Amazon is still playing the dangerous game called 'race to zero'

Jeff Bezos Michael Seto/Business InsiderAmazon CEO Jeff Bezos

Amazon delighted investors on Thursday by posting a rare profit, helped in large part by its profitable cloud computing business, Amazon Web Services.

AWS sales surged 81% over the year-ago quarter, brought in revenue of $US1.82 billion for the quarter and dropped $US391 million of profit to the bottom line, an operating margin of 21.4%, CFO Brian Olsavsky told analysts on the quarterly conference call.

So analysts couldn’t resist the question: with AWS contributing so much to Amazon’s new-found profits, will the company keep cutting prices in what the tech industry calls the “race to zero”?

Short answer: Yes.

The race to zero is still on, Olsavsky says, because it’s part of AWS’s “business model.”

The “race to zero” is a term for the dangerous price-war game that the biggest cloud computing companies are playing especially Amazon, Microsoft and Google.

This race refers to cutting prices so low that eventually they will be nothing — absolutely zip — for them. For instance, in May, Google announced that its new Photo app would be free and come with unlimited storage. Cost for unlimited storage = $US0.

It’s a dangerous game because providing cloud services is an expensive business. Companies in this market are spending billions building and maintaining data centres to host everyone’s apps and data. If they blow it with their pricing strategy, those facilities don’t just disappear.

Amazon CFO Brian OlsavskyLinkedIn/Brian OlsavskyAmazon CFO Brian Olsavsky

The price war also means only the biggest tech companies can get into the market.

Amazon is not only convinced it can win this game, it’s the one that invented it. As Amazon grows its cloud, its costs have decreased and it passes those savings along to the customer.

Amazon has cuts prices 49 times since it launched AWS in 2006, Olsavsky says, including several price cuts this year.

The goal is to treat cloud computing like retail, something that Amazon knows a bit about. Customers are likely to fill their baskets up with more stuff when every item seems affordable, so Amazon makes more money on each customer.

Here’s what Olsavsky said when Goldman Sachs’ Heath Terry asked about price cuts vs. margins vs. investment.

We have continued to lower prices. We’ve had multiple price cuts this year. We are now up to 49 since launch in 2006, so it is a fundamental part of our business model. So is innovation. As I said, we have over 350 new features and services — also significant features and services that have launched this year. And as we were just talking with Carlos, the capital investment is very large as well, so we continue to fund it.

By the way, Heath Terry seemed satisfied enough with the answer. He reiterated a “buy” rating for the stock in his research note this morning, as did just about everyone else.

Disclosure: Jeff Bezos is an investor in Business Insider through hispersonal investment company Bezos Expeditions.

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