Talking Tech

Talking Tech is produced by the Progressive Tech Team of George O’Connor, Ian Robertson and Gareth Evans. Our aim is to bring you up to date with the tech news cycle each week. We comment via blog and podcast on the slings and arrows of the sector at a time of huge change.

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February 21, 2024

We’re cloudbusting, daddy

In the investing world, ‘cloud’ is supposed to be a one-way bet. But ‘cloud’ numbers ain’t what they used to be. IaaS vendors experienced a recovery in Q4/2023, which arrested their tapering revenue growth (see below). Welcome to a mixed world; ‘hybrid’ is back and the notion that innovation is ‘cloud first’ or ‘cloud only’ seems fanciful. As the data migration theme morphs to data movement and cloud native is established, software vendors must support a variety of deployment environments or start bullying users. With little clarity for now, long-term software company profitability modelling is itself under a cloud.

The big debates

  • Cloud spending surge: Expected to happen (again). According to industry analysts Gartner, IT spending is to recover in 2024. Within the recovery, cloud spending is a key beneficiary, with spending expected to grow by 20.4% in 2024. The growth will come from both cloud vendors’ price increases and increased utilization as all cloud market segments grow, with IaaS projected end-user spending growth of 26.6%, followed by PaaS at 21.5% (see below and here).
  • Reported numbers: Rear view tells a different story. The financial results from Microsoft (Azure), Alphabet (Google Cloud) and AWS below indicate a recovery in cloud growth in Q4/2023. This arrested the decline seen through 2023. It is too soon to argue whether the one quarter data is about GenAI cloud deployments or pent-up demand from existing users that were shy until the Q4 Budget Flush season.
  • SaaS, rather than IaaS.Looking into the SaaS world/ apps to sit in the cloud, there has been a similar message from Q4 reports. Note SAP cloud growth experienced a rebound in Q4, after an otherwise lacklustre year. In the UK, Sage growth cloud native ARR growth was an impressive +34% Y/Y, 25% in Q1/2024 (reported 18 Jan). At Atlassian, cloud growth improved in cal Q4/2023.

 

So what is going on?

  • Cloud spend is purloined by AI.Research for theCube (here) concludes that AI is a two-edged sword, sometimes a godsend at AI pure plays (OpenAI, Anthropic, Hugging Face and CoreWeave). However, its research indicates that 40% of customers say that their AI budget is coming from other budgets, with ‘cloud being one of the areas losing budget focus’. According to O’Reilly analysis (here your details required), in the past companies built software to run on-premises and then moved it to the cloud as necessary. However, in 2023 there was a “huge surge in cloud native development shows that we’ve now crossed that chasm and that companies have stopped kicking the tires. They’re building for the cloud as their primary deployment platform.”
  • GenAI deployments are on-prem, and cloud. The cloud leaders are leading with cloud LLMs but there is also a trend towards on-premise deployments. The demand-side drivers are privacy and data sovereignty concerns. Note c30% of Llama 2 deployments are estimated to be on-prem, with some analysts believing it could be as high as 50%. This is leading to a return of interest in hybrid cloud models, with a strong preference for private cloud solutions due to data control and regulatory issues in Gen AI. The interest in hybrid is already being captured in O’Reilly data (below).
  • Cloud as a cost control.The ease of use of spinning up cloud instances can also be cases of not spinning up instances. This ‘ease of use’ factor means that cloud spend consumption can (like other investments) go down and up – the relative ease makes it a prime candidate for a cost-conscious environment.

Non cloud: A force majeure

While vendors guide our eyes to cloud growth. Each financial print tells us about the non-cloud revenue that still account for significant elements of a software company P&L. Note across our three focus companies: at SAP it is 56% of revenue, Sage non-native cloud is 72% of recurring revenue, at Atlassian non-cloud is 40%. Even at Intuit, one of the most impressive cloud migration case studies, worldwide desktop services accounts for c24% of revenue (here).

For us, the evidence suggests mixed environments for software vendors. Away from the on-prem to cloud migration, software suppliers are creating product ecosystem (loosely coupled platform), a platform for better upsell, reduce CaC and better LTV. Through the transition, the financial model is spoiled as vendors retain other deployment platforms as current, a move that depresses target profitability due to overlapping spend on development, sales and support. For example, at Sage cloud native ARR is 28% of recurring revenue (here). This begs the question: what is the source of the mainstay of ARR?

Casestudy: Atlassian

Atlassian Corporation is Atlassian’s team collaboration software, like Jira, Confluence and Trello, which helps software developer and project manager teams organise, discuss, and complete shared work. The company has a range of deployment models. Like the SaaS industry it has favoured cloud – but we still see a big chunk of revenue tied to on-prem data center environments (see below).

At Q2 results (1 Feb, here) we learned that Atlassian has more seats on cloud than on server and data center combined, with migrations to cloud in Q2 increasing more than 2x year-on-year and beating our expectations across both Enterprise and SMB. On the conference call, Atlassian guided that usually c10 points of its cloud growth comes from migrations, and in the coming quarter it would end of life server support, a move that should further encourage users on migrations. That said, Atlassian guided that the migration process “will continue for a number of years”. This is despite (i) AI functionality “only available in cloud” and (ii) business model positives. “We’re also seeing less Server churn than we had originally assumed, which means the overall migration opportunity is larger than we had expected.”

End note: Change fatigue

IT shops have been through a lot. Following a pandemic, the recovery, the Great Return, the on-again/off-again recession and a tense geo-political environment, we wonder if in 2024 we might not experience a degree of fatigue. We expect ongoing Digital Transformation initiatives to morph to GenAI inspired Digital Transformation from 2025. Into that, spend might suffer from fatigue, which could then become resistance to signing new contracts, a lack of willing to commit to long-term initiatives, translating to companies saying that it is taking longer to close pipeline deals. This is a time of transition to a GenAI-centric world… transitions are reliably bumpy.

 

George O’Connor

Global IT Spend by category (US$bn) from Gartner Group

Software architecture 2022 vs 2023 (from O’Reilly Technology Trends 2024)

Public cloud spending forecast US$ (from Gartner, 11/23)

SAP: Cloud revenue as percentage

IaaS vendors (Azure, Google, AWS) sequential growth since Q4/2019 (%)

Atlassian: Revenue by deployment (US$m)

Source: Company data

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