But first some historical perspective. The cloud has long been used as a metaphor to depict the agile, scalable architecture (e.g., high-capacity networks, remote data centers, and advanced software) that connects electronic devices, such as laptops, servers, desktops, tablets, and smartphones, using Internet technologies. Some experts believe that cloud computing represents the fifth generation of computing, following the mainframe, the personal computer, client-server computing, and the Web.¹ (See Chart 1.)

"Cloud computing is redefining the entire IT industry," declared a recent Merrill Lynch research report.² Among the many benefits are cost savings for both providers and customers; "pay as you go" pricing; resource flexibility; and ease of use and speed of deployment. The result is a "rapidly growing digital universe spurred by: Internet applications tracking every click and page view from each user; social networks and exploding user-generated content; smartphones, tablets, and sensors generating constant streams of data; digital video records and digital cameras recording people's lives; and enterprises in various industries capturing and processing all types of business data about customers, products, and transactions."³

Unlike the days of bulky mainframes that required significant capital investment in hardware and expensive-to-maintain software on their own premises, companies of all sizes can now achieve significant savings by building eminently expandable systems in the cloud, while downloading and/or updating critical applications for a fraction of the cost.

As Gartner Group analyst Thomas Bittman put it, "Besides saving companies money and improving customer service, [cloud computing] translates into speed and agility, which in turn can translate into a competitive advantage, particularly for up-and-coming companies, since the cloud allows them to tap into potentially massive IT resources for a short amount of time and do so on the spur of the moment."

According to a 2011 report by Bain & Company, cloud computing's share of technology budgets is likely to quadruple by 2020, growing nearly six times faster than spending on legacy hardware and software—a trend that should benefit industry-leading providers of data centers, open-source software, and customer relationship management systems. "Each customer segment will move to the cloud in different ways," said Bain.⁴ "While 'transformational' customers⁵ have the highest adoption rates today, 'heterogeneous'⁶ customers will nearly match them within three years. Safety-conscious⁷ customers will adopt more slowly, but at twice the size, this segment will cause a significant increase in spending growth. For price-conscious⁸ customers, adoption will nearly quadruple as prices come down, and this segment will focus more on less expensive 'public cloud' offerings than other later adopters. Finally, 'slow and steady'⁹ customers, who have barely begun to experiment with the cloud, will see meaningful adoption over the next three years."

No matter how fast companies move into the cloud, the motivations run the gamut. (See Chart 2.) For a global cosmetics company, a cloud system set up two years ago allowed it to operate very fast, and "speed equals competitive advantage," the company's chief information officer said. For a regional airline, cloud computing allowed it to leverage its IT investments to allow seamless delivery of services 365 days a year with no downtime.

What's Driving the Phenomenal Expansion of the Cloud?
Major advances in technology (see Figure 1) have driven robust growth in cloud computing that analysts expect will last for a number of years. Among the most significant catalysts are a tremendous increase in bandwidth (i.e., the digital pipeline that can handle greater data traffic); the proliferation of consumer-friendly applications with better user interfaces; advances in grid computing; improvements in network storage systems; and commodity servers that lower costs.¹⁰

All of the above-mentioned factors have helped fuel a gigantic data explosion. According to IDC (a global provider of market intelligence), digital information has been growing at a compound annual growth rate of 60%, roughly increasing 10-fold every five years.¹¹ Powering that trend is an exponential increase in the number of IT devices connected to networks and the Internet. (See Chart 3.)

In the last year alone, Cisco Systems reports that global mobile data traffic grew 2.3-fold over the previous year, more than doubling for the fourth year in a row; mobile video traffic exceeded 50% of overall mobile data traffic for the first time; mobile network connection speeds grew 66%; average smartphone use nearly tripled; and the number of mobile-connected tablets tripled, to 34 million.

According to Cisco, the number of mobile devices that can connect to the Internet will exceed the world’s population in 2012. As a result, the biggest growth potential lies in emerging markets equipped with wireless networks and broadband technologies, as opposed to traditional land-line systems.

Between 2011 and 2016, Cisco expects global mobile data traffic will have increased 18-fold, reaching 10.8 exabytes per month; tablets will have exceeded 10% of global mobile data traffic; and China will have exceeded 10% of global mobile data traffic. (See Figure 2.)

(Note: An exabyte equals one billion gigabytes, emblematic of the relentless gusher of streaming videos, tweets, e-mails, and data feeds that gains momentum every minute.)

Cloud Builders and Enablers
Lord Abbett's growth investment team believes the most enduring investment themes in cloud computing can be broken down into two key categories: companies that build the cloud and enable its various configurations, and companies that use the many services and applications stored in the cloud to drive their business models.

Cloud builders represent the most fundamental form of cloud computing. In assembling the building blocks of a highly adaptable warehouse-like infrastructure, these tech whizzes essentially reduce the cost of capital investment for established companies. They also make it easier for entrepreneurs to create new businesses by tapping into powerful computing resources at remote multitenant data centers using low-cost commodity hardware and virtualization.¹²

"Infrastructure is the foundation that connects all the clouds—private [corporate applications and data], public [social media, e-commerce services, digital content], and home [devices like smart meters, wireless thermostats, Internet-enabled TVs]," said one provider of end-to-end provider solutions. "The explosion of the mobile Internet, however, is challenging the efficiencies of the current infrastructure."¹³

Companies that specialize in cloud infrastructure are likely to see very strong growth. One of the biggest players in this space is the world's dominant e-commerce retailer, which leveraged its domain expertise and started a web services division in 2006. By offering low-cost, expandable platforms and applications on demand to other companies, that rapidly growing division has become the outsourced cloud services company to beat.

Among other secular growth stories in this space are a global purveyor of high-performance data centers and network services and a pioneering maker of storage memory platforms. Then there's a provider of virtualization software that vastly expands the capacity of Internet servers, supports the entire lifecycle of large-scale software development and storage on a single platform at potentially huge cost savings, and in turn allows a company to leverage its existing customer base.¹⁴

Now that all this laborious infrastructure is in place, social networking platforms that allow people to interact, play, create, learn, or do business on multiple levels have caused quite a stir. Companies in this area include a provider of innovative web platforms that have allowed prestigious universities to extend their brand; a site that hosts some of the most popular interactive games; a major search engine provider that has built a portal with kaleidoscopic functionality; and a service that enables businesses of all sizes to build apps that can connect them to customers in a social media or mobile setting.

"Big Data" Moves to the Cloud Should Spur More Disruptive Innovation
No discussion of the cloud would be complete without mentioning "Big Data," a reference to companies powered by the latest open-ended software that makes machine-generated data accessible, usable, and valuable to everyone in a timely manner. There are many applications of such technology, but the most recognizable include transaction oversight for online businesses providing round-the-clock operations; tracking web activity and web asset use data to gain customer intelligence; and monitoring social media networks to identify trends and gauge sentiment.

"Companies are increasingly aware of the potential business value in disparate data sources, and data analytics has become one of the most strategic sources of competitive advantage," a recent Merrill Lynch research report said. "Simultaneously, properly managing, understanding, correlating, and drawing useful information from the immense variety of data sets is a daunting computer science challenge that begs new solutions, creating new market opportunities."

When it comes to storage, the biggest Big Data customers may come as a surprise. According to one major player in this sector, discrete manufacturing, with its enormous demand for automation technology, has the largest appetite for data storage, followed by government, communications, and media. (See Chart 4.) Laggards, at least for the time being, include the banking, healthcare, and securities/investment sectors, where the need to protect incalculable amounts of critical information is further complicated by ever-changing regulatory requirements.

Heightened Security
With an exponential increase in the amount of confidential information now coursing through the Internet, security has become a major hot-button issue, as evidenced by the number of financial institutions, retailers, and government institutions that have been hacked in recent years. (See sidebar below.) While it is common to think of hackers as monolithic villains, the reality is much more complex. They range from highly decentralized political "hacktivists" to state-sponsored corporate espionage to organized crime. According to the Open Web Application Security Project [OWASP] Foundation, the most frequently attacked sites are the ones that touch the most lives—namely government, web services, and financial institutions. And the motives fall into five major categories: to inflict downtime; leak sensitive or embarrassing information; defacement; planting of malicious software ("malware"); and monetary loss.

Cloud Users—Anytime, Anywhere, Anyplace
One of the most dramatic aspects of the cloud phenomenon is the proliferation of software as a service, an application-delivery model whereby software code and associated data are hosted centrally in the cloud and usually accessed through a web browser over the Internet. Payments are typically made on a subscription basis. Companies in this area range from the leading sales force productivity software provider to a company that helps small businesses, associations, and nonprofits connect through public relations with their customers, clients, and members, and to a firm that dramatically lowers costs by automating expense reports. They also include a provider of user-friendly, web-based medical billing, practice management, and electronic health record services.

In the meantime, ubiquitous connectivity enabled by the global expansion of the cloud and mobile devices is revolutionizing numerous industries. As Mark Bonchek, senior vice president of communities and networks at Sears Holdings, put it, "Social networks and mobile technologies make it possible to create [service platforms that create value for your customer] with incredible ease. There are many sources of value around which to build your engagement platform. The most common are content, conversation, collaboration, contribution, and commerce."¹⁵

Suppose you're at the soccer field with your kids on a Saturday morning. Wouldn’t it be nice to have a collaboration program open on your smartphone in case your boss wants to talk to you about an important project?

Or picture yourself at a conference in Seattle with nothing but an iPad, but able to access all the applications on your desktop computer in New York. That kind of "virtual desktop interface" enabled by the cloud is in its early stages, but the potential demand could be significant.

At any rate, using the cloud may never be the same now that lower-cost hardware and commoditized software have brought easy, broad options to practically anyone with a web browser. Consumers may be most familiar with cloud-enabled e-commerce, collaboration, photo sharing, streaming music and video, Internet videoconferencing, user-generated content, storage, backup, and myriad portal services. But behind the scenes, businesses of all types are moving to the cloud for software and network infrastructure, application development, application servers, databases, operating systems, security, troubleshooting, monitoring, testing, business software, business intelligence, collaboration, content management, customer relationship management, high-performance computing, and project management, among other uses.¹⁶

"The magnitude of upcoming change will be stunning," said Mary Meeker, the venture capitalist and former Internet analyst that Barron’s dubbed "Queen of the Net" in 1998. "And we are still in spring training."¹⁷

Elaborating on that theme, the CEO of one cloud storage company offered a succinct perspective: "Because of all this change, customers are going to begin to experience a much more dynamic and democratic software environment. Solutions will be forced to update to the latest trends more regularly, and this will drive better business results for all enterprises. Work will be done faster, people will get more value from their technology, and the ecosystem will even grow as a result of the breadth, diversity, and reach of technologies available."¹⁸

F. Thomas O'Halloran, J.D., CFA, Partner & Director, is the lead Portfolio Manager of the small, micro, and multi cap growth equity strategies. Mr. O’Halloran joined Lord Abbett in 2001 as a Research Analyst for the small cap growth equity strategy, and was named Partner in 2003. His prior experience includes executive director/senior research analyst at Dillon, Read & Co., and as a trial attorney. Mr. O'Halloran received an AB from Bowdoin College, a JD from Boston College, and an MBA from Columbia University. He also is the holder of a Chartered Financial Analyst designation, and has been in the investment business since 1987.

Anthony W. Hipple, CFA, is a Portfolio Manager of the micro and multi cap growth equity strategies and also contributes as a Research Analyst on the small cap growth equity strategy. Mr. Hipple joined Lord Abbett in 2002. His prior experience includes senior analyst at Lutheran Brotherhood and senior analyst at Piper Jaffray Asset Management. Mr. Hipple received a BBA from the University of Northern Iowa and an MBA from the University of Iowa. He also is the holder of a Chartered Financial Analyst designation, and has been in the investment business since 1995.