 From theCUBE Studios in Palo Alto in Boston, bringing you data-driven insights from theCUBE and ETR. This is Breaking Analysis with Dave Vellante. In 1987, Nobel Prize-winning economist, Bob Solo, famously observed, you can see the computer age everywhere except in the productivity statistics. This proclamation became known as the productivity paradox. Ironically, Solo's statements preceded the greatest productivity boom since the dawn of the computer age, which subsequently came to fruition in the 1990s. It can be argued that a similar pattern is being seen today where AI is everywhere, but generally not showing up in earnings numbers or productivity statistics just yet. Hello and welcome to this week's CUBE Research Insights, powered by ETR. In this Breaking Analysis, we squint through the latest earnings reports from Microsoft, Alphabet and Amazon to understand what's happening in cloud, evaluate the impact or lack thereof of AI on cloud momentum and explain how we think about the future impact of gen AI in cloud. And the market confusion can be summed up by this chart here. Check it out. Here's Amazon's stock price yesterday, Thursday, prior to its earnings release and after hours up through this morning. The stock was down during the day. Then Amazon announced earnings. After the print, the stock shot up after hours because Amazon beat, but then the talking heads, those experts on the financial channels started to question the attractiveness of Amazon as an investment. One analyst on CNBC called the tepid growth rate of AWS called out the tepid growth rate of AWS and the fact that Azure was growing significantly faster than AWS cited that as a negative. And he said he wouldn't get excited again on the AWS stock until it was growing, an Amazon stock until AWS was growing in the high teens or even said 20% range. And you can see above that narrative, it dampened the enthusiasm after hours and the stock actually shot back down. So I'm on a plane and I'm listening to the earnings call. I had this crappy Wi-Fi sort of in and out and I tweeted, hold on. Here's AWS, they're a $90 billion company. They're growing at 12% with 30% operating margins. That's north of Cisco. And although South of Oracle, it's really, really fantastic. AWS basically came in on its number and has $7 billion of operating income and that only accounted for about a quarter of Amazon's overall operating profit. You remember, we've seen that percentage exceed 100% in the past. Now, Amazon's guide for AWS was conservative. Okay, well, why wouldn't it be? There's no upside to being too aggressive in this market. But then through this sort of half baked Wi-Fi, I got CNBC in one year and the earnings call on another. I hear Jassy say in the call, quote, we signed several new deals in September with an effective date in October that won't show up in any gap reporting numbers for Q3, but the collection of which is higher than our total reported deal volume for all of Q3. And then this expert comes back on TV. It says basically, well, maybe I'm missing something here. And you can see how the stock reacted during the earnings call shooting back up after hours and today, and as of midday, today Friday, the stock is up 7% while the NASDAQ is basically unched, i.e. unchanged. So what's the point of all this? We've seen many waves over the years and what happens is when there's a big disruptive trend that everyone knows is coming, it gets hyped up, of course, big time. But the reality is the size of the new is still so small that despite the momentum and the growth, it's just not nearly big enough to blow through any headwinds or other market friction of which there is a lot today. And given all the market uncertainty, CEOs are not allocating huge incremental dollars to CIOs. Rather, they're saying, figure it out, show some ROI and then we'll reinvest more as like a gain share. And as we've said in previous research notes, AI is stealing from other sectors. This chart here from ETR's latest spending intentions survey shows all the sectors that the company tracks. The N in this study is over 1700 IT decision makers. We call them ITDMs. The Y-axis is net score or spending velocity in a sector and the X-axis is the pervasiveness of the sector in the dataset. And we show here that AI bounced off its low of October, 2022, one month before ChatGPT was announced. And you can see the trajectory of cloud computing over the last 10 quarters. So based on, you see those squiggly lines. Cloud optimization and a rebalancing of hybrid portfolios between on-prem and cloud has been taking place for over a year now. And that's why we see so few sectors over that red dotted line at 40% net score, which is considered a highly elevated indicator of spend momentum. But the takeaway is that AI is still experimental right now showing lots of promise, but most is still in the evaluation stage. Resources are being allocated for AI, but for the most part they're not incremental resources. They're being reallocated. They're stealing from other buckets. It's still a cloud world in the sense that the cloud operating model is setting the tone for IT operating models in general. And the cloud continues to outpace on-prem growth quite significantly. So let's take a look at what the market looks like for hyperscale clouds post earnings. Here are our updated figures for our quarterly IAS and PAS forecasts. Remember, this is meant to be apples to apples with AWS, i.e. we're stripping out applications and collaboration software, things like Microsoft 365 and Google Workspaces. We consider the big four hyperscalers to be AWS Azure, Google Cloud and Alibaba. And we've been tracking these for years now. Now the second column shows our previous Q3 estimates compared to our new actuals based on the latest earnings reports. Alibaba note has not reported yet. We then show the growth rates and our latest full year estimates. So if you keep points here, they like to call out. First is the numbers are pretty much in line with our expectations. However, the total for the big four we want to point out is 172 billion. It's about 10% lower than our early 2022 projections. So if you go back to say January, February, 2022, we were up in the 190 billion. But the reason for the Delta is almost entirely due to our restatement of Azure revenues based on the poorly redacted court documents that came out during the Microsoft Activision hearings when they mistakenly leaked Azure data. We're still actually squinting through some of that, but as of now, this is where we land. So as reported by all three big cloud players, optimization is still happening in the cloud. And AI is not yet showing up in the numbers except for Microsoft, which indicated about a 300 basis point tailwind for Azure as a result of AI. Let's face it, Microsoft is making all the right moves with AI and elsewhere. It's quite remarkable. So it's somewhat understandable why analysts might be negative on AWS, but they're missing the boat in our view. Microsoft is a four decades old plus company with a giant software estate, some would argue a monopoly, which serves as a captive market for Azure. In other words, because Microsoft runs its own software and it chooses to of course run it on Azure, it has this unique flywheel that AWS doesn't possess. AWS has other flywheels, but not one stemming from its application software. AWS competes on the merits of its IS and PAS and the fact that it has the best cloud services. But the point is there's plenty of room for both. So don't assume Azure's success is necessarily a negative for AWS. As Matt Baker says, it's not a zero sum game. Having said that, the performance of Azure is astoundingly good. We have it growing at nearly 30% this year to AWS is 14% annually. The real concern we have is Google. It can be argued that Google has the best tech, the best AI and of course the resources to invest. But at $4 billion in IS per quarter, its growth rate should be at least double that in our view. Both AWS and Azure at this size were growing at rates of 60% plus. Now, accounting for the fact that Google was late to the enterprise cloud game and is ramping up in times of much greater uncertainty and headwinds, they still should be growing faster in our view. Now the last point on this chart is we fully expect accelerated growth in Q4 as a direct result of Gen AI. We have the overall year over year growth rate of 17% in this past September quarter accelerating to 21% in the December quarter with AWS, Azure and GCP growing at 17%, 30% and 25% respectively. Now, while Azure and GCP are clearly growing faster than AWS, AWS remains the largest IaaS Paz player in our models through the next 24 months at least. And we could most definitely see a re-acceleration of AWS growth in our view. As AWS is fond of messaging these days, it's early days, it's the early innings in AI. Here's a chart of 300 respondents from a recent ETR drill down that asks which products from the cloud providers is AI products are currently in use, that's the blue bars and planned to be evaluated, that's the yellow. Microsoft clearly is winning right now, as we've said. There's a little question about that. And Google with Vertex AI combined with BigQuery is a very strong data and AI story, despite the fact that it's not showing up in the cloud numbers yet. An interest in Amazon is also quite high, as you can see here. Note the parenthetical however, if generally available. Now, remember, bedrock went GA this month and with re-invent right around the corner, one would have to believe that AWS will have the last word this year on gen AI and it's going to be a strong word. But a couple of other points here. One, Amazon is not used to playing from behind. They've always led in cloud and for the first time really, they're spotting points to the opposition. Everyone was caught off guard with GPT, the GPT heard around the world, the uptake surprised even Microsoft and open AI, but it's had the biggest impact we think on AWS and Google from a perception perspective. In some ways, Google for good and that even though it called a code red, Google's recognized as an AI leader and has been flexing its AI muscles, but it hasn't yet helped its cloud business. Now, probably not has been as positive for AWS who has always had machine learning and AI momentum with SageMaker, but AWS, they're going to be a player and let's see how they play catch up in this game. The other call out on this chart is IBM Watson X. Take a look, both IBM and Oracle are in the game, both cloud and of course AI and IBM seems to be a little bit further along based on this customer input because you see some blue there, you don't see the blue for Oracle. IBM for years was marketing Watson hard with very unimpressive results, but Watson X from a product standpoint is looking pretty good this time around. Watson X supports open data formats that has strong metadata management. It supports many, many data types, multiple database and query engines. It's got a decent data sharing story. Take a look at this XY graphic with net score on the vertical axis, that's a measure of spend momentum again and on the horizontal axis presence in the dataset. And what we did is we filtered on cloud computing accounts only, okay? So again, vertical spending momentum, a horizontal is presence or shown as overlap. So it's overlap with 1165 cloud computing accounts in the latest ETR spending survey. And we're showing here the platforms in use in those 1100 cloud accounts for machine learning and AI. And look at IBM Watson. Well, it's still well below the magic 40% elevated momentum red line. Look at where it was in the April survey of just this year. Now, IBM announced Watson X in May at its think conference and it's showing momentum. So in April, as you can see in this chart, it's pretty much in the red zone and it's shot up at least, looking pretty good in the positive below the leaders, but still good for them. Arvind's expanded his hybrid cloud story. It now includes AI. And remember when IBM bought Red Hat, we said this was really a consulting and services play. Well, IBM's strong consulting business allows it to have a captive market for software and things like AI provided that it works. And by our assessment, after years of torturing us with Watson mumbo jumbo bolstered by great advertising, IBM seems to have got it right this time around. Now the other callouts here are open AI and Microsoft. They are crushing it relative to the rest of the crowd. It's interesting how AWS and Google, notice how they've come more closely aligned with the followers of this program. You know, we'll notice that. When you cut the data on cloud plus AI, normally AWS would be much closer to Microsoft than to Google, but not when the data is filtered on AI. Surprising or not. Now as a caution, remember Microsoft is so large. You might be wondering, why is Microsoft so large? And Dave, you're saying that Amazon's got the best cloud. This is the, we have no doubt that some of the ubiquity of Microsoft, Microsoft skews the data to their favor because it has such a massive software state. Some of that will filter into the cloud definition that the customers interpret or infer. But nonetheless, AWS has some work to do. That's clearly the message here. My strong bet would be that AWS is going to see accelerated momentum coming out of reinvent. Just as Google saw coming off a Next and IBM off of Think, AWS could be sitting pretty in 2024. I also want to point out anthropic on this chart, which is not as prominent on the X axis, that's presence, but clearly is showing market momentum. Everyone seems to be working with anthropic. They're like a checkbox item on all the cloud plays. And you may recall in the previous chart, the other category of AI players being adopted or evaluated was quite large. So as we've been saying with our Gen AI power law research, that the tail in AI will be very, very long. Okay, let's wrap it up here. So cloud optimization as we posted earlier this year, it's a feature, not a bug. It drives lifetime value. It increases net revenue retention. It minimizes churn and it improves customer acquisition costs in the sense that if you're not churning, you're going to have lower cat. And with cloud optimization, the ability to optimize that cloud is going to lower the risk of the customers. So it's easier to onboard them. So your LTV to cat ratio should be pretty good. Cloud growth is playing out pretty much as we expected from our early 2023 forecast with the exception of the restatement of Azure. We've been pretty much dead on. Certainly at the total market level, you know, perhaps we were a little bit too optimistic with Google, but Microsoft has made up for that. So our overall numbers are pretty much dead on. Now cloud growth continues to dramatically outpace overall IT spending rates, 19% growth on $170 billion market is pretty impressive. And the last thing is foundation models like GPT, they shift the economic equation, they're driving cloud demand, we believe. It's going to start, it's already starting to show up just a little bit this past quarter in Microsoft and we're going to see it, we think in both AWS and Google and Q4, but then really driving in 2024, Silicon, large language models, APIs, apps are going to drive compute and storage and other infrastructure. So we expect an acceleration in Q4 and into 2024 with the obvious macro caveats that of course we'll be watching. All right, that's it for now. Thanks to Ken Schiffman who's flying solo today. Alex Meyerson is on production and manages our podcast. Kristen Martin, Cheryl Knight, they help get the word out on social media and in our newsletters and Rob Hoth is our editor in chief over at siliconangle.com. Remember, all these episodes are available as podcasts wherever you listen, all you got to do is search breaking analysis podcasts. I publish each week on wikibon.com, which is being rebranded, the cube research and advisory. So look for that. And we publish on siliconangle.com every week. So you can email me if you want to get in touch, david.balante at siliconangle.com. We're getting a lot of in bounds already on our prediction posts, which we do in mid-January. So we print them and we go through every one of them. We get a huge stack of paper. Sorry, we are killing trees. You want to get in touch? You can DM me at davilante or comment on our LinkedIn post and please do check out etr.ai, best survey data in the enterprise tech business with tremendous data scientists over there. This is Dave Vellante for theCUBE Insights, powered by ETR. Thanks for watching and we'll see you next time on breaking analysis.