Amazon Web Services could be set to transform the ecommerce group

Twelve years ago, Jeff Bezos, chief executive of Amazon, gave the green light for an experimental business that would rent out computing power by the hour.

Amazon Web Services was started by a team of 57 people but has become one of the most valuable - and least understood - parts of the world's biggest ecommerce group by sales. If AWS continues to grow at its current pace, it could profoundly reshape Amazon itself.

"AWS has the chance to some day be the largest business at Amazon which is saying something, considering how big our retail business is," says Andy Jassy, head of AWS, referring to Amazon's $61bn a year in retail sales.

Amazon Web Services essentially created the market that it now dominates: renting out computing power by the hour, and data storage by the gigabyte. This has allowed IT professionals and entrepreneurs to access computing power the same way they access electricity - like a utility. Many early customers were start-ups, but today the list includes most of the Fortune 500, and the US government, having received high-level security clearance from the Pentagon.

Gartner, the consultancy, believes that the total market for public cloud services if $180bn this year, rising to $207bn next year.

Mr Jassy, an 18-year Amazon veteran who helped found AWS, does not shy away from even bigger numbers, suggesting AWS's potential global market, including value added services that go far beyond utility-style computing, is "trillions" of dollars. "Over time, very few companies will want to own their own data centres," he says. "All of that computing is moving to the cloud."

Thanks to the first mover advantage, AWS has a considerable lead over competitors, such as Microsoft and Google. Gartner, the consultancy, estimates that AWS has five times as much computing capacity as the next 14 public cloud providers combined. Its annual revenues are estimated to be $5bn and growing at a rate of 40 per cent annually.

Lydia Leong, an analyst at Gartner, says AWS retains a significant lead, both in terms of scale and functionality, with Microsoft a distant second and Google an even more distant third. It believes that the total market for public cloud services if $180bn this year, rising to $207bn next year.

Yet AWS has become so big that at times it sits awkwardly next to Amazon's main retail business. The group has not historically broken out financial information for AWS, lumping it into the "other" category. This lack of clarity, and a lack of profits for Amazon as a whole, has weighed down the company's share price, which underperformed the Nasdaq over the past 12 months.

This is one likely reason that Amazon will begin breaking out AWS financials later this month, an unusual move for a company known for being tight-lipped.

The numbers are expected to show how quickly revenue has increased, and how deeply Amazon has been supporting the capital-intensive business of building the data centres behind AWS.

"They may be around break-even," says Carlos Kirjner, an analyst at Bernstein. "The opportunity is very large, they are by far the leaders and demand is still skyrocketing."

Analysts at JPMorgan have already assigned a $44bn valuation to AWS, suggesting it represents a quarter of the enterprise value of Amazon as a whole.

But AWS faces growing competition, particularly from the likes of Google and Microsoft.

Developers say Google could be the biggest direct threat, because it is based on the same operating system, Linux, and because of the group's fast networking capabilities. Last year, Google also announced a drastic price cut, which Amazon promptly matched.

The race to win market share is likely to be expensive. Last year, Amazon reported that it had spent $4bn acquiring assets acquired through capital leases, which were "primarily" for AWS infrastructure, according to company filings.

Google and Microsoft, with $55bn and $61bn in net cash respectively, have plenty of ammunition to deploy.

AWS's first customers were developers and start-ups. It offered simple building blocks for computing projects enabling users to launch a website or test a software program without having to buy their own servers.

But the market for basic computing and data storage is a low-margin business, and AWS has increasingly been working to move up the value chain and into the more challenging area of software and enterprise services.

A recent example of its shift in approach is the machine learning service it unveiled this month, to enable clients analyse big data. It also has a data warehouse product, Redshift, which poses a potential threat to similar offerings from companies including Oracle and IBM.

Enterprise solutions - long the domain of companies such as IBM, Microsoft and Hewlett-Packard - have also become a target.

"I think we are really at the early stages of enterprise and public sector migration and adoption to the cloud, " says Mr Jassy.

Amazon as a whole has even changed its mission statement, which now refer to four types of customers: "consumers, sellers, enterprises and content creators".

AWS has introduced secure corporate email, secure document collaboration, and virtual desktop services. Last year, Johnson & Johnson, the pharmaceuticals group, bought 25,000 "virtual desktops", software which allows a user's PC to be stored on a remote server, instead of a physical computer.

Yet even if AWS succeeds in this new arena, it plans to continue to still to push down prices - a strategy that could keep eroding margins. Enterprise solutions traditionally have higher margins than basic infrastructure services, but AWS's approach is to "provide as cost-effective an experience as we possibly can", says Mr Jassy. He repeatedly emphasises that this is a "high-volume" business.

As Amazon prepares to unveil new details about AWS, investors will finally get a snapshot of the company's most promising business.

The challenge of selling services to your competitors

When AWS was founded, it was partly a response to Amazon's own technology problems. But today AWS is so ubiquitous that it even supports companies that are direct competitors of Amazon's other businesses - raising the question of whether these will eventually move to other platforms.

Netflix, the video streaming service, is one of AWS's biggest customers, even though Amazon's own streaming offering poses a competitive threat. Dropbox, the photo and file-sharing service, is also a big customer, despite Amazon's free photo storage service for Prime members.

Mr Jassy says Amazon's retail competitors are comfortable using AWS because it operates as a separate entity within Amazon. "It has a different leadership team. It has a different customer base," he says. "Amazon the retailer is really just one of several large, helpful important customers of AWS - Amazon the retailer is no more important to AWS than Netflix is."

Yury Izrailevsky, vice-president of cloud computing at Netflix, says the company migrated to AWS following a big database outage in its own data centres in 2008. "We are about eight times as cost-effective running in the cloud as we were in our own data centres," Mr Izrailevsky says. "It really was the only option that met our needs at the time, and that is still true today."

Last quarter, Netflix streamed 10bn hours of video - which would last more than 1m years if watched continuously. One of the advantages of AWS is that Netflix can easily accommodate bursts of traffic, such as during bad weather when lots of viewers stay home to watch video.

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