Amazon posted weaker 2Q 2014 results for Amazon Web Services, leading some to speculate about competitive pressures despite continued enormous growth in usage.

Investors are asking, probably reasonably, what’s going on here. Is the overall market for cloud computing weakening? Are competitors taking more market share? Or is this largely the result of the price cuts that went into effect at the beginning of 2Q? And if it’s the price cuts, are these price cuts temporary, or are they part of a larger trend that eventually drives the price to zero?

The TL;DR version: No, cloud growth remains tremendous. No, AWS’s market share likely continues to grow despite the fact that they’re already the dominant player. Yes, this is a result of the price cuts. No, the price cuts are permanent, and yes, cuts will eventually likely drive prices down to near-cost, but this is nevertheless not a commodity market.

The deep dive follows. Note that when I use the term “market share”, I do not mean revenue; I mean revenue-generating capacity-in-use, which controls for the fact that prices vary significantly across providers.

What’s with these price drops?

I have said repeatedly in the past that the dynamics of the cloud IaaS market (which is increasingly also convergent with the high-control PaaS market) are fundamentally those of a software market. It is a market in which customers are ultimately buying IT operations management software as a service, and as they go up-stack, middleware as a service. Yes, they are also getting the underlying compute, storage, and networking resources, but the major value is the actually in all the software that automates this stuff and delivers it as an easy-to-consume, less-effort-to-manage solution. The automation reduces a customer’s labor costs, which is where the customer sees cost-savings in services over doing it themselves.

You’ll note that in other SaaS markets, the infrastructure is effectively delivered at cost. That’s extremely likely to be true of the IaaS market over time, as well. Furthermore, like other software markets, the largest vendors with the greatest breadth and depth of capabilities are the winners, and they’re made extra-sticky by their ecosystems. (Think Oracle.) Over time, the IaaS providers will make most of their margin off higher-level services rather than the raw resources; think about the difference between what a customer pays for Redshift data warehousing, versus raw EC2 compute plus EBS storage.

The magnitude of the price drops is scaring away many rival providers. So is the pace of innovation. Few competitors have the deep pockets or willpower to pour money into engineering and data centers in order to compete at this level. Most are now scurrying to stake out a niche of the market where they believe they can differentiate.

Lowering the price expands the addressable market, as well. The cheaper it is to do it in the cloud, the more difficult it is to make a business case to do an on-premises solution, especially a private cloud. Many of Gartner’s clients tell us that even if they have a financially viable case to build a private cloud right now, their costs will be essentially static over the amortization period of 3 to 5 years — versus their expectation that the major IaaS providers will drop prices 30% every year. Time-to-value for private cloud is generally 18 to 24 months, and it typically delivers a much more limited set of features, especially where developer enablement is concerned. It’s tough for internal IT to compete, especially when the major IT vendors aren’t delivering software that allows IT to create equivalent capabilities at the speed of an AWS, Microsoft, or Google.

The size of the price cut certainly had a negative impact on AWS’s revenues this past quarter. The price cut is likely larger than AWS would have done without pressure from Google. At the same time, the slight dip in revenue, versus the magnitude of the cuts, makes it clear that AWS is still growing at a staggeringly fast pace.

The Impact of Microsoft Azure

Microsoft has certainly been on an aggressive tear in the market over the last year, especially since September 2013, and Azure has been growing impressively. Microsoft has been extremely generous with both discounts and with free credits, which has helped fuel the growth of Azure usage. But interestingly, Microsoft’s proactive evangelism to their customers has helped expand the market, particularly because Microsoft has been good at convincing mainstream adopters that they’re actually late adopters, spurring companies to action. Microsoft’s comprehensive hybrid story, which spans applications and platforms as well as infrastructure, is highly attractive to many companies, drawing them towards the cloud in general.

Some customers who have been pitched Azure will actually go to Azure. But for many, this is a trigger to look at several providers. It’s not unusual for customers to then choose AWS over Azure as the primary provider, due to AWS’s better feature set, greater maturity, and better ecosystem; those customers will probably also do things in Azure, although they may be earlier-stage and smaller projects. Of course, many existing AWS customers are also adding Azure as a secondary provider. But it may well be that Microsoft’s serious entry into this market has actually helped AWS, in terms of absolute usage gains, more than it has hurt it — for the time being, of course. Over time, Microsoft’s share gains will come at AWS’s expense.

The Impact of Google

Google has been delivering technology at an impressive pace, but there is an enormous gulf between its technology capabilities and its go-to-market prowess. They also have to overcome the perception problem that people aren’t sure if Google is serious about this market, and are therefore reluctant to commit to the platform.

While everyone is super-interested in what Google is doing, at the moment they do not seem to be winning significant customers from AWS. They’re doing reasonably well in batch-computing scenarios (more as a rival to AWS spot instances), and in scenarios where all of Google Cloud Platform, including App Engine, is of interest. But they do not seem to have really gotten market momentum, yet.

However, in this market and in many other markets, a competitor does not need to win over the market leader in order to hurt them. They merely need to change customer expectations of what the price should be — and AWS has allowed Google to set the price. As long as Google seems like a credible threat, AWS will likely continue to be competitive on price, at least for those things that Google also offers. Microsoft has already publicly pledged to be price-competitive with AWS, so that pretty much guarantees that the three providers will move in lockstep on pricing.

The Impact of Smaller Providers

Digital Ocean, in particular, is making a lot of noise in the market. They’ve clearly established themselves as a VPS provider to watch. (VPS: virtual private server, a form of mass-market hosting.) However, my expectation is that Digital Ocean’s growth comes primarily at the expense of providers like Rackspace and Media Temple (owned by GoDaddy), rather than at the expense of AWS et.al. A Digital Ocean droplet (VM) is half the price of an AWS t2.micro (the cheapest thing you can get from AWS), and they’ve been generous with free-service coupons.

VPS providers have friendly control panels, services that are simple and thus easy to use, and super-low prices; they tend to have a huge customer base, but each customer is, on the average, tiny (usually just a single VM). These days, VPS is looking more and more like cloud IaaS, but the orientation of the providers tends to be quite different, both from a technology and a go-to-market perspective. There’s increasing fluidity between the VPS and cloud IaaS market, but the impact on AWS is almost certainly minimal. (I imagine that some not-insignificant percentage of AWS’s free tier would be on VPS instead if not for the free service, though.)

There’s plenty of other noise out there. IBM is aggressively pitching SoftLayer to its customer base, but the deals I’ve seen have generally been bare metal on long-term contracts, usually as a replatform of an IBM data center outsourcing deal. Rackspace’s return to its managed hosting roots is revitalizing. CenturyLink continues to have persuasive sales. VMware customers remain curious about vCHS. And so on. But none of these providers are growing the way that AWS and Microsoft Azure are, and both providers are gaining overall market share at the expense of pretty much everyone else.

The sky is not falling

With Microsoft and Google apparently now serious about this market, AWS finally has credible competitors. Having aggressive, innovative rivals are helping to push this market forward even faster, to the detriment of most other providers in the market, as well as the IT vendors selling do-it-yourself on-premises private cloud. AWS is likely to continue to dominate this market for years, but the market direction is no longer as thoroughly in its control.