Will size determine destiny in this market?

SOURCE: SNL Financial, Team analysis

While consolidation has occurred in the banking industry, post-regulation…

Share of banking profits

% of publicly traded US banking operating income, 1990-2010

$97B

41

59

1995

$28B

55

45

1990

$12B

56

44 61

2000

39

$210B

All

others

Top 4

banks

34

66

100% =

2010 2005

$151B

Regulation2

Many thought banking would end up with the “big 4”, but it hasn‟t

Fragmentation persists:

• ~1,200 public banks

• ~6,500 private banks not in this data

• Robust ecosystem of other financial sector players:

Fragmentation persists for several reasons

SOURCE: Institute for Research in Economics and Business Administration (SNF), McKinsey

Principles of transaction economics

External

costs

Internal

costs

Time/Complexity

Transaction costs

Consolidate

(e.g. Build)

Contract

(e.g. Buy)

Industry standardization

Mass customization

Dis-integration

11%

34%

53%

50-250 PCs

21%

26%

10-49 PCs

27%

39%

1-9 PCs

14%

75% Partner Managed

Self Service

Internal IT (with

external advisors)

SOURCE: McKinsey US SMB Survey (2010), US Small Business Administration, Team analysis

Survey – which is the best description of how you

manage IT in your company

(e.g., purchasing & servicing HW/SW products)?

Total annual spend ($B) ~25-35 ~15-20 ~20-25

Many SMB companies are “DIY”, yet others want help

Partner-managed and some Internal IT SMBs will be primary consumers of partner-provided cloud services

0

10

20

30

40

50

60

70

80

90

100

Number of servers

10 100,000 10,000 100

Average utilization rate %

1000

Increasing utilization can have significant cost benefits…

Typical scale provider server

utilization ~70-75%+

Typical SMB provider

server utilization ~40-60%

SOURCE: VAR/SP Interviews, Microsoft, Team analysis

Improving utilization to

within ~10-20% of scale

yields 10-15% cost savings

Increasing CPU utilization rates

Scale-like economics can be achieved by smaller players at relatively low levels of investment

SOURCE: VAR/SP Interviews, McKinsey

Cost management

Small players are managing their costs well…


Vendor discounts on HW and SW

Creative facility and energy approaches

Lean, nimble operations

Maximization of equipment useful life


SOURCE: McKinsey

But, the entire TCO matters


Infrastructure is a small fraction of overall customer TCO

Components of TCO

% of TCO for CRM, indexed to 100

4Telecom

Facilities and Fabric

Hardware

Software

Internal Services

IT Services

100

3 8

27

22

37

Cost management


Market structure over the next 5-10 years

• In spite of consolidation, cloud services market will remain fragmented

• There will be a mix of asset-light and asset-intensive players in the market

• Two key success factors:

• High quality self-service interfaces

• Localized relationships will still matter


Follow the growth

Size is not destiny

Playing to win

22

SG&A

10-25

Gross margin3 30-50

Other (e.g.

SW licenses)1 10-15

Energy 5-10

Ops labor 10-15

DC facilities

(e.g., Power)2 2-7

Equipment1 25-35

Net revenues 100

Operating

margin

Cloud solution provider P&L example

Percent

DISGUISED EXAMPLES

10-30

Gross margin3 25-50

Operating

margin

SG&A

15-20

Other (e.g.

SW licenses)1 10-20

Energy 8-10

Ops labor 15-25

DC facilities

(e.g., Power)2 5-10

Equipment1 10-30

Net revenues 100

Highly successful

players see

20-40% operating

margins

Mass market hosting provider P&L example

Percent

Players that pull levers effectively can make healthy profits

SOURCE: VAR/SP Interviews

Increase ARPU through cross-sell/up-sell

Drive loyalty / stickiness

Winning requires working 4 key economic levers

Pursue operational excellence

Minimize customer acquisition costs

Examples of particularly effective industry practices

276

128

36

232

35

Hosted

email

Hosted

PBX

SaaS

apps

Hosted

infra

Web

hosting

Increase ARPU through cross-sell/up-sell

Average spend by offering for SMB survey respondents

$/month/SMB

SMB’s

adopting 64% 17% 14% 7% ~30%

SOURCE: VAR/SP Interviews, Parallels SMBs Research, US Small Business Association, Gartner, Team analysis


Percent

15-20

10-30

10-20

SG&A

10-30

Energy

Gross margin3

Net revenues

5-10

8-10

25-50

100

Other (e.g.

SW licenses)1

Ops labor

Equipment1

15-25

DC facilities

(e.g., Power)2

Operating

margin

DISGUISED EXAMPLES

“We’re moving up the food chain and trying to eliminate people who only do part of the stack.”

–Hosting provider

• <3% of SMBs adopting 4 or more services

• ~14% adopting 3 services (majority web, infra, and email)

• ~35% adopting 2 services (majority web and infra)


Percent

Operating

margin 15-20

SG&A

10-30

Gross margin3

Other (e.g.

SW licenses)1 10-20

Energy 8-10

Ops labor 15-25

DC facilities

(e.g., Power)2 5-10

Equipment1 10-30

Net revenues 100

25-50


Drive loyalty / stickiness

Best

performer

Worst

performer

-60% Each 1% reduction in

churn can be worth ~3-

5% in profit improvement

for typical players

Best-performing SMB cloud service providers are:

• Adopting deep CLM focus

• Being proactive about prevention

• Driving stickiness (“Smart people focused on personalization”)

• Establishing “save desks”

• Avoiding churners as targets

SOURCE: VAR/SP interviews, Team analysis

DISGUISED EXAMPLES

Performance gap in churn rate for SMB Cloud providers

Annual churn rate, Index 100 for best performer


Percent

10-30

Net revenues 100

15-20 Operating

margin

10-30

SG&A

Gross margin3 25-50

Other (e.g.

SW licenses)1 10-20

Energy 8-10

Ops labor 15-25

DC facilities

(e.g., Power)2 5-10

Equipment1


Pursue operational excellence

• Decide to build or buy: “We own our own network”; “[We] build our own machines”

• Manage facilities efficiently

• “Do more with less:” automation, standardization, and cross-training of employees

• Situate data centers near environmental advantages (e.g., access to hydroelectric power)

• Virtualize aggressively

DISGUISED EXAMPLES



Percent

Operating

margin 15-20

SG&A

10-30

Gross margin3 25-50

Other (e.g.

SW licenses)1 10-20

Energy 8-10

Ops labor 15-25

DC facilities

(e.g., Power)2 5-10

Equipment1 10-30

Net revenues 100


Minimize customer acquisition costs

• Start with your existing (non-Cloud) customers

• Establish partnerships with other players in the Cloud landscape (e.g., OEMs, SIs, other channels)

• Make your services risk-free to customers (e.g., 30 days free)

• Buy new customers (e.g., M&A)

• Understand/leverage triggers in customer lifecycle

DISGUISED EXAMPLES


• Build your word-of-mouth (“We have stopped advertising”)

The key economic levers apply to the larger players as well

Mass market

hosting providers Cloud solution

providers Cloud

resellers

Hyperscale

providers Telcos/

service providers Managed hosting

providers

Key drivers of success

Bring to market high quality, self-service interfaces

Build out worldclass CRM capabilities

Develop clear, compelling, channel value proposition

Evolve to lower cost, next-generation infrastructures







To recap

Follow the growth

Size is not destiny

Playing to win

28

Presenter contact information

Darren Pleasance

Principal, Silicon Valley

[email protected]

www.mckinsey.com/SMB_Cloud

30

Appendix

SOURCE: Gartner, IDC, Deloitte, BoA-ML, In-Stat Cloud, Team analysis

Worldwide cloud services market size1

$ Billions

Enterprise

SMB

2015

65-85

2010

11 39-52

26-33

4 7

1. Cloud portion of overall IT spend on applications, IT infrastructure HW/SW and PaaS / IaaS (includes both Public and Private cloud markets)

2. 2010 public cloud spend split 80% SMBs and 20% Enterprise (In-Stat 2010); Assumes 2015 cloud IT spend reaches 12% for SMBs and 6% for Enterprises

SMBs will continue to drive cloud services over next 5 years

Percent of

WW IT spend ~2 ~10

~15% by 2020

~6-8X

Growth driven by favorable economics for SMB customers

Public cloud – SaaS Public cloud – IaaS

SaaS (SFDC)

6.6

On premise

8.6

200

Customer data closet

50-250

IaaS provider

Avg

100

-50%

CRM TCO (5 years, 200 seats)

$/user

Total CPU and storage

$/CPU/month

Source: McKinsey

-23%

Reconciling market size estimates

4.2

Hosted

Web

20.6

8.6

3.0

12.0

Hosted

Messaging

0.7

Hosted

Infra

5.6

7.1

2.3

12.0

4.9 Current

Untapped

Total SMB

Cloud

1.4

Parallels SMB Cloud Market (2010)

$ Billions

McKinsey Cloud Sizing (2010)

$ Billions

7.0

1.8

11.0

Public

Cloud

Enterprise

8.8

SMB Total Private

Cloud

2.2

• Reconciliation of differences:

• McKinsey uses IDC definitions for cloud services, which do not include “Hosted Web” (considered an IS Outsourcing expense by IDC)

• Hosted Web as defined by Parallels: “This category includes Web hosting itself, plus blogging services, domain registration, SSL and e-commerce add-ons, and site-building tools.”

• Adding ~$2B of hosted web to SMB portion of public cloud spend would bring two estimates in line

SOURCE: Gartner, IDC, Deloitte, BoA-ML, In-Stat Cloud, Team analysis, Parallels SMB Research

54

41

SOURCE: McKinsey CIO/CTO Cloud Online Survey, Gartner, Team analysis

Worldwide cloud market2 by region3

Percent

1. Includes weighted average for content management, Other LOBs, Data Warehouse, Operations, ERP, Engineering and IT applications

2. Cloud portion of overall IT spend on applications, IT infrastructure HW/SW and PaaS / IaaS (includes both Public and Private cloud markets)

3. Should be regarded as indicative; based on Gartner‟s „top-down” estimates given early-stage of adoption

% of CIOs surveyed on app migration

Percent by architecture

CIOs expect ~20% of apps to migrate to public

cloud and an additional ~40% to private cloud

Growth won‟t be even – go where the market is…

Developed markets, especially

North America, driving cloud growth

21

10

18

19

22

35

42

46

Dev / Test 41 41

Others 1 34 46

Supply chain 39 39

Collaboration 30 35

eComm/Web 21 37

CRM 18

On

Premise Private Public/Hybrid

Average 36 43

Tier 1 LOB 59 32

36 3

2015

~$65-85B

48

30

3 1 13

3

N. America

2010

~$11B

58

24

1 10

3 2

E. Eur

WE

= 100%

MEA

Japan

Asia

LATAM 2

CAGR (%)

47

47

55

58

52

SOURCE: SLN Financials; VAR interviews; team analysis

“[Our] customers prefer small

providers, not big. They need

someone who will react when

there is a problem.”

– Mass market hosting

provider

Service levels / support

Geographic advantage

Cost effectiveness

Flexibility

Security

“There are a lot of applications

with high I/O intensity- if [the

hyperproviders] store data in

Germany, APAC and NA how

do I make sure I don‟t have

latency problems?”

– Cloud solution provider/VAR

“Customers have needs that

[hyperproviders] can‟t meet. If

you want a very specific RAID

configuration, you can‟t get that

at Amazon or Microsoft.”

– Mass market hosting provider

“Customers who use Amazon a

lot also pay a lot; [the service] is

nice for bursting and spikes, but

gets expensive if used a lot.”

– Mass market hosting provider

“SMBs won‟t put customer data

on the [public] cloud – [they

either want] colo or dedicated

hosting or want to build their

own private cloud first.”

– Cloud solution provider/VAR

Many customers require customization that only smaller and more localized IT providers can deliver

Best practice examples of cloud resellers working economic levers to their advantage

Increase ARPU

through cross-sell/up-

sell

Drive loyalty /

stickiness

Pursue operational

excellence

Minimize customer

acquisition costs

• Providing variety of applications in verticalized industries (e.g., insurance, legal, healthcare, etc)

• Driving customers to value added services: consulting services, virtualized infrastructure,

desktop/printer management, etc

• Partnering (and in some cases) purchasing microvertical ISVs that already have established

relationships with end customers

• Equipment acquisition from firesales of other companies

• Negotiating for strong equipment discounts from OEMs (25% or more) and reduced electricity

costs by locating to cost-advantaged locations (e.g., first data center in a state)

• Build-your-own servers

• Stickiness driven through strong customer support and “small shop” profile (e.g., customers like

knowing there‟s a person serving them)

SOURCE: VAR interviews

As a result, solution providers can build profitable cloud services with own data center operations, given ability to efficiently service customers

Base case scenario

• Build data center serving 20K subscribers (e.g., ~200 SMBs with 100 subscribers each)

• Running ~180 virtualized servers and achieving ~50-60% utilization

• Services include wide variety of apps including industry specific and general productivity apps

• VAR efficient in IT purchase and mgmt (e.g., automation), can acquire customers from upper size SMB segment (e.g., larger IT budgets) and finance required capex

Energy

100

Operating

margin

Net revenues

5

Gross

margin*

22

SG&A

4

Ops labor

33

Equipment

11

Other (e.g.

SW licenses)

11

34

DC facilities

e.g., Power)

13

Solution provider economics example (Percent)

1. Includes capex as depreciation; hardware & software assume 4 years useful life at 8% maintenance ratio

2. Assumption for base case illustration based on VAR interviews and SMB cloud spend survey

3. Typical cloud reseller operating profits <10% on average (e.g., for hosted exchange service) – base case for VAR generated higher return than a

cloud service reseller business model

Linux x86 servers & SAN storage (assumes 10GB per subscriber)

ARPU of $20K per SMB (combination of hosted services) 2

$80K average FTE (includes 24x7 help-desk support costs)

Assumes $1/Critical W at 70% utilization

500W per server with a 2X cooling multiple (PUE) at $0.1 kW per hour

Server management and virtualization licenses

Primarily acquisition costs (e.g., sales force and commissions)

SOURCE: VAR interviews; Data Center TCO model

DISGUISED SOLUTION PROVIDER EXAMPLE

Highly successful providers see

up to 40% operating margin

Similarly, some hosting providers can achieve highly profitable economics through heavy automation of DC ops and rolling up sub-scale providers

Provider description

• Typical US-based shared

hosting provider founded

>10 years ago, operating

under 12 brands

• Offers regular managed

and dedicate server

hosting with VPS and

domain registry as well;

not selling any SaaS

applications

• 75% of the business is

focused on SMBs, with

sweet spot businesses

around 30-50 employees

100

Operating

margin 39

SG&A

1

Ops labor

25

20

Gross

margin*

DC facilities

(e.g., Power)

64

5

Other (e.g.

SW licenses)

Equipment

5

5

Energy

Net revenues

Mass market hosting provider economics (Percent)

Heavy emphasis and investment in automation and uniformity - able to stretch usage & redeploy equipment

Revenue base of >$5m

Attract and retain talented systems administration and technical staff

Rent space and choose physical assets to use

Reduce energy costs by including in rent agreement

Leverage Linux-based apps; avoid costly licensing fees (e.g. Microsoft)

Invest in acquiring sub-scale SPs to increase customer base and use automation to bring into own DC; cross- and up-sell within existing base with limited new customers

SOURCE: Service Provider interviews

DISGUISED EXAMPLE

Hosting provider business model

generating very high margins

Additional hosting provider case example – achieving 23% profitability

Provider description

• US-based service provider; founded over 10 years ago

• Offers managed and dedicate server hosting

• Primary customers are SMBs

• 30 – 50 employees

Operating

margin

3

8

23

52

SG&A

Equipment

Ops labor

Other (e.g.

SW licenses)

11

14

12

29

Net revenues

DC facilities

e.g., Power)

Energy

Gross

margin*

100

Build-out of white-box servers

Focused hardware and software redeployment

Parts procurement strategy

Attract and retain talented systems administration and technical staff

Able to lease space with favorable conditions

Software licensing is a necessity and will not be passed along to customers

Emphasis on support in local language and same geography

DISGUISED EXAMPLE Mass market hosting provider economics (Percent)


Additional hosting provider case example – achieving 20% profitability

SP description

• Service provider; founded over 10 years ago

• Offices in the US and abroad with over 100 employees

• Offers managed and dedicate server hosting and recently launched cloud-based services such as private cloud and cloud storage

• 90% of revenues are from SMBs

Operating

margin 20

SG&A

5

15

Other (e.g.

SW licenses)

Energy

DC facilities

e.g., Power)

30

8

Gross

margin*

Ops labor

50

10

Equipment

Net revenues

12

100

SP economics (Percent)

Owns and manages network that connect several data center locations

Automate as much as possible and focus on providing high quality support

Close to 20 DC is 10+ cities across US.

Identify right mixture of costs to pass and not-pass thru to customers

Emphasis on cross-selling to customer base

Searching for “holy grail” model for new customer acquisitions

DISGUISED EXAMPLE


Cost-to-serve is subject to scale economies PRELIMINARY

• Constructing 20MW+ facilities at <$10M/MW (vs. >$20M/MW) and PUE <1.3 (vs. ~2)

SG&A 30

Other DC costs, e.g. SW

Gross margin*

3

Operating margin 5 5

35 35

Energy

16

20

7

Net revenues

Ops labor

100

6

Facilities

Equipment

100

Bandwidth

13

* Includes capital expenses as depreciation

Public IaaS vendor economics

Percent

• Building their own servers and equipment, and by-passing OEMs altogether

• Aiming for avg utilization of 70% from aggregating multitenant demand

• Achieving >1,000 servers/ FTE vs. 100 servers/ FTE

• Locating DCs in remote areas to pay <3c/kWh

Hyperscale providers (e.g. MSFT, GOOG) are:

• Investing in their own dark fiber and CDNs

Public cloud - IaaS

SOURCE: Team analysis

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