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Hybrid, Proximity and Ecosystems Are Elevating the Importance of Colocation

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A Multitude of Secular Trends Are Reinforcing Colocation’s Value Proposition

Market trends over the past few years have made several things clear about the IT strategy of most enterprise customers, all of which reinforce the value proposition offered by colocation providers:

  • Hybrid environments will persist — Whether due to existing legacy investments, divisional or regional nuances, or acquisition and divestiture activity, heterogeneity will remain in most IT environments. At one point, the benefits of public cloud made organizations consider a homogeneous, fully cloud-based IT delivery strategy, but those visions have faded for most. The challenge — and goal — is to embrace the hybrid heterogeneous approach and find the best way to integrate, manage and optimize services across these diverse sets of delivery methods and assets. Colocation data centers play a critical role for customers, offering a hybrid approach to facilities and in the interconnection of cloud and on-premises services.
  • Location and proximity matter — The importance of delivery locations is driven by not only the hybrid nature of the environment but also the latency requirements of many workloads. Edge workloads are the clearest example, but there are other cases where latency is critical or where regulations determine the location of data.
  • Investment costs and opportunity costs are important — While organizations are still looking to control and minimize IT costs where possible, there has been a shift toward selective investment. This started when IT became one of the few levers companies could control as they shifted their business models to adapt to changes wrought by the COVID-19 pandemic. Most recently, the onset of generative AI (GenAI) convinced organizations that IT could be a competitive advantage as well, prompting investment in new solutions and technologies to keep pace with the market and key competitors. In this way, organizations are still closely controlling investment costs in new solutions but also can be swayed to spend due to the fear of lost opportunities. Colocation provides an emerging value proposition with GenAI and AI workloads, offering prebuilt facilities and interconnection services without requiring large retrofits or new capital expenditures.
  • Ecosystems equal innovation — Though hyperscalers have become the center of the IT ecosystem over the past decade, the network of infrastructure providers, ISVs, systems integrators (SIs), colocation providers, consultancies and managed services providers remains intact. With the hybrid approach that most customers are embracing, combined with the digital transformations being deployed and then amplified by the onset of new AI and GenAI technology, numerous vendors are part of most enterprise IT solutions. The orchestration of those multiple vendors is critical and most often handled by a trusted SI partner.

Colocation Is a Relied-upon Option for the Vast Majority of Enterprises

According to TBR’s 2Q24 Infrastructure Strategy Customer Research, a significant portion of enterprises report colocation as some part of their overall IT delivery strategy. Most have less than 25% of their workloads deployed in colocation facilities, which is a reflection of the two predominant delivery strategies: their own centralized data centers and cloud-based environments. Colocation is even more of a consideration for new workloads, however, as 72% of surveyed respondents expect to deploy between 25% and 50% of net-new workloads using colocation providers.
 
We believe this trend is due to two factors. First, enterprises are reluctant to build their own data center facilities for workloads that perform best outside the cloud or that have location and latency requirements. Most organizations want to reduce their data center capacity at this point, not add to it at. Second, for many new workloads, data center requirements are more challenging to provide. With the need for increased density, more power requirements and unique GPU-based AI services, a modern data center is required. The challenges of technology, facilities and staffing highlight the value of a ready-to-use colocation facility.

Digital Realty and Equinix Stand Out in a Tightly Packed Colocation Market

Recent trends around hybrid deployment models, latency-sensitive workloads, data residency and AI-reliant solutions have highlighted the sometimes-overlooked benefits of colocation providers. Especially for large enterprise customers, the scale of colocation facilities, strength of alliances and ability to invest in supporting new technologies make a difference in the value of their services. TBR research shows Digital Realty and Equinix are head and shoulders above the rest of their peers in terms of the ability to meet enterprise requirements. From a purely data center location perspective, Digital Realty is the market leader worldwide, with 309 data centers, including those from unconsolidated joint ventures, effective 1Q24.

 

The current revenue perspective is one component when it comes to colocation spending, but enterprises also want to know their solution providers will be able to scale as demands grow. Especially after the supply constraints over the last couple of years and the ongoing shortage of key components for next-gen workloads like GenAI, customers are not always secure in their ability to access resources on a timely basis. While the supply of colocation capacity remains tight, investing now to guarantee expanded capacity is another differentiator. Here again there are advantages to scale, as Digital Realty actually outpaced all covered vendors in level of capital expenditures in 2023. This commitment to current investment is a signal to customers that they can continue to grow with Digital Realty moving forward.

Digital Realty Is Well Positioned to Address Hyperscaler Demand, Both Financially and in its Go-to-market Approach

Though adamant about vying for mindshare among both enterprises and hyperscalers, Digital Realty has always been better known for its play in wholesale colocation. Over the past several quarters, Digital Realty has employed an aggressive joint venture strategy, allying with private equity firms to build multibillion-dollar hyperscale data centers in both Tier 1 and Tier 2 markets. As such, much of Digital Realty’s financial makeup and recent performance have stemmed from this customer base, with over 80% of annualized base rent from new leases in the >1MW category (effective 1Q24). The retail colocation market will undoubtedly continue to grow, led by robust demand for hybrid deployments and cloud adjacency for reasons highlighted earlier in this piece.
 
But many sources continue to suggest a rampant demand surge in the wholesale market as hyperscalers rush to satisfy their own customers’ AI and GenAI deployments. There are several ways Digital Realty is addressing this demand. Some are financial, including the ability to recycle capital by selling off nonscalable, single-tenant facilities to reinvest in strategic markets and maintaining a conservative capital structure; for context, Digital Realty owns nearly all of its facilities, in stark contrast to competitor Equinix, which is still leasing roughly 40% of its data centers. But the other aspect is Digital Realty’s go-to-market approach and how the vendor is nurturing relationships with the hyperscalers and their own partner ecosystems.

Digital Realty and Oracle Have a Strong Customer-partner Relationship: Other Hyperscalers Should Take Note

Digital Realty has always had a strong relationship with Oracle, which is now Digital Realty’s third-largest customer, deploying in 38 locations and spending $170 million in annualized recurring revenue (ARR). It is hard to dispute Oracle’s success pivoting from a traditional software incumbent and SaaS provider to an IaaS challenger with OCI (Oracle Cloud Infrastructure), which is on track to become Oracle’s largest cloud business in the coming years. Digital Realty astutely took notice of OCI’s role in the market, not to mention Oracle’s tight relationship with NVIDIA, which supplied Oracle with GPUs early in the AI wave.
 
Recent developments like connecting to Oracle’s EU Sovereign Cloud and offering NVIDIA-based OCI instances in its high-traffic Northern Virginia data center only reinforce Digital Realty’s role in powering OCI’s expansion. It is one of the reasons Oracle can not only boast more rapid footprint expansion over peers but also deliver on the “distributed cloud” message that nearly all hyperscalers are eager to convey. For perspective, Oracle holds only a single-digit share percentage in the IaaS market, but Oracle’s ability to leverage Digital Realty to expand ahead of peers is notable and something that other hyperscalers that are adamant about building their own data centers should recognize as they fight to capture net-new AI workloads.

SIs and Consultancies Pull It All Together at Scale for Enterprises

For IT services companies and consultancies, two needs mentioned above — orchestration and scale — illustrate how the colocation piece of the enterprise IT ecosystem can provide competitive opportunities.

Orchestration Is Critical and Most Often Handled by a Trusted SI Partner

Companies like Deloitte, Accenture and Infosys have the most complete view of an enterprise’s IT environment, positioning them best to coordinate vendors that provide disparate technologies. Most consultancies and SIs stay in well-defined swim lanes, delivering their added value while facilitating cloud, software and even hardware solutions from an enterprise’s suppliers. In TBR’s research, the market-leading consultancies and SIs use their industry knowledge, influence and reach within a client as the basis for orchestrating a full spectrum of technology providers, calibrated specifically to an enterprise’s IT needs.
 
As described above, colocation continues to be a pressing need, creating an opening for IT services companies and consultancies that have traditionally shied away from alliances that are too far removed from their core competencies. Just as alliances have formed around cloud computing and enterprise software, with IT services companies and consultancies delivering value through innovation, cost containment and managed services, partnerships with colocation specialists could add a compelling component to an IT services company’s orchestration value proposition. Consultancies’ and SIs’ business models depend on retaining clients and expanding footprint within clients. If colocation can become another differentiating factor and improve enterprise clients’ overall IT environments, SIs and consultancies will willingly seek partnerships.

Enterprises Want to Know That Their Solution Providers Can Scale as Demands Grow

If client retention remains critical to SIs’ and consultancies’ business models, scale increasingly marks the difference between average performance and market-leading results. No SI or consultancy can out-scale the largest players, but TBR’s research shows that companies that manage their alliances well can leverage their ecosystem for scale unattainable on their own. In short, no other company can be Accenture, but an SI or consultancy can replicate Accenture’s reach with the combined forces of a well-oiled tech and services ecosystem.
 
Colocation providers already play within the technology ecosystem but have not traditionally been considered a means for consultancies and SIs to increase scale. As AI and GenAI increase compute power demands and enterprises turn to their consultancies and ask, “How can I take advantage of all this new technology without exploding my IT budget?” and “How can I take this GenAI-enabled solution from pilot to my entire enterprise,” colocation can become a critical component.

The SI and Consulting Tech Evolution: From ERP to Cloud to GenAI to Colocation

In TBR’s view, SIs and consultancies will never become adept at selling those components of the technology ecosystem that are the furthest from their core competencies, but the market leaders have become exceptional at managing and expanding their ecosystems. TBR’s research around the relationships between the largest cloud providers and the largest SIs demonstrates how much revenue can be driven through alliances. As SIs and consultancies mature their partnering practices, colocation will become another element orchestrated by the likes of Deloitte, Accenture and Infosys. Quite possibly some smaller SIs and consultancies will use colocation as a critical component to scaling themselves into competitive positions against those larger players. As GenAI drives new demands — on compute power, budgets and expertise — TBR will closely watch these relationships between SIs and colocation providers.