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Cloud Economics, By The Square Foot

<img src="/sites/" width="475" height="215" /> New data from Terremark provides additional insight into the costs and revenues of cloud computing for service providers, how it impacts existing hosting business models, and why established data center providers are likely to benefit from the transition to the cloud.

A chart from Terremark Worldwide compraing the costs and revenues for its colocation, managed hosting and cloud computing operations.

As data center and hosting companies transition to a cloud computing model, we've been tracking the economics of cloud business models for providers. Cloud computing may be the most economic way for end users to deploy IT capacity. But what about providers?

Is cloud computing more profitable than dedicated hosting or managed hosting? New data from Terremark provides additional insight into this question.

Much of our data on cloud economics has come from Rackspace, whose disclosures allow an analysis of cloud operations by average revenue per user and revenue per server (which Rackspace sees as the best metric).

Analysis of Square Footage
In a recent presentation to analysts, Terremark (TMRK) looked at its colocation, managed hosting and cloud computing operations based on how these services used each square foot of data center space.

The result? All three services had the same baseline cost of $1,200 per square foot for data center infrastructure. The managed virtualized hosting and cloud computing operations have an additional cost of $6,800 per square foot for the racks and servers to run the applications.

Strong Revenue for Managed Hosting
On the revenue side, the managed hosting space generates $20,000 a year in revenue for each square foot, compared to $12,000 a year for cloud computing and $1,000 a year for colocation. That works out to an annual return of $2.50 for every $1 invested in managed hosting, compared to $1.50 for cloud computing and 90 cents for colocation.

While colocation offers the lowest cost of entry, it also has the lowest return. Cloud computing and managed hosting offer a healthy return on investment, but also require an investment of $8,000 per square foot (at least in Terremark's operations; others may do this for less).

That's why we won't see the landscape overrun by cloud computing data centers. Cloud economics offer faster, cheaper deployment for end users, but the barrier to entry remains high on the back end. And the $8,000 a square foot investment in infrastructure only pays off quickly if you can fill the space with customers. For many providers eyeing the cloud, a strong track record in acquiring customers is a prerequisite to access to capital.

Efficiency As a Cloud Differentiator
Some cloud providers can lower ther costs by repurposing servers from its managed hosting operation, extending their live by incorporating them into a cloud cluster (see Is Your Cloud New or Pre-Owned? for more). This is key to the benefits of the cloud model for Rackspace, whose cloud operation has a much lower average revenue per user (ARPU) than its managed hosting business.

But Rackspace says that the efficiency of cloud computing, and the ability to pack many users on each physical server, makes cloud computing a winner in a revenue per server analysis. The ability to automate tasks that previously required support staff is another key benefit of the cloud model. Lower supports costs don't appear to be factored into the Terremark data, and certainly would narrow the profitability gap between cloud and managed hosting.

The higher return on capital for managed hosting is among the reasons why this hosting model will never be fully superseded by cloud computing. Many customers will continue to pay a premium for high-touch support and service for their mission-critical IT assets.

But cloud computing offers a middle path, offering cost and usability advantages for customers, as well as an attractive return for providers. For established data center builders and operators, this creates a "best of both worlds" scenario: a fast-growing customer base and a high barrier to entry for new players.

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