Bigness in the cloud

In his post, "What Tim O'Reilly gets wrong about the cloud," Nick Carr takes Tim to task for describing Google as an example of a business that has grown to dominance because of network effects. The basic idea behind network effects is that something gets more valuable as more people use it. The canonical example is the telephone system. With one telephone it would be pretty uninteresting. With limited penetration, only mildly interesting. With near-universal connectivity, extremely powerful. There's a lot of debate about the details, but few dispute the basic concept.

But Nick argues that network effects don't underpin Google's success. Google determines the best search results using algorithms, not the "wisdom of the crowd." If I were the only person using Google, it might be hard for Google to continue making hardware and software investments. But, money aside, it doesn't inherently depend on having lots of users to deliver quality results. By contrast, social networks or a many-to-many selling site like eBay (especially in its earlier days) are network effect businesses. (In fairness, the myriad creators of Web content make Google's PageRank possible but I see this as a weak form of network effect compared to the other examples.)

However, network effects aren't the only reason why a given industry may end up with just a few--or even one--large players. Nick lists a few that may well be relevant to Google and other "cloud computing" suppliers:

1. Capital intensity. Building a large utility computing system requires lots of capital, which itself presents a big barrier to entry.

2. Scale advantages. As O'Reilly himself notes, big players reap important scale economies in equipment, labor, real estate, electricity, and other inputs.

3. Diversity factor. One of the big advantages that accrue to utilities is their ability to make demand flatter and more predictable (by serving a diverse group of customers with varying demand patterns), which in turn allows them to use their capital more efficiently. As your customer base expands, so does your diversity factor and hence your efficiency advantage and your ability to undercut your less-efficient competitors' prices.

4. Expertise advantages. Brilliant computer scientists and engineers are scarce.

5. Brand and marketing advantages. They still matter - a lot - and they probably matter most of all when it comes to the purchasing decisions of large, conservative companies.

6. Proprietary systems that create some form of lock-in. Don't assume that "open" systems are attractive to mainstream buyers simply because of their openness. In fact, proprietary systems often better fulfill buyer requirements, particularly in the early stages of a market's development. As IT analyst James Governor writes in a comment on Macleod's post, "customers always vote with their feet, and they tend vote for something somewhat proprietary - see Salesforce APEX and iPhone apps for example. Experience always comes before open. Even supposed open standards dorks these days are rushing headlong into the walled garden of gorgeousness we like to call Apple Computers."

The reason this question is of more than academic "nature of the firm"-type interest is that the question of scale in a world where more and more computing happens out in the network has implications that go beyond the cloud computing suppliers themselves. (For our purposes here, cloud computing refers to Internet-based computing generally, whether Software as a Service,SaaS, or some more direct use of computing resources over the network.)

A world with many different cloud computing suppliers, operating at different levels of abstraction--SaaS, Amazon Web Services-style virtual machines, Google Apps-style developer platform, and so forth--looks very different from the world hyperbolically described by Sun CTO Greg Papadopolous as having five "computers." (Computers in the sense of cloud computing providers with distributed worldwide datacenters.)

The computer industry in the first world would look much like today's. Independent Software Vendors (ISV) might deliver applications in the form of Web services rather than programs to be locally installed.  But they'd still be ISVs. And systems vendors would be selling more to those ISVs and other cloud computing suppliers than they would be the ultimate end users. But the sales model wouldn't be all that different from current enterprise sales.

In the second case, things would be much different, however. As I discussed in "The New Systems Companies," if computing were to become something largely consumed by a relative handful of mega-scale service providers, that would fundamentally alter the dynamic between system supplier and system customer that exists today. In the extreme case, the biggest service providers could become the new systems companies, as Google has already done to at least a partial degree.

Understanding to what degree size matters in a cloud computing world is therefore a very important question.