Can Amazon and Microsoft crack cloud computing in China?

Almost all of the six hundred and twenty million Chinese people and the hundreds of thousands of domestic firms that connect to the internet daily store some form of content online. Social media platforms such as Sina Weibo and file sharing services are increasingly a part of daily life.

For the firms that provide these online services, start-up and operating costs can be high. The hardware and software that keep their businesses alive don’t come cheap. But as cloud computing gains traction in China business expenses are coming down. “We are able to quickly deploy a lot of services without spending an enormous sum of money in the early stage,” says Yue Pengyu, director of operations and maintenance at NQ Mobile, a Chinese firm that focuses on internet security and privacy products.

NQ Mobile is a client of Amazon Web Services, which entered the domestic market in December 2013 with a limited offering. Amazon is one of the main foreign players, along with Microsoft and IBM, that are driving the development of the cloud computing market in China. If they can be successful they will earn huge revenues and deliver the benefits that businesses in North America are already realizing. In their way stand national security issues, regulatory hurdles and a lack of market trust.

The next internet boom

“The market itself, even without the foreign players, has exploded in the last year,” says Steve Mushero, CEO of ChinaNetCloud, a foreign-owned sever management and cloud computing company based in Shanghai. When ChinaNetCloud started running cloud services in 2008, there was virtually no competition, and even until last year, Mushero says, the industry had very few significant players.

Growth in China is coming from an explosion of data, digital media and web-based applications in a country with 618 million internet users as of the end of last year. Internet behemoths like Alibaba Group, Baidu and Tencent are driving users online. China is also the world’s biggest smartphone market.

Cloud computing is reshaping how people live, work and do business. People increasingly use the cloud for everything from social networking to online shopping to file-sharing. Companies access cloud services for tasks ranging from document editing and data backup to advertising, sales and customer relationship management. A survey by North Bridge Venture Partners found that 75% of American companies were using cloud services in 2013.

Understanding the size and scope of the market is complicated by differing definitions. Broadly speaking, cloud computing can be defined as the practice of storing data and running software over the internet. This includes cloud software, such as internet apps that allow companies to track sales, and hardware, for instance the data centers that store information. Then there are “public clouds” that anyone can sign up to use and “private clouds” that are built by companies to keep others out.

Consequently, market valuations can vary wildly. Research firm Zero2IPO estimates that China’s cloud computing market will grow at an annual rate of 50% over the next few years and surpass RMB13.6 billion (US$2.19 billion) by the end of 2015. Wang Feng, manager of China Telecom’s cloud computing unit, sees market growth of 26% per year between 2013 and 2017, with a market value of RMB13.4 billion already at the end of 2013. State-run China Software Industry Association estimates the cloud computing value chain, a much wider definition, could be worth RMB1 trillion by 2015.

Global players are following Amazon and rushing in. Microsoft launched its Azure cloud computing platform in China in March while IBM recently entered the sector with its SmartCloud Enterprise+ system, serving mainly enterprise and government customers. Intel and Oracle have either launched their own or bought into existing cloud services in the country.

Foreign knowledge

Amazon, Microsoft and IBM in China all offer what is known as “infrastructure as a service,” one of three service models in cloud computing. It provides virtualized hardware, or in other words computing infrastructure. Yet they each have differing approaches.

AWS is a platform designed to run on economies of scale, which gives clients the ability to provide services at the best available prices, said Justin Mallen, founder and CEO of Silk Road Telecommunications, a Hangzhou-based corporate telecom services provider. IBM is much more focused on the corporate cloud, while Microsoft is all about Microsoft products.

Amazon is the world’s largest provider of public cloud computing services. It currently offers a limited range of its AWS in China, allowing companies to purchase its computing, database and storage services by invitation only. AWS has partnered with the regional authorities in Beijing and Ningxia. Under this arrangement, Amazon supplies the software, while Chinese partners provide local data centers, bandwidth and content delivery.

Microsoft has a stronger foothold in the Chinese market with its Azure service, which launched as a limited preview last June and went fully live this March. “We pride ourselves as the only multinational company that has a true public cloud service here in China,” George Yan, who manages Microsoft’s China cloud business, told China Economic Review in an interview in early June. Azure’s key selling point as a global provider is that any individual or company can sign up for the service, in contrast with AWS, which is not yet fully public. Amazon declined to comment for this story.

Yan claims that Azure’s success lies in its unique partnership model. Microsoft’s partner, Chinese tech firm 21Vianet Group, operates the service, running data centers in Shanghai and Beijing that deliver Azure, while Microsoft licenses the software. The Shanghai municipal government is also a party to the deal. Microsoft claims to have had big success in China so far. Among Azure’s customers are Coca-Cola China, which uses the platform for digital advertising, mobile games company LineKong Entertainment, which hosts top games on Azure, and state-run China Network Television, which will use Azure for this year’s webcast of the Spring Festival Gala, the most watched TV show on earth.

IBM is also partnering with 21 Vianet Group, but unlike Microsoft’s public cloud it is working with the Chinese internet data service provider to host its managed private cloud service. A flagship project for the company is the development of a smart logistics center in the coastal port city of Ningbo, which once complete will enable more than 5,000 firms at the site to share data across the cloud.

In addition to providing services locally, the companies are also working with Chinese firms operating overseas. AWS already serves 5,000 Chinese customers outside of China.

The growing popularity of cloud services hasn’t gone unnoticed by local technology players. E-commerce giant Alibaba has launched Aliyun, the biggest public cloud in China, Tencent offers Q-Cloud and former Tencent executives have formed start-up UCloud. With their local knowledge, strong ties to Chinese businesses through existing internet services and cost competitiveness they come to the market in solid position. Still, they will come up against experienced multinational firms.

Foreign companies have their own advantages that can’t be discounted. “The key strength of major global players are the richness of their product offerings, as well as the quality and experience servicing large scale clients,” said Charlie Dai, an analyst at Forrester Research in Beijing. “The entry of global players will further impact, and actually has already impacted, the Chinese market.”

Heavy cloud

These are exciting times for foreign cloud providers, but can they succeed in what looks like becoming an increasingly difficult market?

Global vendors face a range of challenges in China – lagging infrastructure, a complex regulatory environment, a shortage of skilled personnel and geopolitical tensions. It’s also not clear that Chinese businesses will adopt cloud services on a large scale, let alone those provided by foreign firms. Whether Amazon, Microsoft and others can thrive will depend on their ability to navigate these obstacles as well as the willingness of Chinese companies to entrust their data to the cloud.

Microsoft is the only global company that has managed to offer a completely public cloud service in China. This hints at the knotty legal and regulatory tangles that foreign firms must cut through in order to do business in a sensitive sector. Foreign companies looking to set up data centers or cloud services in China must establish a joint venture with a local firm. Not only do they have to take pains to avoid hosting illegal content, such as pornography and politically sensitive speech, they also have to contend with heavy-handed government measures, like the occasional “lockdown” in which companies are prohibited from moving hardware into or out of internet data centers. The most recent such lockdown lasted for 22 days in February and March, while big political meetings took place in Beijing.

Another issue for cloud companies in China is personnel. In an industry still in its infancy, companies have a hard time finding people with the requisite skills to operate a cutting-edge cloud service. “Running a data center is relatively easy,” says Mushero. “Running a cloud is much more operationally difficult; even Aliyun has had problems with that. Long-term that’s going to be a challenge.”

The government’s preoccupation with “internet sovereignty” poses a particular challenge for cloud service providers. Multinationals are finding that the only way to enter the Chinese market may be to completely segregate local from global operations. “What we have done in China is basically we have carved out an island of services that exist in China, that’s exactly the same as in the rest of the world, but they don’t talk to each other,” says Microsoft’s Yan. “We purposely disconnected the China services from the rest of the world because of the rules and regulations here.”

In the past two months the issue of “internet sovereignty” has become entangled with a diplomatic flare-up that could make life much harder for foreign, especially US, technology companies than it already is. The US government in May publicly named five members of China’s armed forces as suspected perpetrators of cyber crimes against US companies. Beijing reacted with fury. In a vaguely worded notice, state media said China will review all foreign IT products sold domestically and block any that fail to pass a new “cyber security vetting system” designed to weed out secret spying and surveillance activities. Only a few weeks earlier the government banned state agencies from using Microsoft’s Windows 8 operating system, without making it clear why. Reports, which have not been confirmed, also surfaced saying that state companies are being told not to use IBM’s servers.

The speed with which the above measures were rolled out and the lack of clarity on implementation mean that the possible impact on the cloud computing sector is hard to predict at the moment. However, the way in which foreign companies provide cloud computing services in China may make them less susceptible to any sharp or aggressive changes in government regulations.

As Mallen notes, Amazon and Microsoft are the middle layer in the cloud computing chain – they are neither service providers nor data centers. Such functions are sensitive and restricted to foreigners. Non-Chinese companies operating in cloud computing must have a local partner to do business in China. Amazon, Microsoft and IBM all offer services through licenses, partnerships and relationships with local entities. They do not run the entire cloud computing value chain. In the Microsoft partnership 21 Vianet is the contract holder responsible for protecting client data, something that Yan says the company has made very clear to the media and government.

Nevertheless more needs to be done to overcome pre-existing anxieties in the local market about uploading company data to foreign-run services. “We won’t do that now because we don’t know if it is safe to do that for our data,” a spokesperson for Kuke Industry, a Shanghai-based e-commerce firm with annual revenues of US$1 million, told China Economic Review. “It is so hard to handle and control the situation if something unfair happens to us [when] working with a foreign company.”

The question of trust runs much deeper than just worries about foreign companies. In the West, governments and companies are more open to working with cloud providers. Last October AWS won a US$600 million contract with the US Central Intelligence Agency to build a cloud network. China appears to be less ready, partly out of a lack of experience or faith in outsourcing such functions.

“Yes, we do have worries [about cloud computing], such as if they are going to sell our customers’ data to others or if they are going to control us because we have to use their service,” said Kuke Industry.

 “I don’t yet know that that’s something that people here are comfortable with,” says Mallen. “The big internet players in China like to build their own networks, they like to build their own data centers, they like to build their own systems. Where a Netflix will host on Amazon, I don’t know that a Youku would ever host on Amazon.” Youku Tudou is China’s largest online video provider.

Going skyward

If global companies can figure out how to win the trust of the government and local companies, they will transform the industry. Indeed, the entry of big foreign brands is already shaking up the market, bringing healthy competition and global standards to a fast-evolving sector. Mushero sees the trend as a huge positive. “The more competition, the lower prices, the better features, the higher standards, just the better off China is in general,” he says. “It also allows Chinese companies to use global standard tools and clouds, which means then they can go global.”

The spread of the cloud also benefits Chinese companies, particularly small and medium enterprises. Businesses can use the cloud not only to store their data, but also to run their core management systems. To Mallen, the value proposition of cloud computing is “as simple as it gets.” The cloud frees firms from having to buy their own IT infrastructure and hire their own technicians to run, maintain and troubleshoot all that hardware and software. Instead of spending many thousands of dollars on servers, a company might subscribe to cloud services for a few hundred renminbi per month.

Mallen says that cloud computing services can relieve the headache of upfront capital, server and service maintenance and staff problems. “Your headache of what happens when it’s broken and you don’t have the right expertise in-house – gone. One phone call and you fix everything.” By lowering the cost of critical infrastructure and making it more flexible and easier to use, cloud computing also promotes innovation. “You also get more niche things,” says Mushero, “not only innovation, but [apps] that don’t make a lot of money and aren’t mainstream but are useful to some people.”

Yue at NQ Mobile acknowledges the costs savings. “Although we doubled the number of servers, we didn’t double manpower. We do massive operations by ourselves based on AWS. Basically, all we have to do is to press one button to complete the deployment of a group of servers. We don’t worry about where the servers are and what the configuration is, we are concerned only about its services. Product research and development is the only thing we have to do.”

It previously took NQ Mobile around 15 days to start providing services to an overseas client, or three days if they were super quick. The job can now be completed in 20 minutes with AWS, Yue says.

Making it rain

Cloud computing is still at its relative infancy in China. The demand fundamentals are seemingly there to forecast growth at similar levels to North America. Big foreign players have moved quickly to enter the country and are well positioned to influence the development of the local market.

Where analysts see more work needed is in firming up local offerings and having the flexibility to adjust to changing conditions. AWS arrived in China first, but it hasn’t tailored its products carefully enough to meet domestic requirements and still has to define its Chinese partners. Microsoft has built smart partnerships and overcome regulatory hurdles, notes Dai from Forrester Research, but faces the challenge of extending and enabling its partner ecosystem to have technical consistency.

Influencing the biggest change necessary for the market to achieve its full potential is likely beyond the ability of foreign firms. Deals with big companies offer the largest revenues, but they are fewer in number, said Microsoft’s Yan. A number of multinationals who use Microsoft’s Azure services in China are already global clients. But the big money lies in providing services to huge Chinese firms.

Many of these are state run. The challenge in winning their business is two-fold: State-owned enterprises are slow to adapt to technological innovation and extremely protective of their data. Until recently they were not allowed to sign contracts with outsourced data center services. Although they might soon be permitted to buy computing as a service, there is no guarantee they would opt for a foreign provider. SOEs are often obliged to ink deals with Chinese firms, usually other SOEs.

If large emerging private-sector companies, especially in technology and internet, can be persuaded of the benefits of public clouds instead of hosting themselves, then the market could move decisively. That would benefit the likes of Microsoft and Amazon. “I think the only key tectonic shift that ever may happen is if once again the Alibabas and the Baidus and the Tencents of the world decide to outsource their infrastructure, said Mallen. “I don’t see that happening anytime soon.”  

“Maybe a Youku will do it first, maybe not. They’ve got a lot of legacy infrastructure already built in place that I’m sure they’re going to keep using. But I’d say if mid-tier internet companies decide to shift to the cloud, that’ll be tectonic for the cloud business.”

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