0:02

Jeff Bezos has fascinated me for a

0:04

really long time. Not just because he built

0:06

one of the world's most dominant businesses

0:08

in Amazon, but because of how he

0:11

approached problems that didn't even really seem like

0:13

problems to most people at the time.

0:16

So today, I'm excited to dive

0:18

into Amazon's early story. Not

0:20

just how the company came to be, but

0:22

what really made it tick, what Bezos

0:24

embedded in its DNA, and how those early

0:26

decisions still shape its moat today. We'll

0:29

examine the early influences that shaped

0:31

Bezos' mindset, from Summers spent building

0:33

machines with his grandfather, to

0:35

his experiences at D .E. Shaw where

0:37

he learned the value of secrecy,

0:39

raising the bar during the hiring process

0:42

and surrounding himself with generalist problem

0:44

solvers. We'll also examine

0:46

what I believe makes founder -led companies

0:48

so compelling and how Bezos' willingness

0:50

to take bold swings, embrace failure,

0:52

and continually reinvent helped Amazon build a durable,

0:54

customer obsessed business that could take pain

0:57

in the short term for a long term

0:59

game. Along the way, we'll

1:01

explore how small things such as user

1:03

reviews and one click ordering have turned

1:05

into just a massive competitive advantage. We'll

1:07

also walk through why Amazon Prime

1:10

was made specifically to be irresponsible not

1:12

to be a member and how

1:14

internal efficiencies gave rise to Amazon Web

1:16

Services, one of Amazon's biggest success

1:18

stories of all time. This

1:20

episode is for anyone who's curious about

1:22

what it really takes to build something great.

1:24

how enduring advantages are created, and

1:27

what we as investors can learn from the

1:29

early Amazon playbook. So, whether

1:31

you're just running your own portfolio, or

1:33

just want to understand how Amazon

1:35

became Amazon, I think you'll find

1:37

some very valuable takeaways here. Now,

1:40

let's dig into the DNA of Amazon and

1:42

unpack what helped turn a scrappy online bookstore

1:44

into one of the greatest businesses of all

1:46

time. Since

1:51

2014 and through more

1:53

than 180 million downloads, we've

1:55

studied the financial markets and read

1:57

the books that influence self -made billionaires

1:59

the most. We keep you informed and

2:02

prepared for the unexpected. Now

2:04

for your host, Kyle Grieve.

2:15

Welcome to the Investors Podcast. I'm

2:17

your host Kyle Grieve and today... be

2:20

discussing Amazon, and more specifically, I'll

2:22

be looking at Amazon's DNA. We'll

2:24

look at Amazon's history from its formulation

2:27

by its founder, Jeff Bezos, to

2:29

what he instilled into the business and how he built

2:31

it into a trillion dollar behemoth.

2:33

We'll focus mainly on its first 15 years or

2:36

so of its existence. We'll examine

2:38

why Amazon is where it is today by

2:40

mainly focusing on the rear of your mirror. Now,

2:43

Amazon can't be discussed without talking

2:45

about its founder, Jeff Bezos. He's just

2:47

as integral to the company's story as

2:49

Walt Disney was to Disney or Steve Jobs

2:51

was to Apple. Jeff Bezos

2:53

was a brilliant child from a very, very

2:55

young age. He was a major fan

2:57

of science fiction novels, and especially he was fond

2:59

of Star Trek, which we'll go over here in

3:01

a little bit. He spent his summers

3:03

on a Texas ranch with his grandfather, who actually

3:05

helped build the hydrogen bomb. While on

3:08

the farm, they built things together. When there

3:10

was a bulldozer that broke, Jeff and his grandfather

3:12

built a crane to lift the gears out

3:14

and fix them. They built windmills, they

3:16

laid pipes, and they discussed scientific concepts

3:18

like space travel. And during these

3:20

sessions, his grandfather would take him to the

3:22

library where he reportedly read hundreds of books.

3:25

Now, another interesting aspect of Jeff

3:27

Bezos' background was his self -reliance. And

3:29

this concept, I think, was ingrained by his mother,

3:32

who had Jeff in her late teens. This

3:34

concept deeply resonates with me since learning

3:36

about Ralph Waldo Emerson's impact on

3:38

Warren Buffet. I've also been inspired by

3:40

the idea that, you know, self -validation

3:43

is more important than external validation. You

3:46

can see how much self -reliance has impacted

3:48

Warren when he discusses his inner and outer

3:50

scorecard analogy. Buffett said, if the

3:52

world couldn't see your results, would you rather

3:54

be thought of as a world's greatest investor

3:56

but in reality have the world's worst track

3:58

record or be thought of as a world's worst investor

4:00

when you're actually the best? For

4:02

someone like Warren, knowing one's worth

4:04

despite others' opinions was a value that

4:06

was very high on his priority list. Now,

4:08

when it comes to Jeff, I think

4:10

he utilized self -reliance in a somewhat different

4:13

way. For instance, in a 2017 conference, he

4:15

said, when things don't work, you

4:17

have to back up and try again. Each

4:19

time you back up and try

4:21

again, you're using your resourcefulness. You're using

4:23

your self -reliance. You're trying to

4:26

invent your way out of a box. So,

4:28

Bezos thought of self -reliance as kind of a

4:30

tool to help him innovate and return to

4:32

the drawing board when things didn't work out as

4:35

he initially thought it would. And as we'll

4:37

see, Amazon has thrown many, many things against the

4:39

board. And even though they've had a number

4:41

of many failures, Amazon's ability to

4:43

make its success's work has more than

4:45

offset many of its failed ventures. The

4:48

last thing I want to touch on with

4:50

Bezos' childhood was his love of electronics. So

4:52

reportedly, his mom let him turn the family

4:54

garage into something of a science project lab.

4:57

And in that garage, he would create booby traps

4:59

for his siblings. Jeff said that

5:01

his mom would end up driving him back

5:03

and forth to Radio Shack multiple times just

5:05

to get the parts that were required to

5:07

make these traps. So as Jeff

5:09

became an adult, he learned a few critical lessons. The

5:12

first one that really took out to me

5:14

was to just focus on what you're really

5:16

good at. So there was a really interesting

5:18

story here of when Jeff was at Princeton.

5:21

And while there, his initial goal was to study

5:23

physics. So he was in one

5:25

of these classes on quantum mechanics, and he

5:27

was trying to solve a very complex problem

5:29

with a friend. They had some problems solving

5:31

it, so they turned to another classmate for

5:33

help. Apparently, when they went to this other

5:36

classmate, he quickly did the equation in his

5:38

head and came to the correct answer. After

5:40

going through this experience, Jeff realized

5:42

that he would never have an edge

5:44

in theoretical physics and ended up

5:46

changing majors to electrical engineering and computer

5:48

science after. I think this is

5:50

an excellent reminder for many of our younger listeners. If

5:52

you can find an area in life where you

5:54

have an edge, spend as much

5:56

time there as possible. Success will come a

5:58

lot easier than trying to succeed at

6:01

something you just don't have natural talents for.

6:03

Now, Bezos first foray into the

6:05

professional world of technology after school

6:07

was working for a business called

6:09

Fytel in the late 1980s. This business

6:12

developed private transatlantic computer networks for

6:14

stock fairs. His boss at

6:16

this firm said that Bezos was not

6:18

concerned about what other people were thinking,

6:20

which is obviously a hallmark of contrarian

6:22

thinking. Now, before landing a job at

6:24

De Shaw, Bezos had already started working

6:26

on ideas for his own business. He

6:28

was always kind of annoyed at what

6:30

he viewed as company's institutional reluctance to challenge

6:33

the status quo. And this is something

6:35

that he and Amazon, of course, are very

6:37

well known for now. So let's

6:39

talk a little bit about De Shaw here

6:41

because Jeff learned some very, very big lessons, I

6:43

think helped him shape Amazon from his time

6:45

at De Shaw. So De Shaw

6:47

was essentially a quantitative hedge fund.

6:49

It was started in around 1988

6:51

by David E. Shaw, and Shaw believed

6:53

in technology, which is a philosophy

6:56

that heavily influenced his company. Now,

6:58

a really fascinating insight Shaw shared

7:00

on secrecy was to keep their insight

7:02

secret to avoid teaching them to

7:04

current and potential competitors. And

7:06

even though D .E. Shaw was a quant

7:08

hedge fund, it operated much differently than its

7:10

competitors, such as Renaissance Technologies. So

7:12

Shaw, very, very interestingly,

7:14

he didn't actually bother recruiting financiers.

7:17

He looked for generalists and often fish

7:19

in the waters full of scientists and

7:21

mathematicians. I believe Bezos learned a

7:23

lot about the importance of hiring people who

7:25

could continue raising Amazon's bar through his

7:27

observations of Shaw while working there. Another

7:29

area which Bezos drew inspiration from D .E.

7:32

Shaw was in their hiring process. During

7:34

the hiring process, they would have

7:36

an example question during the interview.

7:39

For instance, one of them was, how

7:41

many fact machines do you think there

7:43

are in the United States? And so,

7:45

the actual answer to that question wasn't

7:47

as important as just trying to understand

7:49

the interviewee's thinking process and understanding their

7:51

ability to solve problems better. So,

7:53

they'd have a panel of people as part

7:56

of this interview, and after the interview

7:58

was completed, they would voice one of four

8:00

opinions on the interviewee, and that was

8:02

a strong no hire, inclined not to hire,

8:04

inclined to hire, or a strong hire. And

8:06

so, at DE Shaw, if just one of the

8:09

interview panel members had a poor view of a

8:11

potential recruit, the entire application could be rejected. So,

8:13

you know, one person could essentially have veto power

8:15

if they thought that it just wasn't a good

8:17

hire. But looking at Amazon, I

8:19

think Bezos drew inspiration from multiple sources, not

8:21

just D .E. Shaw. So, another source was

8:23

Microsoft, where they had a person who made

8:25

the final decision on a hire. So,

8:27

the observation bred a new program within

8:29

Amazon known as the Barraiser. And this

8:32

person is not necessarily the recruiter or

8:34

even the hiring manager, but can override

8:36

the hiring manager's decision to hire that

8:38

person or not. And this person is

8:40

put in place specifically to make sure

8:42

that the bar is consistently raised for

8:45

new employees. Let's get back to

8:47

D .E. Shaw here. While there,

8:49

Sean Bezos began formulating new

8:51

ideas. As I mentioned

8:53

earlier, D .E. Shaw, even though it was

8:55

a quantitative hedge fund, it wasn't just a

8:57

quantitative hedge fund. While there,

8:59

David Shaw viewed his business more of

9:01

a technology lab that was full

9:03

of highly talented problem solvers who could

9:05

use their talents to solve various

9:07

problems. So, for instance, during the tech

9:09

craze in the 1990s, DeShaw successfully

9:11

created businesses such as an ad -free

9:13

email service and an early type of

9:16

online brokerage for stock traders and

9:18

bond traders online. So, Bezos

9:20

was highly, highly exposed to the internet

9:22

craze and he began to see all

9:24

these different opportunities that were developing. And

9:26

Bezos definitely had his own ideas. And

9:29

one of his ideas, which we all know

9:31

today, is basically Amazon, which he thought

9:33

of as the everything store. So,

9:35

in the book, The Everything Store by

9:37

Brad Stone, Brad writes, several executives who

9:39

worked at Desco at the time say

9:41

the idea of the everything store was

9:43

simple. An internet company that

9:46

served as the intermediary between

9:48

customers and manufacturers and sold nearly

9:50

every type of product all

9:52

over the world. This one

9:54

idea would mark the beginning of

9:56

Amazon, but Jeff didn't think this

9:58

was practical just to start off

10:00

with. So instead of making

10:02

an everything store, he focused just on one

10:04

area of what the everything store would end

10:06

up servicing. And Jeff ended up

10:08

settling on books. So, he reasoned

10:10

that books were a commodity and buyers would always

10:13

know what they would be getting no matter where

10:15

they bought them from. So, even at Shaw,

10:17

Basel started testing competitors to see if

10:19

there was a market looking for what

10:22

he had to offer. So, there

10:24

was one story where a colleague of his at

10:26

D .E. Shaw bought a book from an early version

10:28

of an online bookstore. And when

10:30

the book arrived, it was just

10:32

severely damaged during the shipping process. And

10:34

Jeff realized through this experience that

10:36

competitors simply hadn't figured out how to

10:38

sell books competently online yet. Now,

10:40

as Bezos stood on the idea, he realized

10:42

that he need to actually go at it alone.

10:45

So he ended up quitting his job at Shaw

10:47

and he moved to Seattle with his then girlfriend. Seattle

10:50

was an interesting place to base the

10:52

business. But as you can probably tell, Bezos

10:54

didn't do things haphazardly. He chose Seattle

10:56

for a few very, very specific reasons. The

10:58

first reason here is that there was a

11:00

recent Supreme Court ruling that stated that merchants

11:03

didn't have to collect sales tax where they

11:05

do not have physical operations. And

11:07

this ruling reduced the playing field and eliminated more popular

11:09

states. Maybe you would have thought he would set it

11:11

up in something like California and New York, but he

11:13

would have been taxed there and therefore he would have

11:15

had to charge more to his customers. So

11:17

Washington was just a good choice because they

11:20

didn't have any state corporate income tax. And

11:22

Seattle also was home to Microsoft, which

11:24

had tons of talented engineering graduates that

11:26

were entering the workforce. And therefore, he

11:29

could easily onboard them into Amazon. And

11:31

then lastly, was just, it was a little bit

11:33

closer to many of the book's distributors. And

11:36

so in Amazon's early days, they would actually

11:38

get the distributors to ship the books to Amazon

11:40

and then Amazon would then ship it out

11:42

from there. So it just made more sense in

11:44

terms of logistics costs. So, you

11:46

know, it just made a lot of sense

11:48

for the headquarters to be in Washington and

11:50

it's still there today. But Amazon really started

11:52

out in Jeff's garage. So the

11:54

story goes that Amazon's first two desks were

11:56

actually built from two doors and some wood

11:58

that cost $60, I think, from Depot. The

12:01

business was basically bootstrapped by Jeff Bezos,

12:03

a couple other employees, and his parents.

12:06

And according to Jeff's parents, they didn't actually understand

12:08

the company very well, but they just invested because

12:10

they believed in their son, Jeff. Now,

12:13

Jeff was definitely shooting for the stars

12:15

with this business, but he also

12:17

realized that his chances of failing were

12:19

probably a lot higher than his

12:21

chances of success. So Bezos

12:23

told his parents when they made the investment

12:25

that there was probably a 70 % chance that

12:27

he'd lose their entire investment. He actually wanted

12:29

to tell them this because he wanted to

12:31

know that he could go home for Thanksgiving,

12:33

even if things didn't end up working out

12:35

with their investment. Now, I'd really

12:37

admire this honesty. And I think it

12:39

shows that Jeff was very honest about how

12:41

unlikely Amazon's success would be at the

12:43

very, very beginning. Now, the history

12:45

of Amazon's name is something we're briefly touching

12:47

on here as well. So, Jeff ended up

12:50

settling on Amazon for a few very rational

12:52

reasons, which probably won't be surprised about. So,

12:54

it was an A word, first of all. And

12:56

therefore, obviously, when search directories were more

12:58

important than they are now, A

13:00

was going to be first in the search directory.

13:02

So, there you go. And then, you

13:05

know, the reason that he's focused on Amazon as

13:07

a word that began with A was just that

13:09

Amazon kind of evoked a scale that he wanted

13:11

to get to at one point. So, you know,

13:13

the Amazon River is the largest river in the

13:15

entire world. And this was just

13:17

kind of a metaphor for just Bezos with what

13:19

he wanted to take Amazon to at one

13:21

point in the future. And again, you know, obviously

13:23

he knew that it was probably not the

13:26

best chance that he would get there, but he

13:28

ended up doing incredibly well. So

13:30

Bezos had a few employees working under him

13:32

in his garage and they had to run machines

13:34

that drew a lot of power into his

13:36

house. So some of these computers

13:38

basically drew so much power that they had

13:40

to power them from different circuits in the

13:42

house. Otherwise, they would end up blowing the

13:44

fuses on Jeff's home and killing his power.

13:46

So he fixed the problem by running these

13:49

giant long orange extension cords from all

13:51

sorts of rooms in his entire house. That

13:53

was kind of his work around. I

13:55

really like this story in particular

13:57

because I think it shows the

13:59

length that someone will go to

14:01

make their dream become a reality.

14:04

And I wrote in my notes in

14:06

the book here that it would be

14:08

really hard to see anyone other than

14:10

a founder doing something like this. I

14:12

mean, you know, how are you going to

14:14

tell your wife or your girlfriend that

14:16

you have all these hideous orange cores running

14:19

through your entire house unless that business is

14:21

your baby. It's going to be very hard

14:23

to do. I know I probably couldn't do

14:25

that with my wife. So,

14:27

I just think it's really hard to imagine

14:29

like a mercenary CEO is just in there

14:31

to make a quick buck doing that kind

14:33

of action at home. I just think that's

14:35

not really going to happen. And I think

14:37

that's part of the reason why founder -led businesses

14:40

just end up doing very, very well for

14:42

the most part, not always, of course, but

14:44

just comparatively speaking. Looking

14:46

at some of the data about

14:48

founder -led companies, I came across

14:50

a Harvard Business Review article that

14:52

showed some of the performances of

14:54

founder -led companies compared to others in

14:56

the S &P 500. This study

14:58

went from 1990 to 2014. Total

15:01

shareholder terms were actually three times larger

15:03

for founder -led companies than for other companies

15:05

in the S &P 500. I

15:07

personally enjoy investing in founder -led businesses,

15:09

although I don't necessarily consider it a

15:11

must. But founders will

15:13

often understand their business better than

15:15

anybody else. They own significant stock

15:17

in the business usually. And they

15:19

tend to embody that company's culture.

15:22

So having someone with those attributes leading

15:24

a business is definitely a potent

15:26

force in creating shareholder value. Now,

15:29

as I mentioned, Amazon's first goal was

15:31

selling books in a very crowded

15:33

market. So Jeff's original vision was to

15:35

sell books simply just better than competitors could.

15:38

And at the beginning, it worked. At the beginning

15:40

of the business, they had a bell ring. Every

15:42

time someone bought a book, but it got to

15:44

a point where that bell was ringing so often

15:46

that they had to turn it off because otherwise

15:48

it was just distraction for everyone there. So

15:50

kind of the way it worked was

15:53

once the order came in to Amazon, they

15:55

would order the book from its distributor

15:57

paying 50 % of the listed price. The

15:59

book would arrive at Amazon and then eventually

16:01

they would ship it from Amazon's headquarters

16:03

to the customer. Now, back then,

16:05

this business doesn't sound high -tech at all,

16:07

right? I mean, it's a simple website and

16:09

just sending people books, but you know, Bezos

16:12

really understood that he

16:15

could use Amazon to improve

16:17

the customer experience. To

16:19

start off doing this, he wanted to

16:21

find more books that were really, really

16:23

rare that you couldn't necessarily find in

16:25

a regular bookstore or even a regular

16:27

online bookstore. An additional issue

16:30

was that Amazon was so small, of course, at

16:32

the very beginning that they couldn't actually buy

16:34

the volume of books that were required by some

16:36

of their distributors to do business with them. So,

16:38

for instance, a distributor would accept orders of a

16:40

minimum of only 10 books at a time. So,

16:42

if Amazon didn't have 10 orders for that

16:44

book, which they probably wouldn't have when they were

16:46

working out of Jeff's home, it wouldn't be possible

16:48

to order a book from the distributor. But they

16:50

found a loophole here and it was really interesting.

16:52

So, what they would do is they would

16:54

order the one book that they needed and then

16:57

they found an obscure book. For instance, they found

16:59

one about lichens and they knew that the distributor

17:01

had this book and that it was out of

17:03

stock. So, this was kind of how they

17:05

could get around it. So, they would order one

17:07

book. They wanted nine books about the lichens that

17:09

was up stock. And that's how they got their

17:11

one book. Now, another way that

17:13

Bezos wanted to improve the book buying

17:15

experience was through user reviews. So,

17:18

in the early days, Amazon employees would

17:20

actually be the ones who are administering

17:22

many of these reviews to get the

17:24

ball rolling. Bezos thought that having a

17:26

database of user reviews would give Amazon

17:28

a major competitive advantage over its competitors. So

17:31

his thought process was that customers would

17:33

be less likely to go to its competitor's

17:35

websites with no reviews and instead stay

17:37

on Amazon. So Jeff, I think,

17:39

here understood network effects very, very well. So

17:41

one issue with these public reviews was

17:43

how book publishers felt about them. Jeff

17:46

gave a speech in which he said that he received

17:48

an angry letter from an executive at a book publisher.

17:51

And this angry executive stated that Jeff Bezos'

17:53

job wasn't to trash the books that they

17:55

were providing them, but to actually just sell

17:57

them. And Bezos said he actually saw his

17:59

job a lot differently than that. He said,

18:01

when I read that letter, I thought, we

18:03

don't make money when we sell things. We

18:05

make money when we help customers make purchase

18:07

decisions. Now, this is just

18:09

a profound statement and I think really

18:11

shows how misunderstood Amazon was. Jeff

18:14

was creating his own market that just

18:16

didn't exist at the time. And legacy business

18:18

would act in defiance that their method

18:20

was the best, even if you weren't following

18:22

their rules. So if

18:24

you weren't following the rules, they would say

18:26

that you're doing something wrong. But Jeff knew

18:28

where his edge was. He knew that the

18:30

key to making Amazon a great company was

18:32

to simply make the customer happier. Now,

18:34

from my experience, Amazon is still

18:36

one of my top expenses. I

18:39

really appreciate its user reviews.

18:42

When I'm trying to find a new product that

18:44

I want to buy, I love browsing the reviews

18:46

and seeing what other users are saying. It very,

18:48

very often guides my purchasing decisions. So the fact

18:50

that I can go on Amazon and see thousands

18:52

of reviews on a product, make it just easier

18:54

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18:56

can see if there's negatives about a product. A

18:58

lot of times that's what I'm looking for, seeing

19:00

what bad things people say. And if I see

19:02

something that doesn't resonate with me, then I just

19:04

don't buy that one and look for something else. Now,

19:07

this whole review system is really interesting

19:09

because sometimes I really wonder how many of

19:11

these other businesses are just kind of

19:13

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19:17

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right, back to the show. So

22:54

sometimes, for instance, I'll look at a company

22:56

like Timu and see that they have a ton

22:58

of their products. Nearly every one of their

23:00

products seems to have four and a half, five

23:02

star reviews, and they have thousands and

23:04

thousands of these reviews. And so, you

23:06

know, I've bought stuff on Timu and while

23:08

it's very well priced, it's very rare. I

23:10

would give anything I've ever gotten from them

23:12

a five star review. It's just the quality

23:15

is just not as good. So sometimes I

23:17

wonder if all the reviews are being generated

23:19

from employees or from some sort of third

23:21

party service that reviews things for you and

23:23

just automatically gives you a five star rating.

23:25

And there's some other examples of this, you

23:27

know, there's other smaller shoe sites I've seen,

23:29

like, based off advertising, for instance, off of

23:31

Instagram, where I see, you know, maybe they

23:33

have like 1000 reviews for one of their

23:36

product, but then zero reviews for different products

23:38

on the exact same site. And this has

23:40

always been kind of hard for me to

23:42

understand. And it actually really lowers my trust

23:44

with the business because I consider that manipulation.

23:46

I mean, if you have two products for,

23:48

let's just say, for an example, you have

23:50

two products, one has 1000 reviews, one has

23:52

zero, it kind of seems like it's very,

23:54

very obvious that you're probably manipulating the numbers

23:57

of reviews on one to some degree, or

23:59

you just have one product that, I don't

24:01

know, maybe you just don't sell it. It

24:03

just seems like a very, very weird sales

24:05

strategy. So, you know, this

24:07

is just to say that I have a very

24:09

high degree of trust in Amazon's reviews than

24:11

I do for most other companies. And I also

24:13

like that you can filter bad reviews on

24:15

Amazon and how they literally will show you bad

24:17

reviews, not at the very, very top, but

24:19

like They have their own area of bad reviews.

24:22

They're not just hiding them so that you

24:24

don't look at them. I really appreciate that. Now,

24:26

another innovation that Amazon brought to the

24:28

market was one click ordering. If

24:30

you've used Amazon, you're probably familiar with this

24:32

feature. So today, it's called the just buy

24:35

now button instead of the add to cart

24:37

button. And if you click it, you're basically

24:39

just all set to go. This

24:41

feature really feeds into Jeff's obsession

24:43

with improving the customer experience. So

24:45

the reasoning for it was that Jeff wanted

24:47

this feature because he felt like it would make

24:50

it easier for customers to buy things from

24:52

Amazon. Now, I think this

24:54

feature probably is taken for granted now. You

24:56

know, it was formulated in the late

24:58

1990s and Jeff knew that the feature served

25:00

a few purposes at that time. So,

25:02

the first was that it just delighted Amazon

25:04

customers by removing some of the friction

25:06

of filling out fields during the buying process.

25:09

And the second one is that it would

25:11

increase Amazon's competitive advantage against competitors and

25:13

hopefully widen its mode a little bit. So

25:15

I use Amazon's buy now feature maybe

25:17

25 % of the time when I shop

25:19

for just like one item. I think it's

25:22

excellent and it definitely reduces the time

25:24

needed to get to my desired items. But

25:26

you know, speaking from personal experience, I'm

25:28

not sure it's a huge reason that I

25:30

would buy from Amazon over a competitor.

25:32

Generally, what draws me to Amazon is its

25:34

cheap prices and fast and pre shipping. So

25:36

while the buy now feature is good, I

25:38

wouldn't choose Amazon over a competitor just because of

25:40

it. And you know, there's obviously at the

25:43

time that it was created It was

25:45

so that you wouldn't have to fill

25:47

out fields, but now there's technology. Your

25:49

address can be saved in things like

25:51

Google Chrome or in LastPass and just

25:53

pretty much instantly fill it out for

25:55

you. Of course, it still

25:57

takes longer than the buy now feature, but

25:59

it doesn't take that long. I don't

26:02

think that technology existed when Jeff first formulated

26:04

the one click. I can see

26:06

how it would have been a lot more

26:08

valuable, call it 15, 20 years ago than it

26:10

is today. Now, interestingly, with

26:12

that one click buying Amazon needed to

26:14

get patent for the technology behind it. And

26:17

they trademarked the name one click. And

26:19

the tech was so good that actually Apple

26:21

licensed it from them for use in the ice

26:23

tunes store and the Apple store. And

26:25

the technology was rejected by European regulators,

26:27

even though Amazon appealed it in 2001

26:29

and 2011. And the patent has expired

26:32

in 2017. So I think, you know,

26:34

it's not a huge part of Amazon.

26:36

That's probably why for me, from my

26:38

standpoint, it's just not that big of

26:40

a deal anymore. Now, let's get back

26:42

to Amazon in the book. So, once

26:44

Amazon started doing really, really well, which

26:46

was surprisingly fast with their books, Jeff

26:49

realized that he would need to

26:51

add additional products outside of books

26:53

and start diversifying. So, after

26:55

all, this was obviously his original dream for Amazon to

26:57

be the everything store, not just the bookstore. But

26:59

he first wanted to verify that it could work and

27:01

that he could get it up and running in the

27:03

first place and he clearly did. The

27:06

next additions to what Amazon would

27:08

sell would be music and DVDs. So

27:10

interestingly, Amazon's mantra in its early

27:12

days was to get big fast.

27:15

And Jeff knew that getting bigger would give him

27:17

all sorts of excellent scale advantages that could

27:19

then be passed on to Amazon's customers. He

27:22

also had a really, really good understanding of

27:24

the internet as we talked about it from

27:26

his days at DeShop. And his thought process

27:28

were that the internet retail was kind of

27:30

a winner take most type of market. So

27:32

Amazon relentlessly spent on R &D. as a

27:34

byproduct of growth and was willing to take

27:36

a loss for multiple years. But,

27:38

you know, with most smaller growth companies,

27:41

capital is required to continue fuel and

27:43

growth. So in 1998, Amazon raised about

27:45

$326 million in a junk bond offering.

27:47

In the following year, they raised another

27:49

$1 .25 billion. Now, remember

27:51

that we are in the peak euphoria phase

27:53

of the market and approaching the dot -com

27:55

boom here. So Amazon definitely chose the right

27:58

time to raise capital when it was cheap

28:00

and plentiful. Interestingly, even in the

28:02

early 2000s, Warren Buffett and Lou Simpson

28:04

of Geico purchased Amazon's bonds and did

28:06

really well on them. Now,

28:08

I find this really fascinating because it shows

28:10

that Warren and Lou understood Amazon well

28:12

enough to be highly convinced that they would

28:14

get their coupon and principal back from

28:16

Amazon but weren't interested in owning its equity.

28:19

But I suppose, you know, these are just two different

28:21

things and you don't have to be comfortable owning both

28:23

if you don't want to or if it's not in

28:25

your circle of competence. Now, before

28:27

Warren Buffett made his order, For Amazon's

28:29

bonds, he wrote Jeff a letter that

28:31

praised him for expensing stock options. He

28:33

wrote, It took particular courage on your

28:36

part and that will be recognized and remembered. If

28:38

I could show my appreciation by stepping up my

28:40

book orders, I would, but you're already getting all

28:42

of my business. So in

28:44

Bezos' first letter to public shareholders, he wrote, We

28:47

will make bold rather than timid

28:49

investment decisions when we see sufficient

28:51

probability of gaining market leadership advantages.

28:55

Some of these investments will pay off, others

28:57

will not. and we will have learned another

28:59

valuable lesson in either case. Additionally,

29:01

the letter stated that Amazon would

29:03

prioritize long -term thinking and free cash

29:05

flow generation over short -term profitability. Now,

29:09

when we look back today and see what Bezos

29:11

wrote, it's easy to want to beat ourselves

29:13

up for not taking part in the Amazon IPO

29:15

or even buying shares at the bottom of

29:17

the tech bubble if you're old enough, obviously, and

29:19

investing long enough. But Amazon's

29:21

financials weren't pretty during this

29:23

time. adjusted operating income, even

29:25

adding back R &D expenses remain

29:27

negative. And this number

29:29

wouldn't turn positive until 2003. So

29:31

an investor looking at this business might have a

29:33

hard time wrapping their head around whether or not

29:35

the company would make a good investment. The

29:38

only way I personally could see an investor

29:40

justifying an investment into Amazon in the early

29:42

2000s was to make very, very particular assumptions

29:44

with a high degree of certainty. So there's

29:46

three here that I had. So the first

29:48

one was that they were likely to continue

29:50

growing revenues in, let's call it, you know,

29:52

the 20s to 30%, which is obviously very,

29:55

very high. They'd have to

29:57

continue spending prodigiously on R &D, which

29:59

obviously created a lot of value, but

30:01

in terms of gap accounting, obviously,

30:03

was pretty hurtful to their income statement.

30:05

And they would actually have to continue in

30:07

terms of R &D. They'd have to continue seeing

30:10

very, very good returns on that R &D

30:12

spent. But here's the thing, you know,

30:14

Amazon was a very young company in the late 90s

30:16

and early 2000s. And so, assuming

30:18

R &D expenses would continue making as

30:20

good returns as they ended up doing

30:22

is just kind of a tough

30:24

assumption to make unless you just understood

30:26

the business very well and understood

30:28

maybe some of the R &D expenses

30:30

that they were putting capital into. And

30:33

obviously, some people did understand the business very,

30:35

very well. But I think investors for the most

30:37

part just ended up taking a pass because

30:39

the company just wasn't easy enough for them to

30:41

understand. Now, Amazon hit many

30:43

investments out of the park, which could

30:45

have convinced investors that they would continue

30:47

to do so. But they had several

30:50

failures as well. They splurged on acquisitions,

30:52

but some of the integrations with new

30:54

companies have been an issue with, for

30:56

instance, key personnel that were unwilling to

30:58

acclimatize themselves to Amazon's culture or just

31:00

didn't want to be part of Seattle's

31:02

weather. Also, during the

31:04

tech boom, they invested several millions

31:06

of dollars into dot -com businesses,

31:08

things like pets.com, gear.com, windshopper.com,

31:11

greenlight.com, and homegrocer.com. And Amazon lost

31:13

hundreds of millions of dollars on these

31:15

investments. And hundreds of millions doesn't

31:17

seem like anything for Amazon now, but

31:19

it was very, very big for

31:21

them at that time. So

31:23

assuming that all these investments would work

31:25

out that they were making just seems

31:27

like a very, very complicated assumption. And

31:29

on top of that, R &D

31:31

was a very significant

31:34

amortization expense. And

31:36

Amazon just, it's not like a

31:38

constellation software. So adding back amortization,

31:40

of intangible seems like a very,

31:42

very massive stretch to do to

31:44

make the adjusted numbers look better.

31:47

You could argue that you could add back

31:49

a portion of R &D and give them

31:51

some credit for previous acquisitions or R &D

31:53

that ended up working. But again,

31:55

this just all depends on your understanding

31:57

of the business's inner workings and what

32:00

assumptions you're comfortable with making. But

32:02

let's get back to another one

32:04

of Amazon's most significant launches, which was

32:06

the Kindle. Bezos was

32:08

keenly aware of the forces of capitalism.

32:10

Apple did a huge number to

32:12

Amazon CD sales when they launched iTunes.

32:15

Now, this plays well with Jeff's view on

32:17

inventing and wandering, which is the name

32:19

of another book about Amazon that explores a

32:21

number of his shareholder letters and different

32:23

discussions. But what really interested

32:25

me here about Jeff's observation on Apple

32:27

was how it forced him to really

32:30

understand the strength of innovation. And

32:32

the Kindle was one such innovation, which

32:34

has worked out incredibly well. So I myself

32:36

have had three different kindles over the

32:38

years. So I've had experience as a user

32:40

here for multiple years and I've seen

32:42

how the product has improved over the years.

32:45

So with Jeff's observation on the power of digital

32:47

content, he knew that he had to get

32:49

ahead of the game in moving towards digital content

32:51

from analog. So in 2004,

32:53

78 % of Amazon's revenue came from

32:55

books, movies, and music. These were all

32:57

areas that were very, very ripe

32:59

for disruption by moving towards digital. Jeff

33:02

and Amazon knew that building the Kindle

33:04

to what Jeff wanted would end up cannibalizing

33:06

part of their book business. But

33:08

I guess the assumption was that they'd rather

33:10

keep their share of books, whether in analog or

33:12

digital form, rather than losing a part of

33:14

it to a digital -only competitor. Jeff

33:16

ended up transferring one of his top employees

33:18

in books to focus on killing his own

33:20

business in books. So Jeff told him, I

33:22

want you to proceed as if your goal

33:25

is to put everyone selling physical books out

33:27

of a job. Amazon cloned its ideas from

33:29

Apple and Palm to get their initial prototype

33:31

of the Kindle. Eventually, Amazon's

33:33

engineers were tasked with building a

33:35

crude electronic reading device. Jeff

33:37

wanted the device to be so easy

33:40

to use that a grandmother could operate it,

33:42

and he demanded that books be transferred

33:44

to the device wirelessly rather than via a

33:46

computer, via a USB wire. As

33:48

the device was developed in secrecy, there

33:50

were a number of issues that were

33:52

popping up. Some

33:54

of Kindle's earlier competitors were just really

33:56

bad products. Part of the reason for

33:59

that was that they had very, very

34:01

limited book catalogs. Let's say

34:03

you bought an e -reader, but then realized

34:05

that you couldn't buy a book that

34:07

you wanted to read on that e

34:09

-reader. Therefore, that would make that e -reader

34:11

essentially useless. Amazon's goal

34:13

was to have 100 ,000 titles, including

34:15

about 90 % of New York Times

34:17

bestsellers, ready to read and buy

34:19

by the time the Kindle launched. Now,

34:21

just this one little initiative launched

34:23

a whole new set of problems, but

34:25

I think here displayed a lot

34:27

of Amazon's monopolistic powers. So,

34:29

Amazon at this time was a big part

34:31

of the overall book selling ecosystem, and obviously

34:33

publishers knew that. They cherished their

34:35

relationship with Amazon simply because Amazon brought them

34:37

a lot of business. But

34:39

as Amazon began scaling up, they began

34:41

to having more and more power with

34:43

their suppliers, and they could start asking

34:46

for more favorable terms than they were

34:48

able to demand when they were a

34:50

smaller company. So one such strategy that

34:52

Amazon could employ was to actually pull

34:54

books from its automated personalization and recommendation

34:56

system for a multitude of reasons. So

34:58

obviously, if they pulled it, this would

35:00

decrease sales specifically to a publisher that

35:02

would sell them that particular book. And

35:05

Amazon could literally pull this lever whenever

35:07

they wanted to. And so

35:09

it was reported that this one lever

35:11

could reduce sales by up to 40%.

35:13

And so since Amazon was all about

35:15

improving the customer experience often by cutting

35:17

costs, These benefits had to be paid

35:19

by someone else. In Amazon's case, it

35:21

was the publishers who were paying for

35:23

the better experience for Amazon's customers by

35:25

basically being forced into compressing their margins. And

35:28

the time came when Amazon was so

35:30

powerful that its suppliers just needed Amazon

35:32

more than Amazon heated them. Now,

35:34

this is just an excellent position as a

35:37

business owner because you get lower input costs. Now,

35:39

I mentioned earlier here that Kindle was top secret.

35:42

So while Amazon was trying to get publishers to

35:44

go digital, they couldn't actually tell them why.

35:46

which made it a lot harder for publishers to

35:48

want to play ball with Amazon. However,

35:50

they eventually got the Kindle prototype

35:52

and in 2006, they began showing

35:54

it to publishers. Apparently,

35:57

it was just ugly. In the

35:59

Everything Store, Bradstone describes

36:01

it as a cream -colored bastard child

36:03

of blackberry and a calculator. Over

36:05

time, the product ended up improving and the

36:07

publishing executives actually liked what they ended up seeing.

36:10

Once they started liking what they saw

36:12

in the end product, publishers began digitizing

36:14

their content. And the ones who decided

36:16

not to digitize their content or didn't

36:18

want to do it fast enough, obviously

36:21

would be injured by Amazon because, like

36:23

I just said, Amazon can manipulate their sales

36:25

through the use of their algorithms. And

36:28

this is just interesting because Amazon's

36:30

points on innovation come really strong here

36:32

because they essentially invented the e -book

36:34

industry. Maybe they weren't the very

36:36

first e -book that was out, but

36:38

they popularized it and made it a

36:40

lot more user -friendly. But then,

36:42

of course, Like I mentioned in previous

36:44

stories about Amazon's innovations, there are always

36:46

obstacles that would arise. So

36:49

talking specifically about the Kindle,

36:51

Jeff, wanting to, of

36:54

course, make the user experience as good

36:56

as possible, wanted to just charge about

36:58

$9 .99 for all eBooks. And

37:00

of course, this aligns with him

37:02

trying to make the best possible customer

37:04

experience. So if you're interested in

37:06

why he chose that $9 .99 number,

37:08

it just came from basically cloning Steve

37:10

Jobs with charging $0 .99 for a

37:12

song. Amazon figured that the

37:15

average book they bought at wholesale price

37:17

was about $15. So if they wanted

37:19

to charge $9 .99, they'd be taking a

37:21

loss on every single book that they

37:23

sold. And they were okay

37:25

with this because Jeff knew that he

37:27

was just adopting users into Amazon's ecosystem.

37:29

They would spend money elsewhere on higher

37:31

margin products and make up for the

37:33

lower margin Kindle products. Now, this

37:35

was all well and good, but the suppliers

37:37

had to be made happy as well. So

37:40

publishers and writers were just not pleased

37:42

about selling their books at such low

37:44

prices just to appease Amazon's customers. And

37:46

since the project was kept secret, the

37:49

publishers weren't even aware of the Amazon pricing

37:51

model until the Kindle was released. And

37:53

once it was released, publishers were

37:55

confused whether that pricing was discounted specifically

37:57

for the launch of the Kindle

37:59

or if Amazon was planning on keeping

38:01

that pricing in perpetuity. Now

38:04

once it was clear that Amazon was

38:06

just going to keep the pricing at $999

38:08

in perpetuity, they were basically forced to

38:10

roll with the model even if they disagreed

38:12

with it. Now, this is where I

38:14

think Amazon really started ramping up its network

38:16

economies. So let's put ourselves into the shoes

38:18

of a publisher for a moment here. Let's

38:20

say Amazon made up 60 % of our

38:22

sales. Amazon would pay us $15

38:24

for each book. Now, obviously,

38:27

we wouldn't like this move by

38:29

Amazon charging only $999 because it's going

38:31

to affect the other 40 % of

38:33

our business. If Amazon can sell

38:35

digital copies of our books for $10,

38:38

then what happens to our other customers who are

38:40

buying our books and then selling them for

38:42

$20 or $30? They would

38:44

definitely be affected by the competitive pricing,

38:46

meaning our remaining 40 % of revenues

38:48

would end up probably shrinking and

38:50

increase our reliance and concentration specifically on

38:52

Amazon. Now, as a result of

38:54

this, we basically have to bend our knees to whatever

38:56

Amazon's whims were. If they wanted to buy

38:58

books for $14, we wouldn't have much of a choice

39:01

but to just say yes. Now, This

39:03

is just an interesting area because

39:05

if you look at Amazon, I

39:07

think the perception of the business

39:09

is different if you're a customer

39:12

versus if you're doing business on

39:14

Amazon. Obviously, as a customer,

39:16

I love Amazon because all the

39:18

initiatives that they do with Jeff trying

39:20

to make the customer experience as

39:22

optimized as possible, it works. I mean,

39:24

I agree. I love Amazon. I

39:26

spend a lot of money on there.

39:28

But if you try to put

39:30

yourself in the shoes of a seller,

39:32

whether that's like a third -party seller

39:34

or even a supplier to Amazon. It

39:37

probably becomes a little harder to like Amazon.

39:39

I mean, Amazon has so much power that if,

39:41

like I just kind of mentioned with that

39:43

one example, if they want to say, hey, the

39:46

last five years we've been buying your books for $15,

39:48

if you want to keep doing business with us, we're going

39:50

to buy it for $14. And that's

39:52

kind of a hard pill to swallow

39:54

because I'm not a book publishing specialist,

39:56

but I would assume That's obviously going

39:58

to compress your margins and it kind

40:00

of sucks to swallow that pill. But

40:02

if you have Amazon, like I just

40:04

mentioned as well, as your biggest source

40:07

of revenue, you basically have no option

40:09

but to just say yes, you have

40:11

to do it. So it's

40:13

an interesting kind of dichotomy of looking

40:15

at Amazon through both the customer

40:17

and the supplier's view. So

40:19

Kindle at its beginning was a losing

40:21

initiative when it was first kicked off.

40:23

So Even if you fast forward to

40:25

2012, Amazon admitted that it was losing

40:27

money specifically on the physical Kindle device.

40:30

And yet today, that product is still being sold. Now,

40:33

this is an interesting strategy that very few

40:35

businesses can take part in. You

40:37

know, even though the Kindle itself

40:39

doesn't make money, it's impossible to say

40:41

how many new Amazon customers are

40:43

brought into this ecosystem who own a

40:45

Kindle. And so this led to

40:48

another area of Amazon success, which was

40:50

initially seen as something like a

40:52

lottery ticket, which was Amazon Prime. So

40:54

Amazon Prime was launched in 2005

40:56

and it was meant to offer unlimited

40:58

two -day shipping for only $79 a

41:00

year. And it's crazy to think

41:02

that 20 years later, the prices are still

41:04

just $99. And if you adjust for inflation,

41:06

it's actually clear that Amazon Prime is cheaper

41:08

now than it was in 2005. But

41:10

let's examine why Prime was developed in the

41:12

first place. So its ethos

41:14

was similar to that of Amazon,

41:16

which was to increase customer loyalty by

41:18

making their experience better than anywhere

41:21

else. And Jeff's problem was the idea

41:23

of Prime, like many other of

41:25

his ideas, was just uneconomical. So

41:27

it's impossible to know what

41:29

Amazon pays for shipping. But I've

41:31

looked it up and some

41:33

research suggests that on average, looking

41:35

at USPS, a parcel costs

41:37

about $4 to ship. Now,

41:39

expedited shipping, which is what Amazon wanted to

41:41

do, can cost about $9. So

41:43

even today, if you buy 10

41:45

items on Amazon, Prime essentially just

41:48

pays for itself. Now, when discussing

41:50

Amazon Prime, Bezos said, we

41:52

want to make it irresponsible not to be

41:54

a Prime member. And it's pretty clear

41:56

with the cost savings that you get from being a

41:58

Prime member that he succeeded in that goal. Prime

42:00

worked very, very well, even though they

42:02

made a loss on shipping. So

42:04

Amazon Prime members on average doubled

42:06

their spending on the site. And

42:08

as part of their increased spending,

42:10

customers diversified their product mix, further

42:12

strengthening Amazon's relationships with his customers.

42:15

And as Amazon grew, they started playing

42:17

on additional perks for Amazon members, the

42:19

most popular today being streaming video. As

42:22

Amazon added these additional features, it

42:24

became harder for customers to justify churning

42:26

out. Let's look at

42:28

how Prime helped improve Amazon's monopoly

42:30

in e -commerce. So there are

42:32

three primary ways I think it helped

42:34

widen Amazon's moat. The first one was

42:36

in logistics and warehousing dominance. So to

42:38

support Prime, Amazon's logistics had to improve

42:40

and they effectively became their own version

42:42

of FedEx. Now, competing

42:45

with Amazon's logistics was very

42:47

expensive. And therefore, few competitors

42:49

had the capital even to try to compete

42:51

if they wanted to. And then as Amazon

42:53

scaled, they just demanded concessions on shipping costs

42:55

similar to what they did with book publishers. And

42:58

this further creates barriers to entry.

43:00

A smaller competitors would not be afforded

43:02

these similar reduced rates. So

43:04

the second one here is locking in

43:06

consumers. So you know, customer lock -in can

43:08

be healthy or unhealthy. And in Amazon's case,

43:10

I think it was healthy, as Amazon's

43:12

goal was to create customer delight and not

43:14

force them into shopping with them if

43:16

they had a good alternative. So

43:18

Amazon was able to lock in customers

43:21

via convenience monopolization, where it was nearly impossible

43:23

to find a competitor who offered the

43:25

same amount of value and convenience as Amazon.

43:28

And the third one here is forcing

43:30

merchant compliance. So Amazon ended up

43:32

welcoming third -party sellers who basically had

43:34

to opt into fulfillment by Amazon to

43:36

be eligible for Amazon Prime. And

43:39

this made it so that Amazon could let

43:41

third parties own their inventory while Amazon would take

43:43

care of all their fulfillment and logistic needs. Now,

43:45

this was a significant advantage for Amazon as

43:47

it gained crucial data on third -party products it

43:50

could then try to compete with. Now,

43:52

Amazon had some controversy specifically over

43:54

this third point, which helps amend just

43:56

how good of a business Amazon

43:58

is specifically for its customers. Let's

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right. Back to the show. So,

47:42

most of the controversy comes from

47:44

its third -party merchants who feel

47:46

that Amazon engages in anti -competitive behavior.

47:48

So, let's say you want to buy a water

47:50

bottle for your toddler, something that I've done recently. Some

47:53

third -party merchants can post their products on Amazon.

47:55

You'll notice when you make a search query that

47:57

you'll see a bunch of items at the very

47:59

top that say, Sponsored. To be eligible

48:01

for Sponsored items, you must have a buy box,

48:03

which means that you're a good seller, you're able

48:05

to keep your stock full, you have a

48:07

good number of positive reviews, and you continue bringing

48:09

new products to the table. you get your products

48:11

to the top of a search query if you

48:14

have the buy box. Now, this

48:16

is great if you're a high -performing seller.

48:18

However, the problem that was brought to

48:20

light is that Amazon gathers data on these

48:22

items and all other items. Now,

48:24

the data collected is supposed to be

48:26

proprietary, but according to a resource that I

48:29

found on the Wall Street Journal, Amazon

48:31

can use the sales data from these third

48:33

-party retailers to help guide Amazon's own selling.

48:35

And with Amazon Scale, they can then look

48:38

for similar products And obviously, since

48:40

they get favorable terms from their suppliers,

48:42

they can then undercut third -party sellers using

48:44

fulfillment by Amazon. Now, from

48:46

an owner's perspective, if you own Amazon or

48:48

own their shares, this is obviously an excellent

48:50

source of potential sales into the future. Amazon

48:53

can not only see what is selling well,

48:55

but since they can take care of fulfillment, they

48:57

have additional logistics information which can then help

48:59

them determine the margins that they will make on

49:01

a specific product. If a third

49:03

-party seller sees Amazon selling the exact

49:05

same product or a similar product for

49:07

a better price, They're basically forced if

49:09

they want to keep selling their items

49:11

to drop prices and lower their margins

49:13

in order to compete with Amazon. From

49:15

a customer's perspective, of course, this

49:17

benefits you. If Amazon or a

49:20

third -party seller wants a customer's

49:22

business, I think a lot of times

49:24

on Amazon, they're just going to go to whoever

49:26

provides the most value. Obviously, Amazon has been at

49:28

the top of the game in providing customers with

49:30

a lot of value for almost its entire existence.

49:33

Now, Amazon Prime is an excellent example of

49:35

an analogous business unit that was created by

49:37

Amazon. Let's move on to something

49:39

that seems much different, but has made it

49:41

a ton of value for Amazon, and

49:43

that's Amazon Web Services. In

49:45

2002, a book publisher visited Jeff Bezos

49:47

and showed him a tool that

49:49

would visit Amazon's websites every few hours

49:51

and then copy the ranking of

49:53

this specific publisher's books and the ranking

49:56

of its competitors. This

49:58

publisher suggested to Bezos that

50:00

Amazon create application program interfaces, APIs,

50:02

that would quickly harvest data

50:04

on Amazon's products that others could

50:06

build upon. Amazon eventually settled

50:08

on developing these APIs, which allowed

50:10

other websites to publish sections

50:12

of Amazon's catalog on their websites.

50:15

This was an open source tool, and Jeff thought

50:17

the market could surprise Amazon with new and innovative

50:19

use cases of it. Now, if we fast

50:21

forward today, Amazon Web Service is

50:23

a much different service. Today, it's

50:25

best known for things like web

50:27

hosting, content delivery, data storage, backup,

50:29

archiving, applications development, data

50:32

analytics, machine learning, enterprise

50:34

IT, and migration. Clearly,

50:37

Amazon Web Services has evolved from its

50:39

initial use case into another being

50:41

entirely. And the reason is

50:44

interesting. So Amazon had its own internal

50:46

struggles in the early 2000s. And a

50:48

big struggle was that compute power was

50:50

one of the limiting factors in the

50:52

ability of members of Amazon to test

50:54

out new products and services. So

50:56

engineers were performing these repeatable

50:58

and time consuming tasks, such as

51:01

creating databases, finding storage and

51:03

getting compute power. In the following

51:05

few years after this, Amazon

51:07

realized that standardizing and modularizing each

51:09

of these components would save

51:11

Amazon's employees a ton of time.

51:14

And since they had these APIs available to others,

51:16

they could also be used to save others

51:18

time as well. So AWS

51:20

was officially launched in 2006 and

51:22

was based on three foundational services. The

51:25

first one being file storage, the second

51:27

one being scalable computing power, and the third

51:29

one being messaging between applications. Now,

51:32

while this doesn't really seem like a massive animation

51:34

today, it was an absolute game changer at the

51:36

time. It allowed developers to

51:38

rent compute power and storage on

51:40

demand, bypassing expensive servers and hardware

51:42

management. Amazon did a great

51:44

job of keeping this segment's growth and

51:46

profitability up to one's imagination. I

51:49

mentioned that D .E. Shaw, he

51:51

took part in these similar secretive

51:53

business practices. In 2009, they

51:55

had a line on their annual report called

51:57

Other. This one

51:59

line bunched AWS with other

52:01

Amazon services in a consolidated

52:04

manner. So I then

52:06

looked for Amazon Web Services just through

52:08

the find function. And I had to

52:10

fast forward all the way to the

52:12

first quarter of 2015, nearly 10 years

52:14

after AWS has started, just to see

52:16

the actual economics of the unit. So

52:18

in that quarter, AWS generated

52:20

$1 .57 billion in revenue and

52:23

$265 million in operating income with

52:25

about a 17 % operating margin.

52:28

Google and Microsoft had their own

52:30

versions of AWS, but they

52:32

weren't really popularized until around the

52:34

time that Amazon started publishing

52:37

that segment's financials. I find this

52:39

corporate strategy both fascinating and

52:41

frustrating. So for instance, I own

52:43

Tencent for a time. Now, while

52:45

I could develop different scenarios for what

52:47

their different segments were doing, Tencent

52:49

does an excellent job, I think

52:52

intentionally, of keeping their financials pretty

52:54

vague for investors. So

52:56

for instance, Tencent's cloud business is

52:58

inside of its fintech and business

53:00

services segment. While this

53:02

is great from a business standpoint,

53:04

potentially hiding a business's potentially most

53:07

high margin business in spite of

53:09

specific segments, it can be really,

53:11

really aggravating as an investor. If

53:13

I want to learn about a specific company,

53:15

but there's certain parts of that company that

53:17

are kept in a black box, it's really,

53:19

really hard to get comfortable with making an

53:21

investment. It forces you to

53:24

place your trust in management. And I

53:26

believe this is not a China problem.

53:28

I've seen this in European and North

53:30

American businesses as well. So,

53:32

for instance, there's been times where I've wanted information to

53:34

reach out to management only to get an answer

53:36

along the lines of, you know, we know the answer

53:38

to your question, but it's not public information and

53:40

therefore they can't share it. So, for instance, I own

53:42

a trust engineering and manufacturing company. And I've always

53:45

been interested in knowing how many board feet they are

53:47

making and what the pricing is for what they

53:49

sell it for. But it's just not

53:51

a number that I've been able to

53:53

find in management. doesn't share it because

53:55

it's not publicly available information. So

53:57

essentially, I have to rely on other numbers and my trust

53:59

in the management team. Now, let's

54:01

get back to Amazon's growth story here.

54:04

So Amazon has obviously had a

54:06

great deal of organic growth, but they've

54:08

also grown through a few very

54:10

important acquisitions. So one of the

54:12

most value -created acquisitions they made was with Whole Foods,

54:14

which I think everyone's going to be familiar with. And

54:17

they bought that for about $13 .7

54:19

billion, which helped Amazon experiment with

54:21

brick and mortar stores. However, I'd

54:23

like to focus here on two

54:25

acquisitions that made an earlier date, which

54:27

was Zappos and Quidzie. Zappos

54:29

was an interesting business. Its

54:31

CEO, Tony Shea, wasn't the founder, but was

54:33

one of its earliest investors and obviously

54:35

believed very much into the company. He

54:38

injected $1 .5 million of his own

54:40

money at one point, selling off his

54:42

own assets to fund the cash infusion. Shea

54:45

built a fascinating culture as well inside of

54:47

Zappos, where he actually offered employees $1 ,000

54:49

just to quit on their first week on

54:51

the job. So he figured that employees who

54:53

took that offer weren't right for the business

54:55

and this was his way of filtering them

54:57

out. I think Bezos would have

54:59

liked Tony because they both believed in

55:01

optimizing the customer experience. Managers

55:04

who under promise and over deliver tend to

55:06

be great managers and it appears that Shay

55:08

followed that mantra. So for

55:10

instance, Zappos would promise customers about five

55:12

to seven days of free delivery but

55:14

could often reduce that to two days

55:16

in major urban areas. So

55:18

Bezos began courting Zappos in 2005 trying to

55:20

understand if he could maybe acquire it. The

55:22

initial buy price that he assumed that they'd

55:24

be looking for was about $500 million. Now,

55:27

Jeff didn't want to pay that. So he

55:29

ended up getting a team together at Amazon

55:31

to create a separate website, which

55:33

was called endless.com. That sold shoes very, very

55:35

similar to what Zappos was doing. So

55:38

Amazon offered overnight shipping and free returns.

55:40

And this was an interesting maneuver specifically

55:42

done to undercut what Zappos was doing

55:44

and would end up costing Amazon money.

55:46

To entice customers even more, Amazon decided

55:48

to pay them $5 to order from

55:50

them on top of what they were

55:52

already getting just to further injure Zappos.

55:55

But even with these initiatives, Zappos continued to

55:57

grow, but it was hit very hard

55:59

during the great financial crisis. So,

56:02

Zappos required funding for their inventory.

56:05

Now, Zappos had some early investors including

56:07

Sequoia and they wanted to exit

56:09

their investment, which was putting further pressure

56:11

on them to find a buyer for the business.

56:14

Amazon then swooped in with an all share deal

56:16

for about $900 million. Now,

56:18

I have no idea if those shares were

56:20

held onto, but today they'd be worth $23 billion.

56:22

From this experience, Amazon learned how they

56:24

could gobble up competitors by using

56:27

very, very particular business tactics. If

56:29

Amazon could run a business unit at

56:31

a loss, it could pressure competitors to either

56:33

wither in a bankruptcy or just simply

56:35

sell out to Amazon. However, since

56:37

Amazon was putting pressure on the smaller guy,

56:39

Amazon came from a place of strength while

56:41

the acquired would come from a place of

56:43

weakness. Another very good example of

56:45

this is Quidzie. Quidzie ran

56:47

several successful dot -com businesses

56:49

like diapers.com. The founders of

56:52

Quidzie admitted to learning a ton from Jeff

56:54

Bezos and modeled much of their business off

56:56

of Amazon. Amazon here use

56:58

a similar tactic of dropping prices

57:00

to levels that were just impossible

57:02

to compete with dropping by up

57:04

to 30%. Quidzie, through these price

57:06

drops, started experimenting with changing prices

57:08

and then checking what the prices

57:10

of Amazon's basically clone products were.

57:13

And it was very interesting because as soon

57:15

as Quidzie would change their prices, Amazon's prices

57:17

would change basically immediately. And this was a

57:19

product of Amazon's pricing bots. So

57:21

in the everything store, Bradstone points

57:23

out that Quidzie executives took what they

57:26

knew about shipping rates factored in

57:28

Procter & Gamble's wholesale prices and calculated

57:30

that Amazon was on track to

57:32

lose $100 million over three months in

57:34

the diaper category alone. Amazon ended

57:36

up offering about $540 million for Quidzie.

57:38

with a 48 -hour response window and

57:40

clarified very specifically that Amazon would

57:42

inflict further pain on the business if

57:44

they didn't sell to them. Now,

57:46

the sell window here was made specifically because

57:48

Walmart was already engaged in its own due diligence

57:50

on Quidzie and Amazon didn't want to lose

57:53

out on that deal. So, it

57:55

became clear here that Amazon had some very,

57:57

very significant advantages that it can employ to take

57:59

control of its competitors. The option

58:01

for its competitors were to be driven on

58:03

a business or to join Amazon. Many

58:05

companies face this reality and if they

58:07

don't move fast enough, the deal can get

58:09

pulled and the walk away with nothing,

58:12

which was what Amazon intended to do had

58:14

Quidzie not taken Amazon's offer. Now,

58:16

let's shift here more to some of

58:18

Amazon's organic growth initiatives. Amazon

58:20

Echo and Alexa were other

58:22

areas of innovation that Amazon worked

58:24

incredibly hard to develop. Alexa,

58:26

in case you don't know, is kind

58:29

of Amazon's version of Apple's Siri. Echo

58:31

is the device that you speak

58:33

to to ask questions, play music, or

58:35

even order items directly from Amazon. I

58:38

haven't discussed many of Jeff Bezos'

58:40

personal preferences, but he's a Trekkie,

58:42

which means he loves Star Trek.

58:45

Now, one area of Star Trek that he enjoyed

58:47

was the ability to speak to a computer from

58:49

various places. And in Amazon's case, that

58:51

would be the ability to talk to a device from

58:53

the comfort of your own home. One

58:55

of the most significant controversies of this

58:57

product, similar to Google Home, was that these

58:59

devices constantly listen to all the conversations

59:02

that you have. In Amazon's case,

59:04

they felt they had to take this route

59:06

because it improved the product's usefulness. The

59:08

downside is that Amazon can potentially listen to

59:10

all conversations where the device is, even

59:12

when the prompt word is not used. Amazon

59:15

took measures to try to minimize this,

59:17

but some data shows that Amazon has

59:19

been able to leverage this information specifically

59:21

for targeted advertising. There was

59:23

a study at UC Davis that

59:25

showed that Amazon processes user interactions to

59:27

derive user interests. For instance, Amazon

59:30

concluded that the fashion and style persona

59:32

was interested in beauty, personal care, and

59:34

clothing. but also that the inferred interests

59:36

are in fact used for ad targeting.

59:39

Some of the personas, like health and fitness

59:41

and fashion and style, received up to

59:43

30 times higher advertising bids than the baseline

59:45

persona. I once worked as

59:47

a smart home integrator using cutting edge technology.

59:50

There was an analog to Echo and Google Meet

59:52

that was meant more for controlling your smart

59:54

home than access to information, like asking what the

59:56

weather is going to be. This

59:58

product was priced at about four

1:00:00

to five times higher than anything

1:00:02

from Amazon or Google. One

1:00:05

of the bigger selling points of the

1:00:07

item was that it specifically did not track

1:00:09

data. So from what I heard, they

1:00:11

had to charge a lot more specifically because

1:00:13

the device wasn't subsidized from additional ad

1:00:15

revenue on the back end from advertising. So

1:00:18

if you're being bombarded with ads about

1:00:20

things that you speak about, it might

1:00:22

be because smart devices like Amazon Echo

1:00:24

or Google Home are hearing keywords and

1:00:26

feed them into the algorithm specifically to

1:00:28

target you with advertising. So

1:00:30

I personally have actually never used the

1:00:32

Amazon Echo, only the Google Home. And

1:00:35

while they're similar devices, I never used

1:00:37

Echoes because I never really felt comfortable

1:00:39

ordering something specifically with my voice. It's

1:00:41

not that I don't like Amazon's products, but

1:00:44

if let's say I wanted pens, for instance, I

1:00:46

enjoy looking at some the reviews and finding

1:00:48

the specific pen that I want. And it might

1:00:50

not necessarily be the cheapest, for example. But

1:00:52

from my research, Amazon will use prior

1:00:54

purchases to guide their suggestions to you.

1:00:56

So If I asked for pens, perhaps

1:00:58

it would see that I like my

1:01:00

Muji half -millimeter pens and then ask

1:01:02

me to confirm ordering those exact pens. Now,

1:01:06

back to the Echo. As far

1:01:08

back as 2016, Jeff wrote in

1:01:10

the annual letter, our vision for

1:01:12

Alexa is ambitious. We

1:01:14

want to create an assistant that is

1:01:16

so powerful that you wouldn't imagine

1:01:18

going back to life without it. As

1:01:20

of 2023, reportedly 500 million Alexa -enabled

1:01:22

devices have been sold globally. So

1:01:24

it's been an excellent way for Amazon

1:01:26

to integrate its customers' lives into

1:01:28

its ecosystem. This is similar to

1:01:30

other products that I've already discussed today, such as

1:01:32

the Kindle and Amazon Prime. Now,

1:01:34

all of this is to

1:01:36

say that Amazon is really an

1:01:39

incredible business. Jeff built

1:01:41

a business with a culture of

1:01:43

innovation that embedded itself deeply into

1:01:45

its customers' shopping preferences. Many

1:01:47

companies claim to have their customers'

1:01:49

interests first, but their actions speak

1:01:51

otherwise. In Amazon's case, I

1:01:53

think part of its success has been

1:01:55

its laser -like focus on optimizing customer

1:01:58

experience. As you've heard today, Amazon

1:02:00

has sometimes been willing to cut the head

1:02:02

off of the Hydra because they know another

1:02:04

head would grow back and be even stronger.

1:02:06

A business that can harm itself in the short term

1:02:08

to improve itself in the long run is very,

1:02:10

very rare. So if your company

1:02:12

isn't capable of this, like 99 % of

1:02:15

businesses out there, it's just not a business

1:02:17

strategy that can easily be emulated. As

1:02:19

you saw with Zappos and Quidzie, those businesses

1:02:21

didn't have the scale and alternative revenue

1:02:23

streams to take on a company like Amazon.

1:02:26

You can argue that Amazon has utilized

1:02:28

unfair business practices. Amazon has had many

1:02:30

lawsuits throughout the years and I assume they're going to

1:02:32

have many, many more in the future. But

1:02:34

when it comes down to it, Jeff built

1:02:36

a business with naturally embedded advantages that are very,

1:02:38

very difficult to compete with. Businesses

1:02:40

with scale like Costco and Walmart have

1:02:42

these advantages too. However, smaller

1:02:44

companies trying to compete with them simply

1:02:46

don't. Amazon's army of engineers can

1:02:49

pretty easily emulate businesses that can try

1:02:51

to come in and utilize new technology

1:02:53

or strategies to compete with them. But

1:02:55

the problem is estimates have numbers of engineers

1:02:57

inside of Amazon at about 50 to 70 ,000. So

1:03:00

suppose a new technology is starting to

1:03:02

disrupt a product or service that Amazon offers.

1:03:05

In that case, they can easily divert resources to

1:03:07

create a competitive product and have the resources

1:03:09

to do so. And if that doesn't work, they

1:03:11

can always just take a loss on a

1:03:13

product and make life so miserable for a competitor

1:03:15

that they'll be forced to sell to Amazon

1:03:17

or to an inferior competitor. Amazon has

1:03:19

spent half a trillion dollars on R &D

1:03:21

since it went public. There's not that

1:03:23

many businesses worldwide that have spent that much

1:03:25

money to improve their products and services. You

1:03:28

must contend with that kind of R &D spend if

1:03:30

you want to compete with Amazon. Now,

1:03:32

as a competitor, you'd have to

1:03:34

imagine that your exit strategy would be

1:03:36

to either create a product that just doesn't

1:03:38

compete with Amazon or make a product

1:03:40

so good that Amazon would want to buy

1:03:42

you out. Other businesses like

1:03:44

Google and Microsoft have been able to

1:03:46

compete with, for instance, Amazon Web Services. However,

1:03:49

they can also spend hundreds of billions

1:03:51

of dollars on R &D, an advantage that

1:03:53

most competitors lack. I personally haven't

1:03:55

noticed my own spending on Amazon decreasing.

1:03:58

If anything, it's increasing as I find that

1:04:00

I can buy more and more items

1:04:02

at excellent prices on Amazon and all from

1:04:04

the comfort of my own home. Additionally, Amazon's

1:04:07

return policy is superb. So I recently

1:04:09

bought the Kindle Scribe and was having

1:04:11

some issues with it. After speaking

1:04:13

to an agent, I was very, very promptly

1:04:15

sent a new unit and sent the defective unit

1:04:17

back. It was a very, very easy and

1:04:19

painless experience. Now contrast this with

1:04:21

a clothing brand that I used to buy that

1:04:23

had no affiliation with Amazon. So with this

1:04:25

clothing brand, I purchased a pair of pants. And

1:04:28

after only wearing them twice and not in like

1:04:30

a rough manner whatsoever, they began pilling. So I

1:04:32

ended up emailing them and telling them about this. I

1:04:34

think this was only after about two weeks of

1:04:36

wearing it. And they said that this was just a

1:04:38

natural part of their apparel and that there was

1:04:40

nothing that could be done about it. Well, that was

1:04:42

the last time I ever shopped with that brand. And

1:04:45

I highly doubt that Amazon would have treated

1:04:47

my complaint similarly, which is probably why I just

1:04:49

keep returning back to Amazon. Now,

1:04:51

part the reason that Amazon has such

1:04:53

competitive pricing is that it is very similar

1:04:55

to Costco. They can both

1:04:58

purchase large volumes of products from their suppliers. If

1:05:00

Amazon wants to buy products from the supplier,

1:05:02

they can negotiate better rates than nearly anybody

1:05:04

on the planet because there are exactly zero,

1:05:07

that's right, zero e -commerce businesses that

1:05:09

get as much traffic to the website

1:05:11

as Amazon. According to similar

1:05:13

web, Amazon is the 13th most visited

1:05:15

website in the entire world. Therefore,

1:05:18

Amazon's network effects are just massive

1:05:20

compared to its competitors. So

1:05:22

even if we take the supplier out of

1:05:24

the equation and look at third -party sellers, you're

1:05:26

basically just doing yourself a disservice by not posting

1:05:28

your product on Amazon. Because if you have

1:05:30

the scale, there basically are no competitors out there

1:05:32

who is going to get the amount of

1:05:34

eyeballs on their site that Amazon can offer. Now,

1:05:37

while Amazon is a very moaty business, it

1:05:40

can't disrupt all industries. The

1:05:42

luxury industry comes to mind as an industry

1:05:44

that doesn't really seem to fit Amazon's market.

1:05:47

So I searched for Louis Vuitton and Hermes

1:05:49

on Amazon.com and it didn't come up with

1:05:51

any items. So my guess

1:05:53

is that these brands just don't want

1:05:55

their inventory to be associated with

1:05:57

Amazon's brand and therefore they just refuse

1:05:59

to do business with Amazon. However,

1:06:01

Amazon does own other websites outside of

1:06:03

Amazon.com. So perhaps it could take

1:06:05

market share with an unaffiliated website. But

1:06:08

the thing about luxury goods is

1:06:10

that the product's price is usually not

1:06:12

the primary reason that people buy

1:06:14

it. It's because of the symbol that

1:06:16

owning the product provides. Amazon

1:06:18

is really focused on making things

1:06:20

simple, cheap, effective, and fast. And

1:06:23

oddly enough, many luxury companies take

1:06:25

the exact opposite approach and have had

1:06:27

tremendous, tremendous success. For instance, if

1:06:29

you look at Ferrari, they make customers wait

1:06:31

for up to two years to buy a car. They

1:06:34

charge well over $350 ,000 just

1:06:36

for their entry -level products, and

1:06:38

they cater to driving enthusiasts, not just

1:06:40

the general population. An example of this

1:06:42

is that some of their cars have

1:06:44

no air conditioning or automatic windows simply

1:06:46

because it would make the car heavier,

1:06:48

but they don't care because Ferrari is

1:06:50

meant to go fast. Lastly

1:06:53

here, if you even want

1:06:55

to buy one of Ferrari's high -end models,

1:06:57

you actually need to own multiple lower -end

1:06:59

Ferraris just to warrant an offer on a

1:07:01

higher -end model. So, just

1:07:03

going through that, does that sound like

1:07:05

it resonates with Amazon's business model

1:07:07

or philosophy? To me, it doesn't at

1:07:09

all. But there's obviously a

1:07:12

ton of adjacent industries that Amazon could continue

1:07:14

scaling into, or it could just continue

1:07:16

scaling into the products and services that it's

1:07:18

already in, which it seems to be

1:07:20

doing very, very well. To

1:07:22

conclude here, I think Amazon's story

1:07:24

is just a masterclass in competitive advantage.

1:07:27

It teaches us that great businesses don't

1:07:29

just find product market fit. They build

1:07:32

stronger systems over time. If

1:07:34

you're an investor searching for long -term

1:07:36

compounders like myself, the lesson

1:07:38

here isn't to just look for the next

1:07:40

Amazon. It's to look for companies

1:07:42

with similar DNA, things like

1:07:44

having a long -term orientation, having

1:07:46

a founder's edge, and a

1:07:48

relentless focus on delivering more and more value.

1:07:50

Because in the end, the market may

1:07:52

misprice the business for years, but it won't

1:07:54

misprice greatness forever. That's all

1:07:56

I have for you today. If you want

1:07:58

to interact with me on Twitter, please

1:08:00

follow me at irrationalMRKTS or on LinkedIn under

1:08:03

Kyle Grieve. If you enjoy my

1:08:05

episodes, please please feel free to let me know how I

1:08:07

can make your listening experience even better. Thanks

1:08:09

again for tuning in, Bye -bye. Thank

1:08:11

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