The Fox Guards the Henhouse!

Ramesh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

"The fox guards the henhouse." This proverb appears in many forms, but basically means that you should not trust something that you value to someone who might be tempted to exploit it for his or her own ends.  For example, you wouldn’t want a hungry man to watch over your lunch, would you? (NASDAQ: AMZN) has proved this old adage over and over again in situations where they have been trusted to run another company’s online business. In those situations, Amazon has ended up directly competing with its customers, sometimes destroying their business in the process. 

One spectacular example is that of the now-defunct Borders book stores. Borders declared bankruptcy in 2011 and cited "online competitors" as one reason that led to its bankruptcy filing.  Borders committed the fatal mistake of trusting Amazon to host their website and take responsibility for everything including order fulfillment! Amazon was already billing itself as the world’s largest bookseller; by controlling Borders’ website; they were effectively the proverbial Fox in the Henhouse

Considerable irony lies in the fact that Jeff Bezos, founder of Amazon, sent over a case of champagne to Borders to celebrate the outsourcing deal!  Amazon had no stake in the survival and success of Borders, and while business steadily declined at Borders, Amazon’s business steadily prospered.  

Despite this highly visible example, it seems that other companies today such as Netflix (NASDAQ: NFLX) are repeating the mistake that Borders made.  They are not likely to fare any better.

The Public Cloud Model

The nascent dot-com boom of the late '90s and early 2000s involved a rapid evolution of Internet technology.  As technology infrastructure matured, architecture improved as well, offering companies greater choices in deploying their online presence.  In the early days, it was easy and preferable to outsource all aspects of an online business to a website operator such as Amazon.  This meant that hosting companies like Amazon were privy to the very internals of outsourced business operations of companies they were competing with!

The latest twist to the website operator model of the past is the Public Cloud model. Public Clouds come in various forms, but the concept in essence is very simple.  A Cloud Operator, such as Amazon will offer customizable and configurable hardware and software, along with services to manage it. Companies and even individuals can then host their applications on this infrastructure. 

The difference with this model over the older website operations model is that Amazon is now NOT privy to the internals of their customer’s business operations.  Amazon is responsible only for the maintenance, performance and general health of the infrastructure.  But, what happens when Amazon provides infrastructure to a company that it is directly competing with? Thanks to recent events, we know.

The Netflix Story

On Dec. 24, 2012, Christmas Eve, Netflix (NASDAQ: NFLX) suffered a major disruption to its online video streaming service. Its streaming videos were hosted by Amazon Web Services, the public cloud division of (NASDAQ: AMZN). At that time, Netflix blamed the outage on malfunctions in Amazon’s cloud computing division; Amazon apologized for the disruption and explained in somewhat technical terms that this affected only some customers who relied on an aspect of their cloud architecture called Elastic Load Balancing Services. Its own Amazon Prime Video streaming service that is hosted on the same infrastructure platform was however not affected.

In addition, in a detailed explanation on their website, Amazon described their error which could be traced back to the lack of enforcement of best practices in the IT (Information Technology) world.  For instance, it is not a good practice to allow developers to access production and development environments from the same device or bypass CM (Change Management) processes.  

On Dec. 31, 2012, exactly a week later on New Year’s Eve, Netflix experienced another disruption, this time in its DVD fulfillment section. Netflix did not blame Amazon this time -- at least not publicly. The disturbing fact is that these two events were not the first time that this has happened to Netflix.  There was a similar prior outage in August 2011, after which Netflix claimed to have learned some “lessons” from that incident.  One wonders.

Other Examples

Another great example of overly trusting Amazon is Toys “R” Us, the well-known and privately held toy retailer.  Toys “R” Us struck a deal with Amazon in 2000 to take over their online operations.  The deal went sour as detailed in this article by the Wall Street Journal and unlike Borders, Toys “R” Us was smart enough to notice the rapid cannibalization of its core business by Amazon and wanted out. However, Amazon resisted. Apparently, the Fox was NOT going to let go of its chicken! 

Toys “R” Us successfully sued Amazon to terminate the agreement.  The list of disenchanted customers goes on.  The nascent dot com boom of the late 90's roped in a lot of retailers, including Target (NYSE: TGT), who trusted their online operations to Amazon, only to discover later that they were being ripped off.  In 2011, Target finally launched its own website after separating from Amazon, again after a lawsuit. However, the damage has already been done and it is a long lasting one, despite attempts at retaliation such as the decision by Target not to sell Kindle devices any more.

Netflix and Amazon

The Netflix story is not likely to have a happy ending, either.  As one variation of the oft repeated quote (attributed to George Santayana) goes, “Those who ignore history are condemned to repeat it.”  Netflix has repeatedly ignored the warning signs and if nothing else, is making a major mistake in trusting its core business to a rapidly growing competitor.  For $79 per year, Amazon offers a service called the “Prime Instant Video” that includes unlimited on demand video streaming in addition to free two day shipping on thousands of items it sells.  For those not interested in a subscription, Amazon also offers the “Amazon Instant Video” that allows A la carte downloads. 

Technology architects at Netflix justify using AWS because they want to “use public clouds, not build them.” This reflects shortsighted thinking.  Amazon not only built Netflix’s infrastructure, but also profits from it by purveying its own video service on the same platform!  If only Netflix had been savvy enough to build out its own infrastructure, their future would have been brighter.  At the very least, one would have expected them to have turned to other cloud providers such as Oracle, HP or DELL.  Why trust a cloud provider who is also a major competitor? 

I rate Netflix a Sell. 

malayappan is a Dell employee, and owns restricted stock units of Dell. The Motley Fool recommends and Netflix. The Motley Fool owns shares of, Netflix, and Oracle Corp.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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