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ecommerce giant Amazon (AMZN -0.21%) It took a while for the concept of cloud computing to really catch on, but now AWS generates more than $20 billion in revenue each quarter.
And unlike Amazon’s core e-commerce business, AWS has very high margins. In the third quarter of 2022, AWS reported his 26% operating margin.
Over the past decade, the growth of AWS and the cloud infrastructure market has been relentless. Startups are opting for cloud computing by default, and companies are increasingly moving workloads to the cloud. AWS captured about 34% of the market and has become the default cloud provider for many enterprises. Longer term, demand is likely to continue growing at a healthy pace.
However, AWS may be facing its first major headwind since its emergence as Amazon’s primary revenue engine.
canary in coal mine
Amazon management has already shown that AWS customers are becoming more concerned about cloud computing charges in a tough economic environment. CFO Brian Olsavsky said at the company’s third quarter earnings call in October. Cut budgets and try to save money in the short term. “
Amazon reported a 27% year-over-year increase in AWS revenue in the third quarter, but Olsavsky said growth slowed to the mid-twenties by the end of the quarter. In Amazon’s fourth-quarter guidance, the company assumed this mid-20% growth rate would continue.
Amazon’s warnings about AWS customer behavior were the first signs that growth in its most important cloud business was slowing.Latest Earnings Reports from Memory Chip Manufacturers micron (Mu -1.10%) provides further evidence of an ongoing downturn in the cloud infrastructure industry.
Micron manufactures DRAM and NAND memory chips. The company isn’t splitting sales to data center customers, but Micron is seeing those customers pull back. “In the data center, we expect cloud demand for memory in 2023 to be significantly below historical trends due to the significant impact of inventory reductions at key customers,” said CEO Sanjay Mehrotra of his latest earnings report. said in the report.
One of the key customers mentioned is arguably AWS given its size. The cloud infrastructure provider has piled up memory his chip inventory based on growth forecasts that have proven to be overly optimistic. Micron thinks this will be an issue throughout his 2023.
AWS profits could be hit
Amazon’s cloud business is capital intensive and profitability depends on utilization. All servers, chips, and network equipment that fill Amazon’s data centers incur depreciation regardless of whether they are fully utilized. These fixed costs are incurred regardless of how much revenue is generated.
If Amazon can accurately predict future demand, it can adjust infrastructure growth to meet that demand and keep utilization high. However, when companies overestimate future demand and build excess capacity, it can lead to underutilization.
Based on what Amazon said about slowing customer consumption, and what Micron said about declining sales of memory chips to cloud providers through 2023, Amazon has somewhat overbuilt its cloud business. It seems that there are His AWS operating margin in the third quarter was down about 4% year over year. This suggests that the company expanded too quickly.
Investors should prepare for worsening AWS profitability when Amazon reports fourth quarter results in a month or so. AWS’ disappointing results won’t help the stock price recover when the retail side of the business is losing big.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Timothy Green has no positions in any of the stocks mentioned. The Motley Fool has a position on and recommends Amazon.com. The Motley Fool’s U.S. headquarters has a disclosure policy.
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