In a very short time, phrases like 'on the cloud,' and 'cloud computing' have become part of everyday corporate vernacular. With more and more companies using this technology to share information with employees, customers, and vendors in real-time, Internet giants like Amazon (AMZN), Google (GOOG), and Microsoft (MSFT) have realized the potential profits for providing cloud-based services -- and the potential downfalls when servers fail.
However, with intense competition comes intense scrutiny. During a violent series of thunderstorms in the Mid-Atlantic region a few weeks ago, Amazon faced a temporary shutdown of its EC2 cloud computing services. This shutdown hurt several companies, including the popular dating site, Whatsyourprice.com, because customers could not use the service during peak hours. As a result, the company dropped EC2 and moved to another cloud provider.
The particular area, also known as availability zone US-East-Zone-1, affected by the storms also suffered downtime due to technical difficulties in March and June. The repeated outages have caused some customers to deem the service "unreliable." Any future disruptions could cause a mass exodus if Amazon can't find faster ways to resolve issues and safeguard against future ones. Amazon does request that companies work on at least two availability zones in case one goes down, however.
Storms and technical difficulties are just some of many issues companies offering cloud services face on a daily basis. Most consumers now have a "connect wherever, whenever" mentality when it comes to the Internet, thanks to new technology and slick marketing. So outages and other malfunctions instantly trigger outrage and psome customers to find other providers. But are consumers just becoming too difficult to please, or is faulty technology, or an unfortunate weather event to blame?
Consumer Demand: Just Too Hard to Handle?
While an argument can be made that consumers demand too much and lack patience when it comes to Internet connection issues, companies promoting these services must also take their fair share of the blame. For years, companies including Amazon, have touted fast delivery of products and services. In fact, one of the industry's biggest marketing tactics is 'fast, reliable service.' So, in effect, these companies created this growing consumer impatience monster by promising too much, too soon.
Even though Amazon has many other online endeavors, including on-demand streaming video services and online content creation assistance, this latest round of EC2 shutdowns could tarnish the company's reputation -- at least in the cloud computing community. And with Google poised to enter the cloud computing market, this is the last thing Amazon needs right now.
For the past three months, Amazon stock has seen some ups and downs. As of this writing, the stock price is hovering between $224 and $225. And while the power outages and subsequent shut down of EC2 service hasn't dramatically affected the stock price, if outages like this continue, businesses will go elsewhere for more reliable service. In the long run, this could cause some investors to become skittish and seek shelter from more reliable companies.
One sticking point that may save Amazon from losing customers to other cloud computing services is its ability to cut prices for services when it needs to. With a net operating cash flow of $3.9 billion (based on 2011 annual financials), the company has the means to slash prices of goods and services to remain competitive.
What's interesting to note here is that even though the company continues to show a profit each year and has a healthy operating cash flow, its cost of goods sold (COGS) is very high, absorbing much of the company's earnings. For example, in 2011, Amazon earned $48.08 billion in sales revenue, but spent $38.44 billion in COGS. As a result, its net income was just $631 million.
This means that much of what the company brings in, it also spends to maintain steady sales and revenue. This requires a delicate balance and careful monitoring of operating cash flow and costs in general. Investors should pay close attention to quarterly financials and reports about upcoming business decisions concerning the future of the company, as any misstep could cost Amazon and its shareholders a lot of money.
New Business Ventures
While Amazon has been suffering some setbacks in cloud computing, the company recently reported that it will manufacture its first smartphone. Coming off the success of the Kindle Fire, Amazon hopes this product will be just as or even more successful. But with other heavy competitors in the ring, including Google and Apple (AAPL), this may be the tipping point investors need to watch out for when it comes to that delicate balance of sales/revenue vs. COGS.
Apple, meanwhile, is set to release a smaller version of its iPad. It has been estimated that the company may sell up to 6 million smaller devices by the end of the year. This could affect future sales of Kindle, Google tablets and the smartphone market as people may put off upgrading their current device in favor of upgrading to a smaller iPad instead.
In addition to entering highly competitive markets, including tablet and smartphones, Amazon is also producing original content for its Amazon Instant Video online streaming service. This will allow the company to compete more aggressively with other streaming media giants like Netflix (NFLX).
With new projects on the horizon, Amazon's cloud computing issues seem small in comparison. But what investors need to consider is the overall picture. Even though creating new and innovative products and services may boost the stock price temporarily, if these goods and services fail to provide quality Internet connections, phone service or fail to entertain consumers, the stock price will eventually fall. For more aggressive investors, Amazon remains a great play. I think the company has some amazing products and services that may require a bit more monitoring, but nonetheless, these services are competitive, and very valuable to consumers.
More conservative investors may believe that reducing their stake or pulling out completely for now is a good decision. In the long-run, however, I think Amazon will continue to generate profits for investors who enjoy taking risks and going along for the ride.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.