(Bloomberg ) Amazon.com Inc. (AMZN)'s Web Services division, whose server farms generate the processing power the retailer sells to heavy corporate data users on the cheap, has grown so large that the unit routinely finds itself with thousands of spare machines.
So the e-commerce giant created a supply-and-demand-driven market called Amazon EC2 Spot Instances that lets clients rent processors for as little as 10 percent of Amazon's standard cloud-services fees. To use Spot Instances, companies bid for the rights to a certain number of servers. Winning bidders are billed by the hour, as long as the market price hasn't risen above an upper bound they specify.
The marketplace gives Seattle-based Amazon and its 7-year- old cloud-computing division an added advantage over Microsoft Corp. and Google Inc. (GOOG), which are racing to catch up after a late start. Analysts at Macquarie Securities estimated in a Jan. 7 report that total Amazon Web Services revenue will almost double this year to $3.8 billion and will reach $8.8 billion by 2015. Web Services will kick in close to 5 percent of sales this year, up from 3.4 percent last year, and will rise to almost 8 percent by 2015, Macquarie projected.
Were AWS a standalone company, it would be worth $24 billion, according to a March 5 report by Carlos Kirjner, an analyst at Sanford C. Bernstein & Co. That's more valuable than two-thirds of the companies in Standard & Poor's 500 Index, and accounts for about a fifth of Amazon's stock market value.
Amazon's lead in the public-cloud market, which Gartner Inc. estimates jumped 20 percent last year to $109 billion, poses a challenge for technology competitors. As an e-commerce company, Amazon's operating margins are already razor-thin - -1.11 percent in 2012 -- while Google and Microsoft generated margins last year of greater than 25 percent. That means Amazon can cut prices on cloud services without affecting its total profitability.
Investors aren't fazed by Amazon's low margins. The stock trades at 186 times estimated earnings for this year, compared with a ratio of 18 for Google and 10 for Microsoft.
Spot Instances was started in 2009, though the spot market has taken off only in the past year, Amazon EC2 Vice President Matt Garman said. Researchers in genomics and drug design as well as online advertising increasingly use Spot to analyze terabytes of data, while companies such as Cycle Computing LLC, Princeton Consultants Inc., and Numerate Inc. have built businesses that track market prices for heavy data users.
"We're finally starting to see the real change in the slope of adoption," Garman said. While he declined to provide specifics on how profitable the product is or how many customers use it, the company says much of its increased spending on "technology and content" went to add capacity for Amazon Web Services.
Princeton Consultants, a strategy and software firm, is among the companies that developed algorithms to monitor Spot Instances' pricing and availability for clients in need of server time. Chief Executive Officer Steve Sashihara said his program, OptiSpotter, provides small hedge funds with the edge they need to compete with investment banks and global funds in the cutthroat world of high-frequency trading.
"It's completely game-changing" for clients to cut a project's processing costs from $100,000 to $10,000 and get supercomputer-like processing power, Sashihara said. "A couple guys with $50 million can be trading at high frequency and be taking on Goldman Sachs and Morgan Stanley."
One big catch limits the utility of Spot Instances: If rising demand sends prices skyward, a customer must outbid the higher price to keep its project running. Otherwise, Amazon shuts their servers off in midstream. That's a deal-breaker for clients using it to host websites or stream video.
"For people running with hard deadlines, it's not an appropriate solution," said Michael Crandell, CEO of RightScale Inc., which helps companies manage cloud services.
Still, Crandell says he expects Spot Instances to keep growing. As much as 15 percent of Amazon servers his customers rent is now from Spot Instances, he says, up from the low single digits in mid-2011.
Julie Black joined Web-advertising startup TellApart Inc. in 2011 as director of engineering after six years at Google. She uses Spot Instances regularly, because her former employer's recently introduced cloud platform, Google Compute Engine, doesn't offer a comparably cheap market. Burlingame, California- based TellApart analyzes online shoppers' habits for retailers such as Nordstrom Inc. (JWN), One Kings Lane Inc., and CafePress Inc. (PRSS)
To provide better results than its dozens of competitors, TellApart uses Spot Instances to collate more than 10,000 queries per second from hundreds of millions of people, with the bulk of the work occurring during off-peak hours when prices are lower. Black said the company, backed by almost $18 million from venture investors including Greylock Partners and Bain Capital Ventures, rents hundreds of machines at a time. Its monthly check to Amazon is about 75 percent less than it would be for cloud servers at the on-demand price.
"We process data faster and cheaper because we can use more machines," she said. "Everything we do relies upon this core piece of technology."