Tim O’Reilly nails it on cloud computing

In this long and very interesting post, Tim O’Reilly divides cloud computing into three types: Utility, platform and end-user applications, and underscores that network effects rather than cost advantages will be what drives economics in this area. (This in contrast to the Economist’s piece this week, which places relatively little emphasis on this, instead talking about the simplification of corporate data centers – though the Economist piece is focused on corporate IT.)

Network effects happen when having new users on a platform or service are a benefit to the other users. This benefit can come from platform integration – for instance, if we both share the same service we can do things within that service that may not be possible between services, due to differences in implementation or lack of translating standards.

Another benefit comes when the shared service can leverage individual users’ activities. Google’s Gmail, for instance, has a wonderful spam filter, which is very reliable because it tracks millions of users’ selections on what is spam and what isn’t.

Tim focuses on the network effects of developers, which is an important reason why Microsoft, not Apple, won the microcomputer war. When Steve Ballmer jumped around shouting "developers, developers, developers", he was demonstrating a sound understanding of what made his business take off – and was willing to make a fool of himself to prove it.

Tim also invokes Clay Christensen’s "law of conservation of attractive profits", arguing that as software becomes commoditized, opportunities for profits will spring up in adjacent markets. In other words, someone (Jeff Bezos? Larry and Sergei?) need to start jumping up and down, shouting "mashupers, mashupers, mashupers" or perhaps "interactors, interactors, interactors" and, more importantly, provide a business model for those that build value-added services on top of the widely shared platforms and easily available applications they provide.

One way to do that could be to make available some of the data generated by user activities, which today most of these companies keep closely to themselves.  That will require balancing on a sharp edge between providing useful data, taking care of user privacy, and not giving away your profitability too much. As my colleague Øystein Fjeldstad and I wrote in an article a few years ago – the companies playing in this field will have to make some hard decisions between growing the pie and securing the biggest piece for themselves.

If we cannot harness network effects, cloud computing becomes a cost play, and after awhile about as interesting, in terms of technical evolution, as utilities are now. USA is behind Europe and Asia in mobile phone systems partially because US cellphone companies were late in developing advanced interconnect and roaming agreements, instead trying to herd customers into their own network. Let’s hope the cloud computing companies have learned something from this….