This is Part IV in a series by 6fusion Co-founder and CEO John Cowan on the emerging trend of Cloud Brokerage and the impact it will have on the technology industry and markets. Be sure to check out Part I of the series here, Part II here, and Part III here.

The IT industry to me looks a lot like the commercial airline industry did many years ago and I think the latter is rife with lessons about the power of a true commodity market.

For those of you keeping score, late last year American Airlines’ parent AMR declared bankruptcy.  The Chapter 11 filing of the once largest airline in the world brought to a conclusion the era of disintegration for the legacy commercial airline market.  You can argue about the principal cause for the airline industry’s demise, but ultimately it came down to the fact that the market leaders in the industry refused to adapt to the changes going on around it while others embraced it and found creative ways to rise to the top.

Flying around on airplanes became a mass-market product over the last 40 years.  And with a mass market product comes mass market demands – particularly around pricing.   Incumbent airlines had the benefit of established market share but the trouble of managing a return on investment in infrastructure in a changing financial dynamic.  The signs were there in the 1990’s but the dramatic collapse really took place over the last 10 years or so, which I will come back to later.

The cloud computing industry is structured and organized very much like the airline industry in the years leading up to its rapid disintegration.  There are a handful of incumbents that some say are untouchable and then there’s everybody else in the market.

Amazon Web Services (AWS) is one such incumbent.

Competitors to AWS are really not unlike the competitors in the airline industry.    Competition centers on squeezing more value into the same dollar with hopes of swaying customer loyalty.   This is further compounded by the arrival of new entrants aggressively positioned to challenge the market leaders.  I see no difference between the airline that boasts three extra inches of legroom in coach and the cloud operator that boasts an extra 9 on an SLA.  This is simply the nature of an increasingly competitive market.

Let me get back to the dramatic collapse of the airline industry for a moment.

After careful examination of the commodity market demand, Southwest Airlines determined the answer to challenging its industry peers had little to do with product innovation.  Instead, it had much more to do with financial innovation.   How did they do this?  Among some other things, they began a sophisticated program to hedge their projected jet fuel consumption.   Hedging jet fuel was nothing new to the industry, but Southwest made it the centerpiece of an operating strategy.  If you want, you can read an extended analysis of the Southwest case study here.  In short, their strategy allowed them to accurately forecast their future costs, and hence offer aggressive pricing to undercut the market, whilst remaining profitable in a market forcibly applying downward pricing pressure.  It was a commodity market that allowed Southwest to give the market what it wanted – a low cost, no frills flying experience.

For an airline, Southwest’s strategy is about as radical as it gets.

It is telling at this point to illustrate the reaction of the incumbent vendors in the industry when Southwest made its move.   “I don’t think any sensible airline believes that by hedging it saves on its fuel bills,” they said.

As history proved, they totally missed the point.

Southwest had worked out that it could employ hedging strategies to make the derivatives market for jet fuel work in its favor.  They dramatically reorganized their financial operation in order to turn the process of commoditization into a dangerous market weapon.

Which brings me back to the subject of compute, network and storage resources.   If a derivatives market for jet fuel could underpin the upheaval of the airline business, could the same thing be possible in the market for cloud computing?  Not only do I think it possible, I believe it is going to happen.

Not too long ago I was chatting with Joe Weinman, author of Cloudonomics, in his Manhattan office.  As I explained my perspective on the industry we both spend a lot of our time thinking about he interrupted me to ask if I had ever heard of Dr. James Mitchell.  I hadn’t.  James, as it turns out, is a former Morgan Stanley commodities trader who now runs what would appear to be the world’s first “cloud broker-dealer”.

Something James is not is a “technology guy”.  Doctorate in physics, yes – IT background, not so much.  As far as he is concerned, cloud computing infrastructure as a service is just another commodity like electricity, coal, oil or potatoes, and should be treated as such.

Sound familiar?  In Part II: The Cloud Vendor and the Agnostic Intermediary I characterized the evolution of the cloud brokerage model as one that would see two distinct groups playing a role: Those that dealt with the business of compute and those that dealt with the technical organization of compute.

When I met him he expressed his frustration at having to trade compute, network and storage resources in an inefficient manner because each providers’ cloud offering was separated by qualitative differentiation.  You trade a “barrel of oil”, a “kWh of electricity” or a “kilogram of coal”.  “So what is the unit of cloud computing?” he asked.  He made the reverse of the usual analogy between electricity and cloud computing.  He said, “can you imagine letting your electricity supplier bill you for your electricity using a measurement that they have made, using a meter that they invented, and then quoting it to you in a unit that they have pulled out of thin air, that cannot be compared to their competitors?  Ridiculous!”

Exactly.

James and I agree on two fundamental principles on which the future of the cloud industry will be based.

The first is that cloud brokering has little to do with technology.  Let’s consider an illustration of my point (techie readers, you might want to tune out for a moment). Provided that there is an independent third party who is able to measure what gets consumed on various different cloud providers, then it is possible to calculate a reference price for a reference quantity.  Even if what a customer actually uses is different from the standard measurement, this does not matter as the variation in the different pricing between a “special” cloud infrastructure and a “standard” cloud infrastructure will vary slowly compared to the price for the “standard” cloud infrastructure.  This is akin to proxy hedging a particular type of coal with a financial settlement on an API-2 index price for standard coal delivered in, say, Amsterdam (to give a very specific analogy).

The second is that the capability to trade cloud like a real commodity will create a world where the immovable IT asset can become movable for the first time in history.  IT is arguably among the single biggest sunk cost in any modern enterprise and the albatross that hobbles disrupters from challenging market incumbents in the emerging cloud computing industry.  As I illustrated in Part III: The Market Unified, more than $1 Trillion is spent every year on compute, network and storage resources.  Nearly all of this spend is done in a fixed capitalization structure that sits on the balance sheet for years.

Every business that consumes a significant commodity resource speculates and hedges its overall position.   It is clear to me that if the opportunity to establish liquidity in IT becomes real for the modern enterprise and market brokers, compute, network and storage resources will become to the emerging service provider what jet fuel is to an airline operator.   And when that happens, you will want to be Southwest, not AMR.  This is a reality that few cloud incumbents see coming and, like the once powerful commercial airliners, a dynamic few will choose to embrace.

A commodity exchange cannot exist without transaction velocity and price volatility, and brokers do just that in any other example.   This is precisely why the role of “cloud broker” will become so important in the years ahead.  This is why, as I’ve stated so often in the past, “the future of the cloud brokerage belongs to a new cadre of agnostic intermediaries that will enable a true utility computing marketplace to flourish.”  And when the modern enterprise or resource supplier can apply the principles of financial trading to the IT industry we are going to see a force capable of completely redefining everything we currently think we know about the business of technology delivery.

Considering that new thinkers like Dr. James Mitchell are already on the scene I wouldn’t go making any bets that what we see is merely a distant future.

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• Cloud Brokerage and the Future of the IT Utility
• The Cloud Vendor and the Agnostic Intermediary
• The Market Unified