Will Cloud Computing Prices Keep Dropping to Zero, or Close to It?

Amazon Web Services has cut prices about 50 times. So will it keep doing so? Most would say “yes.” Will other suppliers such as Google and Microsoft follow suit? Most would also say “yes.”

In most industries, “ruinous” levels of competition often are said to represent a “race to zero” in terms of retail pricing, with negative implications for firm or industry sustainability.

But AWS has chosen such a strategy deliberately. AWS rationally has decided to keep cutting prices as the foundation of its business model.  

“How can that be?” is a reasonable question for any outside observer. How can a market leader in cloud computing literally price its core services at nearly zero, in either consumer (free computing, free storage, free apps)  or business markets (cloud computing, storage, apps or platform)?

After all, big data centers and the software, hardware, real estate and energy required to run them are substantial.

The business advantages of huge scale are part of the answer. Firms such as Amazon and Google count on the fact that only a few providers, with enormous scale, can afford to compete in such a market.

So gaining scale, then lowering prices, feeds a virtuous cycle where additional customers, buying more services, allow the supplier to gain even more scale and drop prices even more, attracting yet more customers.

With sufficient scale, “scope” also becomes relevant: AWS and other leading cloud computing suppliers can sell additional services and features to the customers they already have aggregated.

So even if a “race to zero” has generally been considered dangerous and unsustainable in big existing markets, it is the foundation of strategy in many new digital--and some emerging physical markets--as well.

It is hard to compete with a competitor that gives away what you sell. That, in fact, is precisely the logic often driving business strategy in the Internet realm.

That strategy is at work with voice over IP, instant messaging, online streaming video and audio, Internet access, search and most “print” content. Many would agree, but note that these all are non-tangible, digital products. That notion is correct.

In most “physical product” areas, the Internet has lead to reduced prices, or less friction, but surely not to “near zero” levels.

That, of course, is not really the issue. The issue is a competitor’s ability to destroy enough gross revenue--and strategically, profit margin--as to break the market leader’s business model.

This is a rational strategy for some new contestants because they actually have other revenue models that are enhanced when an existing supporting market is “destroyed.”

In a real sense, Apple gains business advantage when content prices are very low. That helps it sell devices enabling content consumption. Facebook and Google gain when each additional Internet user is added, since they make money on advertising.

Prices for physical good distribution do not have to reach “near zero,” only “near zero profit,” for whole markets to be disrupted.

An attacker able to create a positive and sustainable business case in a market that is perhaps smaller (in terms of overall revenue) still wins is the attacker emerges as a market leader in the reshaped market.

One example: many observers would say that the chief revenue stream for Costco, the discount groceries retailer, is membership fees, not groceries. Likewise, the business model for most movie theaters is concessions, not admission tickets.

That is one sense of the term “zero billion dollar market.”

The strategy is inherent in business models used by many leading application, device or service providers.

The difference is that the trend is extending beyond businesses that are inherently “digital.” Some see shared vehicle businesses as disrupting the automobile market on a permanent basis. Shared accommodations businesses have potential to disrupt the commercial lodging business.

Without a doubt, we will see spreading efforts to replicate such sharing models in most parts of the economy where ownership is the dominant retail model.

Suppliers of cloud computing, especially infrastructure as a service (IAAS) but even the biggests segment--software as a service--also must directly confront pricing strategies that deliberately aim to reach near-zero levels.

There are several analogies you might might apply, to Moore’s Law, marginal cost pricing or experience curves, for example. Some might say that same logic is embedded in much of the economics of the Internet as well.

The notion is that, over time, performance vastly improves while retail price either remains the same or also shrinks, not just on a per-bit or per-instance basis, but absolutely, adjusted for inflation or not.

Suppliers of network bandwidth and computer chips long have had to create or recraft businesses built on such assumptions.

The obvious business implications are stark. Many firms, in a growing range of industries, face competitors who literally base their business models on marginal cost pricing, near zero pricing or actual “free” prices.

Those competitors can do so because widespread use of the “near zero” or “zero” price function allows them to make money indirectly. For Amazon, the other way is retailing all manner of products. For Google and Facebook the other way is advertising. For Apple the other way is device sales.

In all those cases, the direct revenue contribution for one input--while important--is less important than ubiquity or huge scale as it relates to the primary revenue model.

“Zero” levels of pricing are a fundamental reality in a growing range of industries. How successfully the legacy providers can adapt always is the issue. In many cases, the answer is “we won’t be able to do so.”

Some would say that is an example of creative destruction. But it is destruction, nevertheless.

Near Zero Pricing Remains the Top Issue Connectivity Providers Face

Near zero pricing is the term I use to describe the larger framework of connectivity provider pressures towards ever-lower prices. Others might prefer to emphasize marginal cost pricing. The point is that there is a reason the phrase dumb pipe exists. What we need to remember is that dumb pipe now is the foundation of the whole connectivity business. 

A caveat is that what people usually mean by “dumb pipe” is that a product is sold at low prices and generates low profit margins. But think about it: industry revenue growth now is lead by broadband services (internet access), which is, by definition, a dumb pipe service. It is a way to get access to applications, not an actual application itself. 

You might call that trend another example of the impact of Moore's Law on business and economics. And near zero pricing is a big industry issue. It might be the single-biggest issue. 

In a recent survey by Telecoms.com, the number-one threat to long-term business success was “increased pressure to lower prices” and “lower profit margins,” for example. 

source: Telecoms.com 

Agility or “speed” was also a major concern. Third on the list was competition from webscale firms including Google, Amazon or Microsoft. 

But there are good reasons why “lower prices” and “lower profit margins” are the top issues. Simply, they are the most-important result of other industry threats causing the price compression and lower profit margins: competition, the shift to internet protocol as the next-generation platform and the embedding of the whole connectivity function within the larger internet ecosystem.

Aside from deregulation of the telecom industry, which lead to competition and price competition, technology is among the root causes of price pressures. 

The most-startling strategic assumption ever made by Bill Gates was his belief that horrendously-expensive computing hardware would eventually be so low cost that he could build his own business on software for ubiquitous devices. Basically, I believe he asked himself what his own business would look like if computing hardware was free. 

How startling was that question? Consider that, In constant dollar terms, the computing power of an Apple iPad 2, when Microsoft was founded in 1975, would have cost between US$100 million and $10 billion.

The point is that the assumption by Gates that computing operations would be so cheap was an astounding leap. But my guess is that Gates understood Moore’s Law in a way that the rest of us did not.

Reed Hastings, Netflix founder, apparently made a similar decision. For Bill Gates, the insight that free computing would be a reality meant he should build his business on software used by computers.

Reed Hastings came to the same conclusion as he looked at bandwidth trends in terms both of capacity and prices. At a time when dial-up modems were running at 56 kbps, Hastings extrapolated from Moore's Law to understand where bandwidth would be in the future, not where it was “right now.”

“We took out our spreadsheets and we figured we’d get 14 megabits per second to the home by 2012, which turns out is about what we will get,” says Reed Hastings, Netflix CEO. “If you drag it out to 2021, we will all have a gigabit to the home." So far, internet access speeds have increased at just about those rates.

As frightening as it might be for executives and shareholders in the telecommunications industry, a bedrock assumption of mine about dynamics in the industry is that, over time, retail prices for connectivity services also will trend towards zero.

“Near-zero pricing” does not mean absolute zero (free), but only prices so low there is no practical constraint to using the services, just as prices of computing appliances trend towards lower prices over time, without reaching actual “zero.”

Will Near-Zero Pricing Happen with Medical and Legal Advice?

Legendary venture capitalist Vinod Khosla predicts free medical and legal advice in about a decade, because of artificial intelligence. Some will dismiss the prediction as fanciful, given many similar predictions in the past. 

As outlandish as that might appear, it is a common belief or prediction in the digital era, though there were some predictions that electricity, for example, would be “free” in the older analog world. 

There were inaccurate predictions that nuclear power, for example, would be so cheap it would not be worth metering its use. 

Study Title/Publication	Prediction	Date of Prediction	Publisher	Reason for Inaccuracy
"The Promise of Nuclear Power" by Lewis Strauss, Chairman of the U.S. Atomic Energy Commission	Predicts that nuclear power will become so cheap that it will be "too cheap to meter."	1954	U.S. Atomic Energy Commission	Underestimated the costs of constructing and maintaining nuclear power plants, as well as the risks associated with nuclear accidents.
"Nuclear Power: The Answer to the Energy Crisis" by Alvin Weinberg, Director of the Oak Ridge National Laboratory	Predicts that nuclear power will make electricity "too cheap to meter" by 1969.	1960	Public Affairs Press	Overestimated the rate at which nuclear power plants would be built and underestimated the costs of building and operating them.
"Nuclear Energy and the Future of Power" by David Lilienthal, former Chairman of the U.S. Atomic Energy Commission	Predicts that nuclear power will provide "a virtually inexhaustible supply" of electricity at "extremely low cost."	1967	Basic Books	Underestimated the environmental and safety concerns associated with nuclear power.

In recent decades, predictions of dramatically-lower product pricing--essentially free or near zero--have been made in a variety of areas where digital technology was expected to operate. In virtually all cases, assumptions were made about substitute products that would operate so affordably that existing products would not be attractive. 

Study Title/Publication	Prediction	Date of Prediction	Publisher	Reason for Inaccuracy
"The World Without Cars" by Peter Newman and Jeff Kenworthy	Predicts that cars will become obsolete in cities by 2030.	1989	Pluto Press	Underestimated the continued popularity of cars and the challenges of transitioning to car-free cities.
"The Information Economy: How Digital Networks Will Transform the World" by Manuel Castells	Predicts that the information economy will lead to a more equitable society.	1996	Blackwell Publishers	Overestimated the potential of the information economy to reduce inequality.
"The Long Tail: Why the Future of Business Is Selling Less of More" by Chris Anderson	Predicts that the internet will allow niche products to become more profitable than mass-market products.	2006	Hyperion	Underestimated the power of marketing and branding in the digital age.
"The Second Machine Age: Work, Progress, and the Future of Mankind" by Erik Brynjolfsson and Andrew McAfee	Predicts that automation will lead to widespread unemployment.	2011	W. W. Norton & Company	Overestimated the speed at which automation will replace human workers.
"The Rise of the Robots: Automation and the Future of Work" by Martin Ford	Predicts that robots will eventually replace most human workers.	2015	Basic Books	Overestimated the capabilities of robots and underestimated the adaptability of human labor.

All that noted, predictions about near-zero pricing for any variety of products continue to be made. It might be too soon to know whether such predictions will prove incorrect. And relative abundance, in some instances, might have outcomes largely indistinguishable from predictions of absolute abundance. 

Internet access is not “free,” for example, but its price is low enough that usage is not a barrier. Many other products, such as search, shopping, social media and some forms of content cost so little that consumption can be subsidized fairly easy by advertising or low usage fees. 

Study/Story	Prediction	Date of Prediction	Publisher
"The Age of Free: Why We'll Soon Pay Nothing for Most of What We Use"	"Within the next two decades, many of the things we now pay for—electricity, food, transportation, housing, healthcare—will become essentially free."	2014	Jeremy Rifkin
"The Free Economy: When Everything's Free"	"In the future, we will be able to produce goods and services in great abundance at very low cost, or even for free."	2016	Tom Slee
"The Future of Abundance: How the Products of Human Ingenuity Will Make the World a Better Place"	"The abundance created by technology will eventually lead to a world where everyone has access to the basic necessities of life."	2019	Peter Diamandis and Steven Kotler
"Radical Abundance: How to Create a World of More Than Enough"	"The potential for abundance exists in every sector of the economy."	2020	Marianne Williamson
"The World We Made: How Our Future Will Be Shaped by Technology - For Better or for Worse"	"We are on the cusp of a new era of abundance, in which the cost of producing goods and services will continue to decline, and the potential for human flourishing will expand."	2021	Michael J. Sandel
"The Future of Electricity: Scenarios and Forecasts to 2040" by the International Energy Agency (IEA)	Electricity prices will fall significantly in the coming decades, with the average price in industrialized countries expected to be about 50% lower in 2040 than in 2018.	2019	IEA
"The Free Economy" by Jeremy Rifkin	The marginal cost of producing and delivering many goods and services, including electricity, information, and transportation, is approaching zero. This will lead to a new era of economic prosperity in which many products and services will be essentially free to consumers.	2014	Jeremy Rifkin
"The Zero Marginal Cost Society" by Thomas Philippon	The marginal cost of producing and delivering many goods and services, including electricity, information, and transportation, is approaching zero. This will lead to a new era of economic inequality in which a small number of companies will control the vast majority of wealth.	2019	Thomas Philippon
"The Rise of the Sharing Economy" by Rachel Botsman	The rise of digital technologies is making it easier for people to share goods and services, such as cars, homes, and clothes. This will lead to a new era of economic prosperity in which many products and services will be essentially free to consumers.	2013	Rachel Botsman
"The Age of Disruption" by Geoffrey G. Parker	The rise of digital technologies is disrupting many industries, including the energy, telecommunications, and transportation industries. This will lead to a new era of economic uncertainty in which many companies will struggle to survive.	2014	Geoffrey G. Parker
"The Economics of Energy" by Jeremy Rifkin	Predicts that solar power will become so abundant and inexpensive that it will be essentially free for consumers.	2014	Jeremy Rifkin
"The Future of Work" by Martin Ford	Predicts that automation will eventually make many jobs obsolete, leading to a situation where governments provide a universal basic income to all citizens.	2016	Basic Books
"The Age of Surveillance Capitalism" by Shoshana Zuboff	Predicts that data will become the most valuable resource in the world, and that companies will be able to extract immense profits from it by selling it to advertisers and other third parties.	2019	PublicAffairs
"The Next Revolution: Work, Wealth, and the Future of Capitalism" by Nathan Myhrvold	Predicts that artificial intelligence will eventually surpass human intelligence, leading to a new era of unprecedented economic prosperity.	2022	Crown Business
"The 21st Century Revolution: A New Economic Vision" by Jeremy Rifkin	Predicts that a third industrial revolution, based on renewable energy and distributed manufacturing, will eventually replace the fossil fuel-based industrial economy.	2021	St. Martin's Press

But sometimes, intangible products and digital products do approach near-zero pricing levels, reducing barriers to usage. And that is the reason some believe AI is going to attack price levels for any number of intangible products including advice and diagnosis. 

Near-zero pricing might seem outlandish, but not for intangible products. We already have seen that impact in content delivery, shopping and information discovery, as well as social media. And advice based on experience might be the next large set of areas to be affected by the near-zero pricing trend.