The real impact of Cloud on the enterprise value

I remember a presentation of Satya Nadella in 2016, when he said he was convinced that Cloud Computing would be widely adopted by all organizations, not only as a new model of technology consumption but as a "new practice of developing business". And I think it was from that moment on, as an instant insight, that I realized that the Cloud was indeed something disruptive. And it would mark history.

Cloud computing has evolved very fast since that day. As a strong paradigm, widely recognized, it established the Internet as the means for access to multiple services, data, and applications - consumed on-demand, self-service, following the best "Internet style".

In recent years, a growing number of companies have been dedicating efforts to adopt cloud computing and unlock an ocean of competitive advantages that, until a few years ago, was thoughtless:

• Reduce the requirement for continuous capital expenditure in infrastructure, making the business more asset-light and therefore more attractive to the market;
• Have a more elastic and scalable operational backend therefore better prepared for market uncertainties and volatilities;
•  Increase the frequency of updates to your systems and applications and thus have the security of responding more promptly to customer and market signs;
• Enable new business models that explore data monetization and the development of digital platforms;
• Have the freedom to opt for a data center supplied by renewable energy sources and reduce the environmental impact of your business (in one click!).

 But what was the real impact of the adoption of this "new practice" on the economic value of the organizations?

Is the technology's value-generating power the same regardless of the size of the company and the industry where it performs its activities?

 Inspired by this background and to answer these questions, a group from the Xiamen University School of Management in China developed a study to empirically evaluate the effects of Cloud adoption on the performance of 658 publicly traded companies, listed on large stock exchanges, in different countries and sectors of the economy. More specifically, the study looked for “statistical evidence” of a causal relationship between enterprise performance and Cloud adoption.

The profitability indicator adopted in the study was the ROA (return on assets). And the metric used to evaluate how the market value of companies evolved after the adoption of Cloud was a ratio of stock price, debt, and equity value (known as Q Tobin).

The conclusions of the study were very interesting. The companies that adopt Cloud computing, in the same period considered by the study, significantly improved profitability. 

The results revealed a difference in ROA between companies that adopted and did not adopt Cloud of 0.070 points (one year after adoption), 0.072 points (two years after adoption), and 0.087 (three years after adoption).

To get better color, imagine a hypothetical company that chose not to adopt cloud, with US$ 20B in Assets and reported US$3B of Net Income. This company, by the average of the study, would have a positive impact of US$ 140M on its Net Income (+4.5%), just one year after Cloud adoption.

When analyzing the impacts on the valuation of the shares of these same companies in the market, it was also higher in the case of Cloud adopters, reaching 2.0 points of difference (one year after adoption), and 1.8 points of difference (two years after adoption), based on the adopted measurement (Q-Tobin), showing that the market ended up rewarding Cloud adopters with a higher valuation multiple, in average.

 Another interesting aspect revealed by the study was the degree of relevance of the sectors (industries) and the size of companies for the magnitude of the effects of Cloud on performance.

And, interestingly, it was concluded that companies on manufacturing activity, for example, have a significantly positive impact on profitability after adopting Cloud. On the other hand, service companies (including financial services) show a larger increase in market value.

This is probably because manufacturing companies, once involved in the production of tangible products, have a highly investment-dependent model and typically with more operational complexity. In these cases, any improvement in the collaboration, for example, may unlock synergies between plants and increase profitability. 

Many things could justify why Cloud adopters in manufacturing, despite the higher increases in profitability, did not have the same effect on valuing their shares when compared to service companies, for example. Perhaps one of these explanations is the complexity of the business that avoids the market immediately "buying" an improvement in profitability (even significant) in manufacture.

This same dynamic seems to be much more direct for service companies such as financial institutions and digital platforms, for example. These businesses have as characteristic to seek a better relationship with customers (or users) and, therefore, the market ends up learning how to project future profits from metrics such as an increase in the volume of users and reduction of churn, clearly reflecting the effects of technology on the value of companies.

Regarding the size of companies, the study showed that small Cloud adopters showed a more significant increase in profitability than in the case of larger companies. On the other hand, interestingly, large companies had a higher appreciation in the stock price.

The larger impact of the Cloud on the profitability of smaller adopters is probably due to more structural aspects of these organizations. Lighter and with less bureaucracy, they end up capturing the value of the Cloud and unfolding profitability before the larger ones. In addition, the Cloud ends up eliminating asymmetries in the access to advanced technologies, which in the past were seen as competitive advantages for the big corps. Just think that currently, it's not uncommon to find startups exploring technologies not yet affordable for large companies (despite a larger investment capacity).

Once again here, the situation is reversed when analyzing the impact on the valuation of companies. The share prices of the largest Cloud adopters increased more than the smaller companies. And this is probably because large companies (blue chips) tend to have more visibility in the market. Thus, the adoption of Cloud computing by larger organizations (even with proportionally lower impacts on profitability) may seem more attractive to investors. In contrast, investors pay less attention to small caps because they are volatile and less liquid – which means that even a very positive impact on the margins could not be immediately reflected on the value of their shares.

This study may naturally carry some inaccuracies, such as the fact that it only considers the initial adoption of Cloud – losing the context and the depth of these transformational journeys over time. Financial information also carries inaccuracies when analyzed coldly, such as the fact that net income may be affected by a higher depreciation or non-recurring events at the time of data collection.

Anyway, the value of the study developed by the Chinese researchers is notorious, and I understand that it deserves to be appreciated due to its essential contributions. It is a rich and pioneering insight into understanding the causal effect of technology on business value creation, providing strong evidence about the real impact of cloud service adoption on companies' accounting outcomes and how this has been valued by the market over the years after the initial adoption.

I've been thinking a lot about what the next chapters of Cloud Computing will look like.

All organizations, in different sectors, large and small, will continue to infuse digital technology into every process and function of their business. Like a "new practice."

So they do more with less.

And that might seem a little obvious. It may even seem that "do more with less" has always been a very important thing. But it's never been as vital and urgent as it is now.

In the next 10 years, digital technology will be the deflationary force in a world recovering from a hard inflationary contagious.

And "do more with less" does not mean, through the technological lens, working or spending more. It's scaling, stretching, multiplying, and innovating. It means using the cloud to amplify the impact of a small squad for an entire organization, for the entire economy. To the world!

 Adriano Bottas

 *Adriano Bottas is an engineer, responsible for the development of strategic partnerships at Microsoft Brazil. The information and opinions expressed in this article are personal in nature and do not necessarily reflect Microsoft's view.