Variable Cost Business Models based on Cloud Computing are Driving Economic Recovery

In 2010 economists and business executives will widely recognize the emergence of a new variable cost business model that enables incremental operating profits through continuous response to changing market conditions. This variable cost model is better suited to our present economy because it reduces need for large capital investments to enter new markets and its flexible cost structure protects operating cash flow. The widespread switch to variable cost business models will fuel a level of economic activity not seen since the 1990s and it will also prove to be a lot more sustainable.

Companies moving to this mode of operation from traditional fixed cost operating models are creating demand for products and services based on a group of related technologies such as cloud computing, and server and network virtualization. Cloud and virtualization services are provided to customers on a variable cost pay-as-you-go basis determined by the number of users and their volume of transactions. Suppliers of cloud computing and virtualization products services have seen their stock prices return to and even exceed pre-meltdown levels of last September. The stock prices of these companies have been rising since April and provide a clear indicator of the shift companies are making toward variable cost operating models. Some of the companies (and their stock symbols) providing cloud and virtualization products and services are: Akamai (AKAM); Amazon.com (AMZN); Cisco Systems (CSCO); EMC (EMC); Google (GOOG); Hewlett-Packard (HPQ); IBM (IBM); Microsoft (MSFT); Rackspace (RAX); Salesforce.com (CRM); and Terremark (TMRK).

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Fixed Cost Business Models focused on Operating Efficiencies do not Work

In the last century business models were largely based on a fixed cost operating model employing large capital investments in order to leverage economies of scale to produce incremental profits by turning out ever increasing volumes of standard products and spreading operating expenses over larger and larger numbers of units sold. This model worked as long as product demand was reasonably predictable and stable because it allowed companies to allocate labor and capital to optimize production and return on investment. But when product life cycles are shortened to months instead of years and when the predictability of mass markets is replaced with the uncertainty of a global real-time economy and rapidly evolving consumer preferences, the capital intensive fixed cost business model based on efficiencies derived through economies of scale no longer works

Output of basic products and services was the focus of the 20th century industrial economy because consumer demand for basic products was in effect infinite and output was the limiting factor to how much a company could sell. The real-time economy of this century is composed of many smaller and rapidly evolving market segments where customers want more than low priced products. Customers want products at a good price, not necessarily the lowest price, and they want products that deliver value by responding to their changing needs and desires.

A graphic case in point that illustrates this is the evolution of the mobile phone. In the last years of the 20th century Motorola (MOT) made the most reliable mobile phones at the lowest prices. Their efficient manufacturing processes enabled them to dominate mobile phone markets around the world. Yet since the turn of the century Motorola has seen its low cost mobile phones become commoditized and marginalized as they lost customers to a succession of new entrants into the market. Each new entrant offered products that cost a little more and were often a little less reliable but responded to evolving customer desires. First came Nokia (NOK) responding to customer desires that a

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