Cloud infrastructure has fundamentally changed how organizations operate and how governments deliver public services. Cloud migration is often seen as indispensable for digital transformation — but is the current predominant model truly the best path to a sustainable future? And can it, in its current unregulated form, create new economic opportunities and help society achieve its sustainability goals?

The UK's regulatory body Ofcom, responsible for oversight of the sector, is currently examining the cloud services market. In its interim report, the authority found that the market does not function well despite signs of individual competition.

As a result, Ofcom recommended a further investigation by the UK's Competition and Markets Authority (CMA) as part of a public consultation process.

The Sustainable Digital Infrastructure Alliance (SDIA) submitted a comprehensive response on May 17, 2023, including comments on the report itself, a Taxonomy Guide on Digital Infrastructure, a position paper on public cloud provider regulation, and the previously published whitepaper on building a European cloud.

Can new entrants enter the cloud infrastructure market?

Cloud infrastructure services are dominated by three corporates, the so-called "hyperscalers." Microsoft and Amazon together control 60–70% of the market, with Google holding 5–10%.

On-Demand and Always Available: The Current Model

"Pay-as-you-go" is now the standard model for cloud services, replacing the previous system of monthly or yearly contracts. However, this model requires massive over-provisioning: Capacity must always be available when customers need it — requiring large-scale infrastructure investments.

While data centers themselves have a comparatively long lifespan, the same does not apply to the hardware they operate with. Storage and computing equipment must be renewed every two to three years. While data centers are considered an attractive investment, financing the equipment within through traditional investors and loans is more difficult.

This is where vertically integrated technology companies come into play.

These corporates can use profits from other business areas to finance the continuous technological upgrades needed to operate digital utility services — data storage and processing. For Microsoft, it's software licensing, for Amazon, e-commerce, and for Google, advertising revenue.

The investment pays off: In the first quarter of 2022, Amazon Web Services generated nearly the entire Amazon corporate profit of $6.5 billion.

Does this model limit competition?

As SDIA notes in its response to Ofcom:

"Without vertical integration, economically building such an extensive digital resource infrastructure as we have today would not be feasible."

The current model makes market entry, expansion, and competition difficult for new providers.

Does the behavior of market leaders increase switching barriers?

This is one of the central questions of the Ofcom report. Egress fees are explicitly cited as a potential issue.

IDED shares this view but also sees the bundling of digital resources with software services ("cloud services") as a major exacerbation of the problem.

High Egress Fees Prevent Provider Switching

Customers pay egress fees when moving their data out of a cloud.

Whether transferring data to or from a platform, the actual costs for the cloud provider are the same. However, there are significant differences in customer fees: Data transfer away from the platform is significantly more expensive and acts like an "export tax."

The result is that data becomes effectively tied to one platform.

Service Bundling Exacerbates the Issue

Software is bundled with the provider's cloud resources in a "package." This software can come from an independent software vendor (ISV) or the open-source community. However, once bundled with the cloud resources, it cannot be moved to another cloud. "Bundling" leads to customer retention.

In the long term, ISVs could end up in a situation similar to Apple's App Store — paying high fees to hyperscalers to access new customers.

The Long-Term Development: First Tied, Then Taxed

The Ofcom report states:

"We fear that the level of competition could decrease further in the long term."

IDED shares this concern: All three major public cloud providers offer new customers credits worth $20,000 to $100,000. Once companies are tied in, tech start-ups often spend up to 50% of their operating costs on cloud platforms (see this analysis by Andreessen Horowitz).

This makes them dependent on cloud providers who also capture the majority of the profit margin created by start-ups. This margin could be invested in further innovation or jobs — instead, it flows as a de facto cloud tax to a few global companies.

The risk is that

"based on the current unregulated model for cloud services, the most likely outcome is that nearly all private and public ICT platforms for computing, storage, and processing, as well as a significant portion of software applications, will end up with just one of three companies."

What Are the Alternatives?

In its response, IDED recommends six measures:

• Require separation of digital resource infrastructure from digital platform businesses (e.g., from advertising, search engines, or e-commerce). Alternatively, create a regulatory framework similar to telecommunications regulation.

• Create a public market for digital resources.

• Limit bundling of cloud services with digital resources.

• Abolish or reduce egress fees for data leaving a cloud platform.

• Restrict the use of discounts and credits.

• Introduce transparency obligations on ownership, usage, and fees for all ICT infrastructure considered "critical information infrastructure" or having the potential to be.

Ofcom plans to publish its final report by October 5, 2023.