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Photographer: Quinn Russell Brown for Bloomberg Businessweek Photographer: Quinn Russell Brown for Bloomberg Businessweek

Tucked near the elevators on the 22nd floor of a 520-foot tower at Amazon.com Inc.’s headquarters in downtown Seattle, Anthony Liguori’s lab is a work in progress. His team moved in this summer, but during a visit last month, tables pushed up against the wall were covered in keyboards and computer accessories still in their packaging. A metal frame hanging from the ceiling awaited to route plugs and fiber connections to 10 experimental server racks that have yet to arrive. This is where Liguori’s team is putting the finishing touches on Outposts, Amazon’s big new move against the likes of IBM, Hewlett Packard Enterprise, and Dell Technologies as well as cloud rival Microsoft Corp.

On Dec. 3, Amazon rocked the $205 billion market for data center systems by joining it. After more than a decade telling businesses that renting computing power and storage space through the Amazon Web Services cloud was better than buying the server racks, the AWS team wants you to buy its server racks, plus software that will join those servers with its machines in the cloud. This is what the IBMs of the world are talking about when they use the term “hybrid cloud”—the ability to use cloud services for some stuff, nearby servers for mission-critical data, and a common interface for everything. A push into this world by Amazon, which used to give ceremonial hammers to startup clients to smash their on-site servers, is a little like Apple Inc. pitching a rotary phone.

“Lots of customers are going to be hybrid for a long period of time,” says Matt Garman, Liguori’s boss. For many businesses interested in migrating more fully to the cloud, he says, “there’s not an easy button that makes that go.”

Garman Photographer: Quinn Russell Brown for Bloomberg Businessweek

Outposts looks like your average server rack: 80 inches tall, 48 inches deep, and 24 inches wide, weighing about 2,000 pounds when all 11 server slots are occupied. The only decoration is a simple AWS logo on its steel door. “Sheet metal is the right thing for the cloud,” Liguori says. “We’re not trying to make it pretty.” The Outposts rack starts at $250,000—pricey were it hardware alone. Amazon says its bundled software and support make the price more competitive and Outposts can juggle more tasks than comparable hybrid cloud systems. That’s partly because a system Amazon invented, called Nitro, outsources much of the server management to AWS-controlled components, freeing up Outposts to handle user demands.

Amazon’s cloud arm reported $32 billion in revenue for its four latest quarters, a big slice of the $227 billion global market for cloud software and services and enough to rank the division among the world’s largest software companies. Analysts estimate that AWS’s market share in infrastructure software for tasks like data storage and networking is at least twice as large as that of Microsoft, its nearest competitor.

Microsoft and Google have begun to narrow the gap in recent years, winning contracts with big business and government clients. Microsoft in October shocked the industry by winning a Pentagon cloud contract worth as much as $10 billion. (Amazon has sued to block the decision, alleging bias in the selection process.) “I think it’s fair to say AWS feels pressure to expand its hybrid” and other data center product lines, says Dave Bartoletti, an analyst at Forrester Research. “They finally said, ‘We’re not going to be proud, we’ll go get any workload you can give us.’ They’re at a scale now where they feel permission to play that game.”

Amazon’s Incredible Cloud Growth Is Slowing Increase in revenue, year-over-year Data: Amazon.com

Garman has been part of Amazon’s cloud team from the beginning in 2006, when he helped name the first AWS services and wrote the copy on the website for EC2, the company’s main computing service. The team expanded its client base from web-savvy startups to boldface names such as Goldman Sachs Group Inc. by steadily underpricing rivals and old-line mainframe makers. To widen the network, cloud chief Andy Jassy pushed Garman and his colleagues to focus on building whatever special features customers might want, whether basic online tools or next-generation artificial intelligence applications, and to ship them as quickly as possible. (Critics say less heed was paid to making those products work well together.) Until now, the CIA is the only customer known to have received a private AWS data center, for $600 million in 2013.

Still, there remain other big customers Amazon hasn’t been able to satisfy. About four out of five corporate software applications still run in on-site data centers, and many need to stay on company servers for security, regulatory, or practical reasons. In 2015, Microsoft became the first big cloud services company to pitch a hybrid cloud product to accommodate customers with those kinds of needs, joining legacy server makers such as HPE, IBM, and others.

For years, Amazon’s response has been dismissive, says Forrester’s Bartoletti. “They responded to it by saying hybrid is just dumb,” he says. But hybrid cloud products started to draw customers away from Amazon’s cloud as well as from an all-hardware model. Jake Jakel, an information technology operations manager at New Belgium Brewing, which recently shifted some software from the cloud to its own hybrid setup using Dell and Microsoft products, says keeping manufacturing data on-site was an essential selling point.

Amazon’s cloud data centers are built on economies of scale—tens of thousands of server racks, designed largely in-house along with power and cooling systems. The company keeps lowering prices for processing power and storage by exploiting minor efficiencies multiplied by millions of servers. So for years, even when Amazon customers as big as Siemens AG asked for hybrid cloud products, Jassy said no. During a 2016 meeting, “Andy was very clear that he’s not interested in that, and we shouldn’t count on AWS” to make data center products for Siemens projects such as airports and power plants, says Peter Weckesser, a former Siemens executive who attended the meeting. Weckesser is now at Airbus SE’s defense and space unit, which is building a hybrid cloud system based on Microsoft’s gear that it hopes to sell to European governments and defense contractors.

Garman says that while executives discussed potential hybrid products at Jassy’s annual AWS planning retreats on and off for a decade, it wasn’t until early 2018 that the project got a green light under the name Frontier. Before then, Amazon’s technology hadn’t advanced enough to build high-quality miniclouds on site, Garman says. But putting servers in clients’ own facilities had its advantages, too.

Some of the last conversations that pushed Amazon into hybrid products were with media companies that wanted to host video streaming and animation software on AWS. For Disney animators working in the Los Angeles area, a delay of more than 10 milliseconds between pressing a stylus to the screen and seeing the mark made the rendering software useless. Amazon’s main West Coast data hub, more than 1,000 miles north in Oregon, couldn’t resolve that. “That’s a speed of light problem,” Garman says.

Almost two years later, a handful of customers, including Verizon Communications Inc., are testing Outposts, which comes with Amazon’s main computing power services. Verizon is using a version of Outposts to back a new service designed to enable faster 5G browsing speeds, starting with trial customers in Chicago. Fox Corp., meanwhile, is using Outposts to help power the broadcaster's production facilities and modernize its video infrastructure.

Along with leaning on extra muscle from AWS server farms, Amazon is betting it can differentiate itself through superior logistics. The company says a specially assigned team will deliver Outposts directly to customers’ data centers, where the IT folks can just plug them in, link them to an AWS account, download software updates, and get to work. When Amazon detects a component failure, it will mail the customer a new server and a return box for the defective one.

Data center hardware makers such as Dell, HPE, and IBM also offer that kind of full-service option. Microsoft’s hybrid cloud system, Azure Stack, is similarly complex, as is Google’s Anthos. Both are software packages that clients must set up on their own servers, and that requires greater tech savvy. On the flip side, Google’s and Microsoft’s hybrid systems are flexible enough that they can incorporate services running on Amazon technology, but the reverse isn’t true. By this time next year, customers will likely have pushed Amazon to make some of its tools comparably interoperable, says Daryl Plummer, a vice president with market researcher Gartner. “They’re going to face a problem they’ve never had to face before—they’re going where they’re not the leaders, not inventing the market,” he says. “They’re on ground where other companies are already. They’re going to have to figure that out.”