23 Years of Day One Mentality (Part 1)
Amazon Through Jeff Bezos’ Shareholder Letters
Amazon was founded in July 1994 and listed on the Nasdaq on May 1997. Since its IPO, Jeff Bezos has written 23 shareholder letters (1997 to 2019), communicating his thoughts and vision of Amazon to shareholders. There are a lot to learn for both investors and business leaders through these shareholder letters. It also gives a glimpse into Jeff Bezos’ strategic thinking while leading Amazon. These are some of the key learnings. Given there are a lot of content from these 23 letters, this is Part 1 of 2 posts.
Obsess Over Customers
“Our vision is to use this platform to build Earth’s most customer-centric company, a place where customers can come to find and discover anything and everything they might want to buy online” — 1999 Letter
“Customers are always beautifully, wonderfully dissatisfied, even when they report being happy and business is great. Even when they don’t yet know it, customers want something better, and your desire to delight customers will drive you to invent on their behalf” — 2016 Letter
To obsess over customers is Amazon’s North Star. A lot has been written about Amazon’s obsession with the customer and it clearly shows in these shareholder letters. Jeff Bezos instills this to his employees and shareholders right from Day 1. Unlike most companies where their focus tends to be on the competition and what they do, Amazon chose to be customer focused.
To obsess over customers is to “work backwards” from customer needs, which can be contrasted with a “skills-forward” approach. A skills-forward approach dictates “We are really good at this, what else can we do with it?”. Existing skills and competencies are used to drive business opportunities. This can be a rewarding strategy but used solely does not drive businesses to develop new skills or invent for the customer. Working backwards from customer needs is to think of new ways or acquire new skillsets to solve that need. This leads to proactivity in increasing value for the customer.
“One advantage — perhaps a somewhat subtle one — of a customer-driven focus is that it aids a certain type of proactivity. When we’re at our best, we don’t wait for external pressures. We are internally driven to improve our services, adding benefits and features, before we have to” — 2012 Letter
“Most big technology companies are competitor focused. They see what others are doing, and then work to fast follow. In contrast, 90 to 95% of what we build in AWS is driven by what customers tell us they want” — 2015 Letter
This North Star drives every Amazon business decision from continuously lowering e-commerce (EC) products or Amazon Web Services (AWS) prices, inventing new AWS solutions, allowing third party (3P) sellers onto their EC platform to compete with Amazon or offering unlimited free and fast shipping for an upfront Prime subscription fee, before they have to due to external competitive threats.
“We’ve reduced AWS prices 27 times since launching 7 years ago, added enterprise service support enhancements, and created innovative tools to help customers be more efficient. AWS Trusted Advisor monitors customer configurations, compares them to known best practices, and then notifies customers where opportunities exist to improve performance, enhance security, or save money. Yes, we are actively telling customers they’re paying us more than they need to” — 2012 Letter
Sometimes obsessing over customers may seem painful now or can be harmful to short term financials. Subsequently, it is important for companies to have a North Star, to help make these in-the-moment tough business decisions that can be highly value accretive in the long term. For example, continuously lowering prices or allowing 3P sellers to compete with Amazon’s products on its EC platform or offering free shipping, these are tough decisions made in the moment but are made with the customers’ best interest in mind, which paid off for Amazon down the road.
On the surface, it may seem Amazon is merely transferring value from shareholders to customers but Jeff Bezos views this as an investment in customer trust. Building customer trust allowed Amazon to earn more businesses from these customers in the long term and potentially in other new business arenas too. To obsess over customers is to think long term.
“More fundamentally, I think long-term thinking squares the circle. Proactively delighting customers earns trust, which earns more business from those customers, even in new business arenas. Take a long-term view, and the interests of customers and shareholders align” — 2012 Letter
Playing The Long Term Game
The benefits of thinking long term is widely preached in the domain of business and investing. Nonetheless, it is still rare to see this put in practice by either business leaders or investors. There is a reason for this: it is simply difficult and takes a long time to reap the benefits of long termism. However, Jeff Bezos is an exception.
“We believe that a fundamental measure of our success will be the shareholder value we create over the long term” — 1997 Letter
“Long-term thinking is both a requirement and an outcome of true ownership. Owners are different from tenants…. Similarly, many investors are effectively short-term tenants, turning their portfolios so quickly they are really just renting the stocks that they temporarily own. — 2003 Letter
Just as obsession with the customers guides Amazon’s business decisions, long termism helps gives the conviction to execute it. While common today, customer reviews on product listing pages was a new concept when Amazon introduced it shortly after launch. Sellers complained why would Amazon want to display negative reviews which discourages customer purchase. Negative reviews undoubtedly costed sales in the short term but helped customers make better purchasing decision which pays off for Amazon in the long run.
Offering free shipping through Prime and ongoing price reductions were one of those short term painful but long term accretive business decisions. These were expensive decisions upfront but Jeff Bezos understood that with scale, the economics of these decisions will improve and are long term value accretive, as fixed costs gets diluted. It also reinforces their obsession with customers.
“Our pricing strategy does not attempt to maximize margin percentages, but instead seeks to drive maximum value for customers and thereby create a much larger bottom line — in the long term” — 2003 Letter
“Long-term orientation interacts well with customer obsession. If we can identify a customer need and if we can further develop conviction that that need is meaningful and durable, our approach permits us to work patiently for multiple years to deliver a solution” — 2008 Letter
Another short term expensive but long term accretive business decision was allowing 3P sellers onto their platform. In 2000, Amazon invited 3P sellers onto the platform to compete with Amazon’s own product listings. This decision was hotly debated within the company.
In 2006, Amazon doubled down on this strategy by launching Fulfillment by Amazon (FBA), allowing 3P sellers to stow their inventory in Amazon’s fulfillment centers. Amazon then takes on all logistics, customer service and product returns for a fee of $0.45/sqf (in 2006).
Enabling its competitors to come onto Amazon’s platform, tap into Amazon’s proprietary customer traffic and leverage Amazon’s fulfillment infrastructure investments do not seem like a logical decision in the short term. Amazon’s obsession with customers guided it to this decision, which is to increase product selection and allow customer access to the cheapest and best product regardless of the seller, but it is their long termism that gave them the conviction to execute it despite the short term pain as Jeff Bezos believed what is good for customers is good for Amazon in the long run. And boy was he right.
Amazon’s own 1P GMV have grown from $1.6bn in 1997 to $117bn in 2018, implying a 25% CAGR, which is impressive. However, 3P GMV have grown from $0.1bn to $160bn during the same period, a stunning 53% CAGR! By contrast, eBay’s GMV only grew at 20% CAGR during the same period.
“We helped independent sellers compete against our first-party business by investing in and offering them the very best selling tools we could imagine and build. There are many such tools, including tools that help sellers manage inventory, process payments, track shipments, create reports, and sell across borders — and we’re inventing more every year. But of great importance are Fulfillment by Amazon and the Prime membership program. In combination, these two programs meaningfully improved the customer experience of buying from independent sellers. With the success of these two programs now so well established, it’s difficult for most people to fully appreciate today just how radical those two offerings were at the time we launched them. We invested in both of these programs at significant financial risk and after much internal debate. We had to continue investing significantly over time as we experimented with different ideas and iterations. We could not foresee with certainty what those programs would eventually look like, let alone whether they would succeed, but they were pushed forward with intuition and heart, and nourished with optimism” — 2018 Letter
“We will continue to make investment decisions in light of long-term market leadership considerations rather than short-term profitability considerations or short-term Wall Street reactions” — 2017 Letter
Affinity For Service Oriented High Fixed Cost Businesses
What does Prime membership, Prime Video, online EC, FBA and AWS have in common? They have large TAMs and are high fixed costs internet businesses with low marginal costs.
“Online selling (relative to traditional retailing) is a scale business characterized by high fixed costs and relatively low variable costs” — 2000 Letter
“The answer is that we transform much of customer experience — such as unmatched selection, extensive product information, personalized recommendations, and other new software features — into largely a fixed expense… our costs as a percentage of sales can shrink rapidly as we grow our business. Moreover, customer experience costs that remain variable — such as the variable portion of fulfillment costs — improve in our model as we reduce defects. Eliminating defects improves costs and leads to better customer experience.” — 2002 Letter
From the early days of Amazon, Jeff Bezos understood that the online EC business is a high fixed cost business with attractive unit economics as it scales larger. Amazon harnesses the internet to deliver units at minimal to zero marginal costs while spreading the high fixed cost base of its fulfillment and technology infrastructure over large units as it scales. The remaining variable costs like delivery and shrinkage are then actively improved through operational efficiency.
“We also like the fixed cost nature of original programming (Prime Video). We get to spread that fixed cost across our large membership base” — 2014 Letter
Prime Video is another example. Content costs whether purchased externally or made in-house are high fixed costs in nature. However, delivering content to users only requires bytes with near zero marginal costs. As the Prime Video user base scales, it allows Amazon to spread content costs over large units, constantly improving the unit economics.
It is the same story with AWS too. It requires heavy upfront capex investments in datacenters and technology to provide cloud computing services but requires little marginal costs to service the additional customer.
This leads to a focus on scale, market leadership, and to get there fast. The key is to do it quick and invest big.
“The stronger our market leadership, the more powerful our economic model. Market leadership can translate directly to higher revenue, higher profitability, greater capital velocity, and correspondingly stronger returns on invested capital” — 1997 Letter
Economies of scale is a well-known competitive advantage but Jeff Bezos took it a step further by sharing the incremental benefits of scale with customers instead of keeping it within Amazon.
Nick Sleep of Nomad Investment Partnership articulates this well in his “Scale Efficiencies Shared” business model. He first identified this model in his investment in Costco in the early 2000s which subsequently led him to his investment in Amazon. He recognized Costco’s customer focused approach and how they were reinvesting their benefits of scale in their relationship with customers.
As Costco opens new stores, the incremental costs savings from scale are pass back to the customers in lower prices. Costco fixes its retail prices at a maximum of 14% over costs, so if costs were lowered, that is passed on to customers. Customers then respond by driving more incremental revenue at existing and new Costco stores. On top of this, Costco charges a recurring membership fee, which has zero marginal costs, to customers for access to Costco stores.
This explains Costco’s below industry average margins but high returns on invested capital. Costco in 2005 had generated $830/sqf of revenue compared to Wal-Mart’s Sam Club of ~$500/sqf and other competitors at ~$400/sqf. Nick Sleep estimated that mature Costco stores then (open for at least 5 years) generated $1,000/sqf of revenue! These extraordinary returns on capital allowed Costco to reinvest even more into scale and further pass these subsequent cost benefits to customers, creating a strong virtuous cycle. This makes competing with Costco a difficult thing to do.
The same is true with Amazon but turbocharged by the internet. Amazon fixed cost base are largely its servers, technology spend, computer engineers and fulfillment infrastructure which scales faster than Costco’s fixed cost base of physical warehouses and retail stores. Amazon’s customer reach is also not physically constrained as transactions were conducted over the internet compared to Costco requiring customers to drive to a nearby physical store. By passing the benefits of scale in the form of lower prices, new customers are enticed to shop on Amazon while existing customers shop more frequently. This fuels further growth and the flywheel continues spinning.
Jeff Bezos recognized this, reinvested heavily in this competitive advantage and pressed it hard over the years. And just like Costco, this makes competing with Amazon a difficult thing to do.
“Growth spreads fixed costs across more sales, reducing cost per unit, which makes possible more price reductions. Customers like this, and it’s good for shareholders. Please expect us to repeat this loop…. Until July, Amazon.com had been primarily built on two pillars of customer experience: selection and convenience. In July, as I already discussed, we added a third customer experience pillar: relentlessly lowering prices. You should know that our commitment to the first two pillars remains as strong as ever” — 2001 Letter
“In the long term, however, relentlessly driving the “price-cost structure loop” will leave us with a stronger, more valuable business. Since many of our costs, such as software engineering, are relatively fixed and many of our variable costs can also be better managed at larger scale, driving more volume through our cost structure reduces those costs as a percentage of sales” — 2003 Letter
In the next post, I will talk about Jeff Bezos’ love for cash and Amazon’s second flywheel, among other things.