Lydia Leong

Investors keep gnawing persistently at the issue of data center overcapacity and the colo market, but it doesn’t look like too many people are thinking about potential overcapacity in the cloud infrastructure market and what that means in the medium-term, economic-downturn scenario.

Many of the emerging cloud infrastructure service providers (”cloud hosters”) are building substantial chunks of capacity in order to accomodate a bunch of Web 2.0 start-ups with unpredictable and sometimes wildly variable capacity needs. (The now-classic example is Animoto.)

If this sounds naggingly familiar, it should. In the ’90s, colo providers built out tons of capacity in anticipation of the growth of the dot-coms. That growth was real enough until VCs stopped pouring money into companies that had no real revenues, causing the whole house of cards to collapse — the dot-coms folded and took many colocation companies with them. (The story is more complex than that, but that’s a succinct enough summary.)

Amazon can presumably afford to have gargantuan capacity reserves in EC2, because Amazon’s got heavily seasonal traffic that leaves it with gobs of spare capacity post-Christmas, meaning that anything it can do to get revenue from that pile of hardware is gravy. As long as EC2 keeps growing, every holiday season it can pile on more hardware and then release it thereafter to be absorbed into the EC2 pool.

Other cloud providers don’t have that luxury. And renting unmanaged hardware at commodity prices has ugly returns on invested capital, and the risk profile is much higher than it is with data center leasing or colo. Most cloud providers are trying not to overbuy, but running out of capacity also has its risks, especially when it looks like the heavens will be raining failed start-ups as they run out of cash.