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Are the Google and Amazon Price Cuts Too Good to Be True?


Growth is holding everything together for now, but will it lead to an inevitable explosion?

There's nothing quite like a good deal, and the Internet is full of good deals. Every day Facebook (NASDAQ:FB) showers us with status updates, for which it never charges a dime. YouTube (NASDAQ:GOOG) is free, and yet it provides us with so many hours of entertainment and such endless quantities of procrastination and schadenfreude.
And one of the best deals of all is the cloud. Unemployment checks might not buy you a DVD library, but they will cover a Netflix (NASDAQ:NFLX) subscription. That's probably a good thing, because cloud technology also allows businesses to avoid buying new equipment and hiring new employees -- two budget items that fell out of favor during the Great Recession. So you can thank Web companies for the fact that, according to Credit Suisse (NYSE:CS), "corporate investment in technology is now farther below trend growth than it has been at any point in the last 50 years."
This raises the question: At which point does a good deal become a big problem? If you follow the technology sector, then you're probably aware that author Jeremy Rifkin has been trolling the Internet for the last two months, pushing a new book called The Zero Marginal Cost Society. He argues that the Web will soon have us all out of work and hunting for jobs in the nonprofit sector. And in the last few weeks, French economist Thomas Piketty became an international celebrity for claiming in a 700-page treatise that capitalism is rigged against the working guy.
But it's hard to blame either capitalism or technology for the success of cloud companies, whose defining feature is that they lose money. Handing out free lunches has always been a brisk business, if not exactly a profitable or innovative one; and Web firms long ago discovered that the more money they lose, the faster they tend to grow. Customers like Toyota (NYSE:TM) are essentially paid to rent software from Web companies like (NYSE:CRM), and the result is a peculiar form of double counting: Tech firms get high valuations for growing fast, while their clients get high valuations for increasing profits.
For example, file-sharing company Box scored a huge win last week when it landed General Electric (NYSE:GE) as a customer. Undoubtedly GE received a great deal, because last year Box's losses were larger than its revenues. On the other hand, SAP's (NYSE:SAP) fledgling cloud division was profitable in 2013, but it didn't achieve the kind of growth that makes shareholders salivate. So, earlier this year, the enterprise software giant threw in the towel, promising an abundance of red ink and "growth at any cost."
Losses in this industry go deep -- all the way to its roots. Even before Google muscled (NASDAQ:AMZN) into a round of deep price cuts last March, it was likely that Amazon Web Services was unprofitable. Amazon doesn't divulge the numbers for AWS, a webhosting platform used widely in the cloud, but the clues all point south; ancillary businesses like Amazon Corporate Services are losing money, and high-end competitor (NYSE:RAX) has seen its margins all but vanish over the last two years.
At the moment, growth is holding everything together. The head of IBM's cloud division suggested that March's price cuts by Amazon and Google would result in "further oversubscription of their services." In other words, by signing up new customers while delaying the purchase of new servers and infrastructure, Amazon can temporarily improve its cost situation. The same is true of cloud software companies that rely on AWS, like Splunk (NASDAQ:SPLK). When your business model is all fixed costs -- servers and maintenance and staff -- then new customers are kind of like free money, at least until you have to start supporting them.
Is this sort of massaging taking place? There's no way to know, and it doesn't really matter. The real problem with fixed costs is that they tend to stick around even when your customers have all left. The real issue with suppliers and customers both losing money is that, when the industry hits an iceberg, everyone ends up fighting over the lifeboats. In the end, what's problematic about today's web companies isn't that their impact on the jobs market or the fact that they make a few people rich; what's problematic is that they're addicted to growth, and wired to explode
Nor is "oversubscription" limited to the cloud. We're sharing cars and apartments for much the same reason that businesses are splitting IT budgets and factories in China: It's cheaper than dealing with regulations and tax laws, and less risky than making big investments in an uncertain environment. But is any of this likely to last? Will the sharing economy escape red tape? Have corporate cash hoards done corporations any good? Are we getting a good deal -- or just one that's too good to be true?

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