The Cloud: A Low Interest Rate Phenomena
May 10, 2023
It is difficult to overemphasize how much “The Cloud” has become a mainstay of the Silicon Valley zeitgeist since its meteoric ascendancy from 2008 onward.
Consequently, it may seem like an impossibly far-fetched idea that the growth and evolution of the cloud was a phenomenon as artificial as the interest rates which fueled it. The public cloud has witnessed roughly 2350% growth between the years 2008 and 2020, with even more headwind made immediately following the COVID-19 response and global lock downs.
This particular spike in growth has been reasonably traced to the skyrocketing demand for digital services from an unprecedentedly shut-in population. But here’s something else this period had in common with the initial 2008 takeoff: historically low interest rates.
Federal Funds Rates
Since the 2008 financial crisis, central banks around the world have maintained historically low interest rates to stimulate economic growth and recovery. These artificially low interest rates have had an expansive range of effects on the economy, including influencing the growth and evolution of the public cloud.
Recently, interest rates have experienced a sudden and sharp reversal. Correspondingly, the decade-long trend of ceaseless migration of digital infrastructure to hyperscalers has also witnessed its first major slowdown and vocal push backs. This article will explore the causative connection between low interest rates and the expansion of public cloud services. Furthermore, we’ll be discussing the alternatives to the public cloud paradigm that are poised to surge in growth, and what that means for various players in the industry.
Interest Rates and the Public Cloud Growth
The tech industry does not operate in a vacuum and is heavily influenced by macroeconomic forces in simultaneously subtle and dramatically impactful ways.
We’ve already pointed at the correlation between the rapid growth of the cloud and historically low interest rates beginning in 2008. But to explore the causative mechanisms at play between these concepts, we need to ensure we understand the economic backdrop of the cloud’s development.
First and foremost, interest rates represent the cost of borrowing money, which is ultimately determined by the Federal Reserve and other central banks worldwide.
When interest rates are pushed artificially low, liquidity is abundant and inexpensive, resulting in both profound and non-obvious downstream impacts on the behaviors and trends of entire economic sectors. In such conditions, companies and investors are strongly incentivized to pursue riskier investments and are more likely to take on debt and fundraising to finance their ventures. The market begins optimizing for growth, often and even inevitably at the cost of capital efficiency, fiscal discipline, and long-term strategic planning.
This is due to the reality that if a company is not leveraging the lower interest rates and increased credit availability to focus on growth while their competitors are, they are unlikely to survive. Consequently, all market participants eventually adopt similar optimization strategies. This leads to the development of entire industries on shaky foundations that would have been impractical and imprudent outside of the influence of extraordinary macroeconomic conditions.
It’s only once conditions return to the norm, that the decision making that seemed sound and rational previously is met with a harsh dose of reality. When interest rates have been kept low for an unprecedented amount of time, it should be no surprise then that the downstream consequences too are unprecedented.
Most obvious amongst these consequences has been the total fragility of the financial system, as highlighted by the recent collapses of Silicon Valley Bank, Signature Bank, and First Republic Bank, in rapid response to the semi-normalization in interest rates. This is only the tip of the iceberg, and the longer interest rates remain raised, the more the economic growth of the last decade will be shown to have severe structural problems. In the case of cloud computing, there are already signs that a half a trillion dollar industry that came to maturity entirely in this easy money time period is in trouble.
Condensing the Cloud
What do we mean when we talk about the “The Cloud”? For most, the public cloud is defined solely by the outsourcing of hardware management to a specialized provider. Despite the adage, the cloud isn’t just someone else’s computer. To be abundantly clear, there are incredibly good reasons for companies to outsource the physical management of compute to other market players better suited to the task.
These decisions are rooted in the simple ideas of comparative advantage and economic specialization. However the major hyperscalers in the cloud oligopoly (AWS, GCP, Azure) share specific traits which define the entirety of their business models, modes of operation, and trade-offs that are far more nuanced than simply outsourcing hardware management.
These massive platforms derive most of their usage, stickiness, and earnings not from compute alone, but ultimately from the additional services and tools tightly bundled with that compute. This includes a vast catalog ranging from managed databases, to identity management, CDNs, managed orchestration tools like Kubernetes, and so much more.
In essence, the hyperscale cloud providers today are an intricate and often confoundingly complex array of proprietary tools and managed services. Why? To lock users into their platforms by bundling their software and services add-ons with their hardware. Want to switch to using a competitor’s compute resources instead? Not so fast: a cobweb of interlocking managed software dependencies now keeps you tethered to your host with no easy way out.
This is the cloud today: a few major walled gardens defined by the bundling of hardware, software, and services in an effort to de-commoditize what is and should be a commodity business: supplying compute. The resulting size, concentration, and control over digital infrastructure that these providers leverage have subsequently become a far cry from the early visions of an open and decentralized internet. This state of affairs is a direct result of the macroeconomic incentives that have been in place almost continuously since 2008.
All That Glitters isn’t Gold
The deliberately “bundled” design of the cloud offers a clear tradeoff: speed over portability and flexibility. Lack of portability results in higher fiscal costs to customers, especially long term, as these providers know moving to a competitor is no trivial matter. The more services and tools customers use from their current cloud host, the more they are disadvantaged over time as the cost of migrating to a competitor tends to only increase.
While using these more easily integrated tools and managed services to increase productivity and optimize for growth may have seemed like a straightforward choice to the customer it is ultimately a Faustian bargain.
For most players operating in an economic environment defined by unprecedentedly low interest rates, this optimization for immediate growth over longer term considerations made total economic sense.
In such a case, fundraising is easy, and as such fiscal discipline is not as valued by investors as speed to market and growth at all costs. If this sounds far fetched, believe me, it was extremely common up to early 2022 for angels and VCs to tell portfolio companies they weren’t spending money fast enough.
When cash is cheap, other things are simply more important, and rationally so within the context of the economic environment. The costs of increasingly large AWS bills hardly registered as long as revenue growth continued and fundraising remained extremely easy, both themselves buoyed by low interest rates driving less discretionary spending all across the economy.
If your competitors are leveraging the dynamics of the easy money environment, and you’re not, you’re likely dead in the water before the longer term considerations even matter. However unlike death or taxes, artificially low interest rates aren’t and can never be constant. As inflation concerns began to reach fever pitch over the last year, the Federal Reserve and other central banks have quickly reversed course by aggressively hiking interest rates once more.
Very abruptly, the calculus driving economic decision making has turned on its head, and the impact on many industries, like banking, have been hard and obvious. Many other’s have been heavily impacted as well, albeit less dramatically. For now. The cloud included.
Revenue and fundraising capabilities are both sinking in lockstep, and suddenly the abrupt need for aggressive fiscal discipline for the first time in over a decade is bringing to light certain glaringly obvious truths.
The Cloud Doesn’t Actually Make Much Sense
As it turns out, making yourself entirely reliant on a single provider with absolute leverage over your infrastructure is a really bad deal if you actually have to think long term or care about fiduciary responsibilities. That’s the conclusion many companies are rapidly coming to, a notable recent example being 37 Signals, as explained by co-founder David Hansson the creator of Ruby on Rails.
In their effort to move from the Cloud, the team at 37Signals has built MRSK, a framework to help manage higher level tooling and application orchestration on top of raw compute, completely agnostic to where that compute is hosted. This serves a crucial function: It effectively helps unbundle some of the functionality typically bundled by cloud providers, giving you greater portability and control over your software.
There is still a bit more additional work involved with this solution compared to ready-to-go cloud tooling to be sure, but MRSK and tools like it are relatively niche and underdeveloped, especially when compared to the vast investment the public cloud tooling has seen over the past decade plus.
These tools and the paradigm it represents offers a starkly different alternative to how the cloud works today. By simply buying or renting raw compute and running the open source infrastructure stack of your choice on top of it, an “un-bundling” occurs which undoes the position of power the cloud oligopoly have created for themselves while the industry has slept.
In this model, businesses can crucially still leverage more specialized third parties to manage their physical compute in the actual actual data center, and still leverage third party software to maximize their productivity, but in a portable and natively agnostic fashion.
In our now higher interest rate environment, that reality of cloud costs and it’s long term implications for organizational flexibility and efficiency is becoming much less palatable for a huge swath of companies all at once. As more continue to flee the lock in and corresponding costs of the cloud out of pure fiscal necessity, the tools to make this “un-bundling” movement even easier and more practical will continue to be improved upon.
With that in mind, we can scarcely imagine how the ecosystem of independent bare metal providers and portable infrastructure tooling might look like 10 years from now, or how they might have looked like today had there not been more than 10 years of artificially low interest rates to begin with. “The Cloud” as we know it today, may never have come to be.
Indeed, the fact that it did evolve in the way it did increasingly seems like the anomaly. A development that was broadly accepted but is in fact seeming more counterintuitive in hindsight by the day. In it’s stead, we are seeing the growth of a much more diverse, distributed, and commoditized pool of compute providers, upon which an ecosystem of open source and highly portable software can flourish.
Unwinding The Cloud
The problem with the growth of major cloud providers isn’t the idea that certain businesses shouldn’t specialize in running the hardware on behalf of other businesses with other priorities. The problem is actually that that specialization doesn’t go far enough. There should be a competitive industry for offering compute as a commodity, and distinct industries for orchestration, managed services, and tool chains to effectively utilize that compute, independent of where the physical hardware is located and who manages it.
Certainly, there will always be a market for vertically integrated hardware and software products, typically thought of as hosted platforms as a service. But if we accept that the expansive proliferation of this bundled pattern was in large part driven by unsustainable incentives derived from low interest rates, then we must conclude that the relative market for these offerings is much smaller than what we’ve seen up to this point.
The logical conclusion of this is a continued “un-bundling” movement, and the gradual but accelerating transformation of a more than half a trillion dollar industry. That means growth for providers of "less-strings-attached" bare metal as a service (BMaaS) and basic virtualized offerings, and vastly increased interest, attention, and development of portable software and services that can be deployed on top of any provider of compute resources.
This reorientation of how we build and deploy applications will have profound effects, but ultimately will likely be a huge blow to the defacto oligopoly and over centralization of infrastructure in the hands of AWS/GCP/Azure, and a big win for industry disintermediation and competition in the long run.
In the midst of ongoing economic uncertainty, we might actually be seeing the internet trending towards a more natural and distributed equilibrium as skewed incentives are removed from the markets comprising it.
One thing seems certain: Were it not for artificially low interest rates to begin with, the way we would use “someone else’s computer” would look very different from the cloud we see today, and much more in line with the original vision of an open, decentralized, and interoperable internet.
For developers and dev ops engineers:
Instead of that next AWS certification, start familiarizing yourself more seriously with bare metal, and how to deploy and work with more fundamental building blocks. Frameworks like MRSK, Supabase, and others offer paths to effectively deploy to bare metal as well as VPSs in manageable ways. Demand for technical talent that can facilitate migrations to this paradigm will continue to grow rapidly.
For companies and organizations:
Are you on the cloud? If so, you’ve likely already taken a recent look at your AWS bill and are wondering how to make some improvements. It’s time to start thinking outside of the box, and ask your engineering teams to take a serious look at some of these trends and technologies mentioned in this write up and present a plan to get to higher ground. Still operating on-premise infrastructure? You might have actually dodged a bullet there, and you’re in a position to carefully plan what your future looks like. There’s plenty of options between remaining on-prem, out sourcing on-prem management, going to a BMaaS model, or some hybrid of these options.
For data centers and independent compute providers:
This is your time to shine. There’s never been a bigger opportunity to grow your business, but to do so you need to offer comparable user experiences and programmatic capabilities to the large cloud providers to make transitions easier for new customers, but otherwise simply focus on delivering superior hardware for the price. At Hydrahost.com, we’re building a data center directory, and helping our data center partners offer modern Bare Metal Self Service capabilities with easy to use UIs and robust API. Contact us to learn more.