Acquired - Episode 28: The Amazon IPO with original Amazon Board Member Tom Alberg

Episode Date: December 31, 2016

Ben & David welcome very special guest Tom Alberg, board member and first lead investor in Amazon.com, to cover the IPO of "earth’s most customer-centric company". From longterm thinking to flywheels to riding big waves, this episode is chock full of lessons and stories from the journey of building one of tech’s most iconic franchises. We hope you enjoy listening as much as we did recording it! Sponsors:ServiceNow: https://bit.ly/acqsnaiagentsHuntress: https://bit.ly/acqhuntressVanta: https://bit.ly/acquiredvanta  More Acquired!:Get email updates with hints on next episode and follow-ups from recent episodesJoin the SlackSubscribe to ACQ2Merch Store!Topics covered include: Tom’s “prolific” bio from the Amazon S-1Jeff Bezos’s journey from a Vice President at the New York hedge fund D. E. Shaw to founding Amazon in a Bellevue, WA garage in the summer of 1994Jeff’s longterm thinking as evident in the early days of Amazon, and his approach that "failure is ok, but not trying things is not ok” Raising the seed money for Amazon before product launch, how Tom met Jeff and decided to invest despite the “high” valuationTom's (and Jeff’s) focus on the power of targeting large and growing markets Amazon’s actual overnight success after launching the website: according to Tom at the time, "By the second or third week… It was clear there was a trend here.”How Amazon’s venture round, led by John Doerr of Kleiner Perkins, came together in the spring of 1996 Amazon’s torrid growth through 1996, Jeff’s mantra of “get big fast” to win the land grab of online book selling, and the board’s decision to prepare for a public offering in the spring of 1997 How Frank Quattrone and Bill Gurley, then of Deutsche Bank, won the lead position for the Amazon IPO, beating out more storied firms such as Goldman Sachs and Morgan Stanley Development of the flywheel concept within Amazon, as an outgrowth of maniacal focus on creating superior customer experienceAmazon's public offering on May 15, 1997 at $18 per share (effectively $1.50 relative to today’s stock price after splits), raising $54M at a market capitalization of $438M — and subsequently trading down during the first few months following the IPO  Amazon and Jeff’s management of investor perceptions of the company, and ability to sell the longterm vision over short term profits — “you get the investors you ask for” The creation of the first annual letter to Amazon shareholders included in the company’s 1997 annual report (and republished every year since), and then-CFO Joy Covey’s role and contributions to it Raising convertible debt just before the peak of the dotcom bubble and subsequent ability to survive the burst, and the impact of the downturn on Amazon culture  The Carve Out: Ben: the band The Album LeafDavid: Cormac McCarthy (author of All the Pretty Horses, No Country for Old Men, etc)’s contribution to W. Brian Arthur’s landmark paper about the economics of the internet, “Increasing Returns and the New World of Business”Tom: Michael Lewis’s latest book The Undoing Project, chronicling the Nobel Prize winning partnership between Daniel Kahneman & Amos Tversky in developing the field of behavioral economics

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IPOs. I'm Ben Gilbert. I'm David Rosenthal. And we are your hosts. Today's episode is on the Amazon IPO. And we have an incredibly special guest with us today, Tom Wahlberg. So Tom, we know very well because he was one of the co-founders of Madrona, which actually brought Ben and me together. And none of us would be here if it weren't for Tom. But in addition to being a co-founder of Madrona, he has had another very special role over the last 20 plus years, which is board member of Amazon.com. And Tom was the first investor and the first, and I guess other than Jeff, longest serving board member of Amazon. Right. So we thought it would be fun. We will get through the whole IPO story here,

but to read Tom's bio from the S1 that Amazon filed in advance of going public. So Mr. Allberg has been a director of the company, Amazon, since June 1996. Mr. Allberg has been a principal in Madrona Investment Group, LLC, a quote, private merchant banking firm since January 1996. From April 91 to October 95, he was president and director of Lynn Broadcasting Corporation. And from July 1990 to October 1995, he was executive vice president of McCaw Cellular Communications. Both companies were providers of cellular telephone services and are now part of AT&T Corp. Prior to 1990, Mr. Allberg was a partner at the law firm of Perkins Coie, where he also served as chairman of the firm's executive committee.

He is also a director of Active Voice Corporation, Emeritus Corporation, Mosaics Inc., Teledesic Corporation, and Vizio Corporation. Mr. Ahlberg received his BA from Harvard University and his JD from Columbia Law School. So are any of those other companies still in business except for Amazon? No, I think, well, Vizio was acquired for a good price by Microsoft, I think over a billion dollars. But you also left out, for example, that I learned the multiplication tables in third grade and probably was class president in fifth grade. I mean, how can you miss these things? At Ballard High School, right?

Right. Ballard High School, eventually, right. Once again, thanks to Tom for joining us. We're super honored to have him on the show. Let's start with the Amazon story. So I expect most listeners are familiar with the lore of how Amazon came to be, but we'll retell it briefly here leading up to the IPO and ask Tom some fun questions along the way. So Amazon was founded in the summer of 1994, but actually started the idea a little bit before that when Jeff Bezos was a vice president at the hedge fund D.E. Shaw and Company in New York. And David Shaw, the founder of D.E. Shaw, assigned Jeff to think about business opportunities enabled by this new thing called the internet. And Jeff went off and did a bunch of research. And as legend has it,

he came across this one report about the growth of the internet that projected that it would grow 2300% annually for the next decade or so. And he kind of read that and decided, that's it. I got to be a part of this. I don't want to miss this boat. So he and his wife, Mackenzie, who he also worked with at D.E. Shaw, they quit their jobs and they road tripped across country to the West Coast with no particular destination in mind other than starting a company at the end of it. Jeff writes the business plan for what would become Amazon along the way, and they end up here in Seattle, where they start Amazon on July 5th, 1994, in a garage in Bellevue. Speaking later about this journey, Jeff would come to talk a bunch about what he terms the regret minimization framework. And this is a quote of there's a great piece in Wired magazine,

I think from 1999, interviewing Jeff and ask him about why he decided to leave and start start Amazon. He said, when I'm 80, am I going to regret leaving Wall Street? No. Will I regret missing a chance to be here at the beginning of the internet? Yes. So even in those early days, Jeff's kind of long-term thinking is evident there. And I'm curious for Tom, is the regret minimization framework something that Jeff talks about in the context of Amazon? What's your experience with that been? Well, Jeff is a big picture, long-term thinker. So I don't think we've really focused so much on that. I mean, I think it was important for him in terms of that decision. But maybe it underlies a lot of his feeling on, let's try things. And we can only regret that we didn't try something we can never regret that we tried something even if it fails so very much in the mode of failure is okay not trying things is

not okay awesome and along those lines of thinking about the origin of the idea for amazon.com as I was reading the everything store uh it says that jeff and and david were on a walk through central park when when jeff told him he was going to leave and and uh david shaw the the founder of de shaw who jeff worked for yes thank you david um and it it occurred to me not me although that would have been awesome it occurred to you know, the intellectual property and all this original research that had been done for Amazon would have been done at D.E. Shaw. What did that look like? And was that ever sort of a concern that D.E. Shaw would come back later with any sort of claim to the idea for Amazon.com? Yeah, well, he, Jeff had signed a non-compete and a non-solicitation agreement.

And I don't remember actually worrying about the non-compete, which, you know, in retrospect is kind of interesting. And actually, Shaw did start a couple of early Internet companies that Jeff was not a part of. And they even had a voicemail, not a voicemail, but an email company that developed and then went public in the late 90s and merged with somebody. But we did talk about, and Jeff paid strict attention to the non-solicitation of employees, and it was a two-year limit. And so Jeff, you know, there were people at D.E. Shaw, at least one person, who really wanted to desperately come with Jeff. Was Jeff Holden? No. So Jeff Holden, well, Jeff Holden might have been.

That might have been Jeff Holden. Jeff was at D.E. Shaw. And, I mean, the story is that. And Jeff is now, I think, SVP of product at Uber? Yes, I think so. Yeah, Jeff has had an interesting, Holden has had an interesting career. And we once looked at investing Madrona at a company he had started. The valuation was only about pre-money at $80 million or something. So we passed on that one.

But the story is that when the two years expired, Jeff Bezos immediately called Jeff Holden and said, pack your bags and come to Seattle, which he did. And then several other people from D.E. Shaw followed. So in the early days of the company, before it was obvious Amazon was doing well and could recruit all these former coworkers of Jeff's from D Shaw. Um, they spent a whole year actually building the site. Uh, so from the summer of 94 till the summer of 95, um, they build the site, uh, and then they launch amazon.com almost exactly a year later in July 1995. And along the way, Amazon raises its first

seed investment. And Tom, you led that first round of angels that invested in Amazon. How did that come together? How did you meet Jeff and end up deciding to do this? Well, the short part of the story is that Jeff was out raising that first million dollars and began in kind of early 1995. And he was calling on people. And a lawyer friend of mine, older lawyer, called me and said his investment group, he had a little angel investment group, that they had met with Jeff. And they didn't really understand this new Internet thing. And would I meet with Jeff and give them advice as to whether this was for real? And your background was in the cellular industry.

Yeah, I was at that time wrapping up selling Macaulay Cellular and LIM Broadcasting to AT&T. But I did know something about the internet. But this was very beginning. Netscape went public, I think, in like September, that fall of 95. And three of the key employees at McCaw had been recruited by Netscape, the president, the CFO, and the general counsel. So, you know, I was intrigued by it. But anyway, but, you know, you never always say,

no, I don't know anything about it. You say, sure. That sounds like a very Bezos-like approach to things. Yeah, well, it's a good thing I said sure. Anyway, Jeff then called me, and I met with him, and he laid out what he was planning to do. And the company, the website hadn't launched at this point, right? No, this was like May of 95 and the website launching in July. And so I was impressed by Jeff.

To say that I foresaw what Amazon was going to become would be not true. I don't think anybody, including Jeff, probably didn't fully. I'm sure he did not foresee what it became. I mean, he was excited about the growth of the Internet. He had done a lot of research. He had focused on books because it had this ability to have this enormous catalog of books that no single bookstore could afford to carry. And so I reported back to my friend and said, I think it's for real. You know, it's very risky, but – and Jeff is for real.

He's obviously a smart guy. He's very passionate about it. And so then my friend who had referred it to me a couple weeks later, he called me back, and he said, well, we called Jeff then after we talked to you, and we told him that the $6 million pre-money valuation was too high and asked him to lower it to $5 million, and he was unwilling to do it. Oh, my God. So he passed. So he passed.

Oh, my God. So years afterwards, and I'm really a wonderful guy, years afterward he would give me a hard time. I bet. About the huge price that you paid. So the point of it is it took Jeff almost 12 months. He didn't close until December of 95, this million dollars. Part of it came from his family, and lots of people passed on it, which is not surprising.

And there were a couple of kind of small venture firms at that time in Seattle. They passed on it. It was too risky in their mind, and they had a lot of risk. So, Tom, you've seen thousands of startup pitches and met with countless entrepreneurs over the years. Was Jeff like head and shoulders above any other pitch, or was this like super different, or was it like, yeah, I meet with a lot of really talented people with great ideas, and some work and some don't?

Yeah, no, I think looking back, it's a little hard, but I don't think he stood out as the only great entrepreneur I ever met, but certainly in the top 20 or 10%. But it was a combination. Like a lot of venture, we tend to think the person is very important, but also kind of what they're doing. I mean, it's not always exactly the business plan and the financial model, although that's important. It's often, are they in the right kind of technology and growth area? And because you could come up with lots of reasons why this was not going to succeed. But the internet was growing.

Some commerce was probably going to succeed. But the internet was growing. Some commerce was probably going to work. At 2,300% a year, apparently. Yeah, right. You know, it strikes me, one of the things, we talk about this a lot on this show, about the importance of the market and targeting large markets. And it struck me, reading Jeff's early writing about Amazon, and in particular, which we'll get to later, the first letter to shareholders after they went public, he really focuses on the market and illustrates how large the market is, even for just books, but then everything Amazon expanded into

is. And when you're operating in a large market, a lot can still go wrong and can go wrong and you'll still be successful. Uh, so that was 1995. And, um, when the website finally launched in the summer, it was, it's funny, you know, I mean, we work with at Madrona, Tom, many, many startups and Ben and me several as well. Um, it actually was an overnight success. Uh, when, uh, by the, this is actually Tom, a quote from you in that same wired article, uh, quote by the second or third week, there was 6,000 or $10,000 in sales. And by the end of September, they just launched in July. Amazon was doing $20,000 in revenue a week. It was, and this is Tom, it was clear. There was a trend here. Good, good understatement. Yeah. Understatement of the century. As that became clear later into 1995 and 1996, lots of VC firms came calling. And Amazon and Jeff eventually decided to raise

a larger venture round that Kleiner Perkins led in 1996, and John Doerr joined the board. How did that come together? Well, you know, Jeff had formed a small advisory board of himself and three other Seattle investors, including myself. So this was not, there wasn't a formal company board at this point, right? No, the formal company board was Jeff, but he wasn't ready for a board, but he was ready for an advisory board. So we would talk about, you know, like a board in the sense of, you know, what do we need to do? You know, gee, it's growing very fast. We've got to improve the website. We need to do, you know, other things.

And so it was becoming clear that it was growing fast, that it was going to take more money than the million dollars, partly just to satisfy growth. And venture capital firms from around the country were calling. And so I came home one night after work at 6 o'clock or something. And my wife said, do you know some guy named John Doerr? And I said, well, actually, I do. And I had said, do you know some guy named John Doerr? And I said, well, actually, I do. And I had actually heard of him. When I was on the Visio board, one of his partners was on that board. And I guess a couple of different ways I had met John. And so she said, well, he calls every 15 minutes and he needs to talk to you now.

That's amazing. It illustrates one of John's great strengths, which is persistence. Tells you something about how to sell yourself, show your interest. A critical trait for getting successful venture capitalists. We don't always follow that enough, probably. And so I talked to John, and he said, well, I'm going to meet with Jeff. I really want to be in this deal. I hope you can help me, et cetera. And so that was sort of partly the introduction.

So they were really eager. Another firm that was very eager was General Atlantic, which is an East Coast firm. And I got one interesting point out of it, I think, is that there was some negotiation on price, and both firms were eager. Both were outstanding firms. And General Atlantic proposed a complicated pricing because we're starting to talk, you know, $80 million pre-money. And that was – although that era started to get hot, it was, you know, reasonably high pre-money for a first venture round. But they proposed sort of a complicated thing. It would be $90 million pre-money if it went public. But if it didn't go public within two years at a certain valuation,

then it was $50 million. And Kleiner came in with sort of like a straight $60 million at some point. It was a little bit lower than the upside. And I think we all kind of favored Kleiner Perkins anyway, but picked Kleiner Perkins, partly, though, on the pricing complication. So when that round closed, is that when the formal board of directors was established with you and John and Jeff? Yeah. Yeah. Yeah.

And a little bit of story there that I think come out before, but Kleiner Perkins, Jeff, John actually said, well, I love you, but I'm so busy. I'm on all these other boards. He was on the Netscape board, I think, at that time. Right, right. And I really don't have time. And so, but here, I've got a great partner here that will be on the board.

And Jeff sort of said, well, that's, I'm sorry, you know's too bad sort of thing and talked to us. And we said, well, why don't you just tell them that Kleiner can only invest if John comes on the board. So Jeff, of course, did. And John joined the board, which was good for Amazon and good for Kleiner and John, obviously. Yeah. And I'm curious on that. So in the everything store talks about how it, and I don't know how much of this is causal, but after that

Kleiner invested in John joined the board, um, that Jeff kind of adopted as a mantra, get big fast. Was that, uh, how did that come together? And, and, and in truth, I mean, Amazon did get very big very fast. Right. Was that associated with investment? What drove that mindset change for Jeff? I think part of it just came from the fact that we were growing fast. The original business plan back when he was raising the million dollars was he had kind of a moderate growth and a fast growth, but nothing like what he was achieving. And the plan actually said he would break even in year two.

And, again, fortunately that didn't happen. He meant to rate year 20. Right. But it was growing fast. And Jeff also had one of his sort of thesis is sometimes there's – in launching a new business, there's a land rush. You want to be first and get into the lead and stay there. And other times – and this is true of launching new projects on Amazon. Sometimes he feels there's a land rush and sometimes not.

And so you really double down. And then the financial markets were clearly willing. I mean, we were in a hot. Robust. Already the financial markets were bidding up other companies. And so he realized that he could raise a lot of money. And so let's grow fast. And we had the specter of Barnes & Noble sort of saying they're going to get in the Internet.

So there was a reason then to really step on the accelerator. And you and Jeff did. So in 1995, which is the first half year of operations, Amazon did about $500,000 in revenue. And then in 1996, and it was the summer when Kleiner invested, so only half a year with this extra capital to grow, Amazon did just a hair under $16 million in revenue, which is, what's that? $20? That's a large amount of growth.

It's so large, I can't even calculate it in my brain. I mean, even today, like, right, we don't see companies do that. Not in the first year. And at this point, we were still in the era of amazon.com was only a bookstore. When Jeff was putting together kind of the pitch deck for that $60 million round and showing around, was there any inkling that it was going to be more than books at this point? Did he start to foreshadow those other categories? Jeff, in those early years, was very focused on books. I mean, he declined to even talk about other things for the first two or three years.

And I think that was including through the IPO, as I remember. And partly was, let's do books well. And books is big. But other people were starting to ask and talk about, well, what about other products? And, you know, I suspect Jeff was thinking about that. But it was good, I think, in the beginning, just let's get this one right. And it was, I can't remember when, but it was probably 98 or so that really launched music and started to launch some other things and movies.

So at the end of 96, just on 16 million in revenue, Amazon hires Joy Covey as CFO, who plays a the company makes the decision and the board makes the decision, uh, that they wanted to prepare for an IPO and go public, uh, in 1997, which, uh, so at this point we are two years into the life of Amazon as a company, one year into it being a publicly available website. Um, you've, you've talked a little bit about the, the financial markets being open, but how did those discussions – I mean, the board was you and John Doerr and Jeff. Did Jeff come to you and say, hey, I think we're ready to go public? Well, I think pretty quickly investment bankers were even calling. I mean, once something starts to get hot, whether there's substance in these companies or not,

they're sort of an investment banker. And that was particularly true in the 95 to 2000 era. People were going public and being worth $30 billion and really didn't have much. It didn't quite happen that way with Amazon because even though there was interest. And I think one of Jeff's motivations, I think the idea that we could raise money at hopefully good valuations and then use that money to grow further was attractive. He also felt that because it was kind of a small, relatively unknown retail company that it would help the brand to get better known. And, you know, I think that's true on some consumer-oriented companies.

It actually can be true even on enterprise startups. We have one in Pinch that went public this year. And they were not widely known among CEOs. Everybody at the CIO knew them. But once you get public, you know, you start to get picked up more in the Wall Street Journal and the New York Times. It certainly happened to Amazon after it went public. What was the preparation process like? In particular, I'm curious. So the lead left bank on the Amazon IPO was Deutsche Bank, not Goldman Sachs or Morgan Stanley.

We covered the Facebook IPO a few episodes ago and talked about the jockeying between the two of those firms for the Facebook IPO. These are the gold-plated Wall Street firms that everybody wants one of them to be their lead book runner for the IPO. But Amazon went with Deutsche Bank and in particular, the lead banker, Frank Quattrone and the lead analyst, Bill Gurley, who obviously is now a partner at Benchmark. How did that relationship come together? If you've met and know Quattrone and Gurley, The answer is Quattrone and Gurley. And, you know, a broader answer is, you know, I think, you know, Jeff always had the view and we had the view that big name companies aren't always the best. You know, Goldman and Morgan Stanley have been the top two then and today. And there's a lot of merit in going with them. But it didn't mean that others weren't as good or potentially better. And often it is the people directly working the deal. And so

I think they made a good impression and we thought they could do the job. There's a great story told in the everything store that after the ipo they organized a retreat in hawaii right and uh and that mexico i think oh mexico that's right i think it was cabo and um and they had an associate working on the deal uh who was jeff blackburn and uh blackburn came along on this along on this retreat and I'm sure had interacted with Jeff. There's so many Jeffs at Amazon, with Bezos and the company and the board beforehand. But the net of that was that Blackburn ended up joining Amazon and is still at the company today and a member of the senior team there. Right. One of the top executives.

Yeah. So one of the biggest things that people who've studied Amazon look at now and is quite well known is their ability to spin the flywheel, to add fuel at any given point and increase the momentum of other parts of the businesses in a very almost perpetual motion way. So that superior selection drives a better customer experience, which increases more traffic, which brings more sellers to marketplace, and on and on and on. Which lowers prices and increases selection. It's a recursive loop. It is.

Had this early in the company, before the IPO, was this something that was frequently talked about? And was this a thing on investors' minds when they were thinking about investing in the IPO? So the actual flywheel concept developed in like 2001 or 2002. It rose out of a board meeting and meeting with an outside consultant. But some of the basis of that, I mean, Jeff, from the very beginning, was very focused on customer experience. And he talked in the meeting with me about we're going to have the world's best customer experience. And it was hard to do in those days because the web wasn't very good.

When we launched, it was hard to do in those days because the web wasn't very good. When we launched, it was a black and white website. There was no publication date on the book. So if you wanted to buy a travel, I mean, I complained about this. If you wanted to buy a travel book, you didn't know if it was published 20 years ago or six months ago. And on a travel book, it's very important. But nonetheless, it was like it was genetic, that customer experience. And then so how do you do that? Well, prices, inventory. And so it was in the background, certainly, and focused, you know, some of those elements.

The flywheel metaphor became useful later, I think. Hearing you talk about that, one, as longtime listeners of this show know, we are great admirers of Ben Thompson and his aggregation theory. But one of the core tenets of that is that superior customer experiences win in a world where your accessible customer base is infinite and distribution costs are low, which is the internet. And really interesting to hear that even in those early days when the internet was so poorly understood by so many people, Jeff got that at his core that providing the superior

customer experience would lead to winning the market. And not all the companies get that. I mean, partly they're focused on short-term, partly, yeah, how to squeeze another two cents out of the customer. Gee, we cut out this product and we save money. So all of this happens, Quattrone and Gurley win the business, lead the IPO, and on May 15th, 1997, so less than three years after the company was founded

and less than two years after the product launch i mean we were talking last week about how snapchat is to be lauded for going public having the courage to go public courage uh four years after company founding this was less than three years uh amazon prices its ipo $18 a share, raises $54 million at an initial market cap of $438 million, which is thinking back today, we'll wrap up at the end of the show with where the market cap is today. But it trades up on the first day, closes at $23.50. But then for the first couple months, it actually trades down. And it's not until the company reports its Q2 revenue numbers later that summer that the shares, when they report that they did $28 million in revenue in Q2 of 1997, which was more than all of, well, much more than Q1 and more than they did in all of 1996, then the shares rise again.

What was it like in those first couple months after the company went public and the stock traded down? Yeah, you're right. It didn't have this enormous pop at the beginning. And yeah, I think by, you know, I vividly remember some of this, that it was pretty flat until those marine release came out and even by the um end of the second quarter so late june i think it was so the equivalent to to today so if you um there's been three or four splits which are equivalent for 12 for one so

if you divide 18 by 12 you get to a dollar 50.50. And so it was trading about $1.50 in late June. And then just a couple of other key points, because you can do this endlessly, but by the end of the year, it was like $5. And then it went to 100 over three years or so in today's numbers. And then the stock split multiple times after that. But by 2001, when you had the recession and all the crashes, it was back down to like $6. So there were moments when you could have bought in at good prices and everybody, you know, it shows partly that the market is not perfect at valuation. But on the other hand, you know, the country was in a recession by 2001.

And Amazon is a retailer. And it was losing a lot of money. And many people were predicting even then that it was going to die. But, yeah, it's kind of fascinating to go back over those numbers. Oh, yeah, I bet. One of the things we talk about a lot on this show is we try to assess whether an acquisition or an IPO was a good move and how successful was it. And one of the measures that we use for that with IPOs is what going public enabled that company to do that they would not otherwise have been able to do. So what in the kind of near term, those next few years after the IPO, did they plow that new influx of capital into?

Well, I think Amazon has been rightly known for not making any money and being willing to invest to the extent that the financial markets allow you to. And so I think if it had been in the hands of, let's say, an acquiring party, you would not have seen this kind of growth and then innovation and expansion. So, you know, Jeff has had a unique ability to think long-term and make it clear he's thinking long-term so that the investors understand that this is a long-term investment. And he likes to say that you get the investors you ask for, meaning that if you focus on, you know, two cents more profit per quarter, then you get investors who focus on that. And if you, you know, it takes you a while, I think, to get the right kind of investors. But if

you say long-term cash flow is how we measure the business, pretty soon you get investors who are willing to invest on that basis. And I mean, it's possible if you don't grow, they weren't going to like your message and sell, but you end up with fewer short-term investors and more long-term. I think that's helped Amazon a lot. So I'm super curious on this. We were chatting a little bit before the show, and this is the perfect place in the story too.

So at the end of 1997, Amazon wraps up the year with one hundred and forty eight million in revenue up from 16 the year before. Incredible growth. But I think to my mind, the most incredible thing that happens at the end of 1997 is Jeff publishes his first annual letter to shareholders. So the company's been public for seven or eight months at this point. And Jeff writes this amazing letter that is included in the annual report, and he's included every year since with his then current year letter as well. And the document is a masterpiece of long-term thinking. How did that document come together? Did Jeff just walk into a board meeting one day and say, hey, I think I'm going to write a letter to all of our shareholders? Well, I wasn't, you know, I didn't help him write it. Unfortunately, I wish I was a co-author.

But I think, you know, one of the key people in those early days was this Joy Covey, who had been recruited as the CFO. And thinking back a little bit on that, when we started talking about going public, John Doerr said, well, I'm going to vote against going public unless you bring in some more senior management. You can't go public with you and a couple of technical people. And so, I mean, it's been a rule that sometimes we violate, but it's a very good, I think, rule that you need. Being private is different than going public. Even if you're growing pretty well, you need a really first-class CFO. You need some more marketing power.

It's when David Risher was recruited from Microsoft, who was a very important, strong senior executive in those days. We brought in, hired some more, Rick Dalzell, all that. He was actually at Walmart, and Jeff started trying to recruit him in January of 97, before the IPO and didn't get him until after the IPO. But so, and I think Jeff wasn't reluctant on that either. But it was really John in a lot of ways saying you've got to have a stronger, bigger team to go public. And I think it's a good lesson for lots of people. So Joy was – and she also really – Joy was unusual.

She was very smart. She hadn't graduated from high school. She ended up graduating from Harvard Business School. She came in second in the nation on the national accounting exam. So clearly she was smart. Joy was an amazing woman, yeah. Yeah, and all she had done in some ways, she had been CFO of a small company in the East Coast that had gone public. I believe she was in her early 30s when she joined Amazon.

Yeah, very young. But, you know, and Jeff was interviewed. Jeff's a very tough interviewer in the sense that, you know, he will interview a whole bunch of people until he finds somebody that he likes and thinks can do the job. He talks about, you know, setting the bar very high. And he had a great lunch with her. He was impressed with her. And she's very smart,

nicely aggressive, personable. And so she really drove the IPO in a lot of ways. And I like to say, you know, we set a record for start of the IPO to the finish. But she was also involved in that letter, I think. Wow. Speaking of the IPO start to finish, was that hard for the company in an era where it had been doing so much PR and so much marketing and Jeff had been doing all these public appearances to endure that quiet period? Yeah, I think, yeah. I mean, it was an era when, yes, the company was starting to get a lot of attention. And I don't know that the quiet period made a lot of difference. We did get some criticism then and even today on how much we disclose beyond what the securities laws and the NASDAQ requires that you disclose everything you have to. But there's always this sort of area of, well, what's the cost of a customer?

And how many customers do you have or how fast is books growing versus video? And Amazon's always felt that that's proprietary. They don't want to let their customers know. They also don't want people focusing on what are, in some ways, short-term small things and it'll work out in the long term. I think maybe bricks and mortar retailers, do they release monthly sales numbers or something? You at least see them. Same store, month over month.

Right, right. Well, that's an example then of something. And so there's always been a little bit of tension with the analysts wanting more and feeling, well, you know, it's only going to help our competitors. So I think that was going on even then. It was sort of like, well, who are you to tell us these things? Well, it's interesting in thinking about company creation from the earliest stages, you get so focused on that cost to acquire

a customer number and making that go down and increasing your lifetime customer value. In Amazon's life as a public company, they're so reserved about releasing that information. Have you ever experienced in other private companies, someone who felt that that was proprietary and that was not something they would divulge in their pitch decks or anything like that. Yeah, I don't know about that specific piece. I mean, I do think sometimes it also comes up. Well, another one for some of our companies that have gone public has been backlog. And backlog often, some companies have backlog and some don't in different ways.

And that wasn't really an issue with Amazon because it was sort of instantaneous sales from any day. But a lot of companies don't want to disclose it because it's misleading sometimes and maybe it tells things to competitors. And so I think a lot of companies refuse to do that, and analysts would love to have it. And this also relates to predicting a range for next quarter or next year. Some of our companies will give you next year's kind of general expectation, and some won't. Yeah, I think there's a lot of variation in that. So one more, we're now post-IPO and we'll wrap up the IPO story in a minute with some fun stats. But one topic that happened a couple of years later that I want to ask you about, Tom, is in 1999, so two years after the IPO, Amazon did a convertible debt offering and raised a billion and a quarter dollars in the debt markets. I'm curious that and then that ended up being, I believe, the last money into the company through the Internet bubble.

How getting that large capitalization at that point, how did that, did that help survive, help the company survive the crash that came thereafter? And how did it dig itself out of, you know, you mentioned the stock price went back down to $5 at that point. Yeah. So it was part of the, you know, money was available. We're growing rapidly. Let's take advantage of the fact that the interest rates were then 5%. I believe it was 4.75%, I believe, or right around there. 4% or something, which today is sort of where maybe interest rates are. But given the 20-year history, those were low interest rates. And I think we ended up, we did two or three debt deals, totaling a couple, maybe $2 billion. So on the

one hand, it did give us money to grow. You know, sometimes for companies, having a lot of money lead to bad habits. And just, you know, you acquire maybe some companies you wouldn't have acquired that are marginal or you overbilled and so forth. And so Amazon was increasingly losing money when that recession hit. And I don't think we were any better predicting recessions than anybody else or the peak of the market. But it was probably taking advantage of the fact that money was available. And then when the recession hit and we were losing a lot of money, and as I remember, some of the terms of some of these debts had no interest for several years. And then interest kicked in.

And so we were facing more interest payments. The debt holders, the value of the debt had gone down. There was a lot of pressure from the debt holders. So really in 2001 or so, the decision, Jeff and the board felt, we need to cut costs and expenses. And so I think we barely did it in time in some ways. We waited quite a while because we're hoping, you know, kind of grow out of it. And at some point said, no, we really need to.

And there were lots of Wall Street people calling it Amazon.toast. Yeah. All these famous, you know, you're going to go out of business. And so we cut costs, and there was this famous saying, cut the crap, which meant they were shipping bags of dog food was a great example. A 20-pound dog of bag food and charging $3 for shipping and losing a lot of money. Well, let's stop selling. Which is amazing because I now get my dog food for my dog from Amazon. Well, we cut it out for a while i assume amazon has figured out how to do it profitably now but again it was you know so it isn't blind

all speed ahead it is you know when you need to you you cut back yeah it's it's interesting to think about uh the fact that the uh pressure from that debt holders forced cost cutting, which was ahead of the rest of companies who had to go to immediate emergency cost cutting mode, and most of them didn't make it. What other factors do you think played into Amazon making it through? Yeah, surviving the burst when so many other companies didn't. Well, you know, it's easy sometimes to look at these and think, you know, boy, they're just following crazy strategies. But I don't think that's true, was true even then at Amazon. I mean, they were still focused on customers,

and they were getting a lot of orders, and the leverage was a concern or a problem. But underlying economics were not bad. Yeah. So I think that helped a lot. And having good management that stuck it out and was able to focus down on cost controls. And there are great stories in the Everything Store about those years at Amazon and the impact it had on the culture.

And I think there was, after those years, did Jeff put a moratorium on M&A because they had acquired so many companies and it wasn't working? Yeah. No, and Amazon's not famous for overspending. That's one way to put it. We've talked about that on this show. We won't ask you about it. All right, listeners,

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points that make sense for them. In fact, it's pretty wild. There are over 125,000 businesses now using Huntress, and they rave about it from the hilltops. They were voted by customers in the G2 rankings as the industry leader in endpoint detection and response for the eighth consecutive season, and the industry leader in managed detection and response again this summer. Yep. So if you want cutting edge cybersecurity solutions backed by a 24-7 team of experts who monitor, investigate, and respond to threats with unmatched precision, head on over to huntress.com slash acquired or click the link in the show notes. Our huge thanks to Huntress. So to wrap up, this has been an incredible story and having Tom join us for it has been special. So today, we're sitting here in December 2016.

As of this morning, Amazon's market capitalization was $363 billion, up not quite a thousand X from the IPO when it was $438 million market cap, but a pretty healthy return. I was in, let's see, I was in middle school when Amazon IPO'd. So I really wish I'd put my bank account into Amazon at that point in time i was buying amazon products but um anyway uh an incredible journey and uh super cool to relive this this moment in history let's move to talking about uh what would have happened otherwise we touched on this a little bit but um but uh you know had amazon not gone public at that moment, where would we be? And I guess in particular, I'm curious, was a path of being acquired by somebody in those early days, did it ever come up? Were people seriously interested? And even if not, it sounds like, you know, from our conversation so far,

and just knowing the lore of Jeff's mission that very unlikely that he wanted to sell to someone. Was it ever on the table to, you know, raise more private capital or wait it out longer? Yeah, I think, I mean, I think we could have, it would have been slower growth because you couldn't have afforded, if you didn't have access to capital. And particularly when we began to broaden the product mix, when we started, we would get an order for a book and then we would contact the distributor and have them ship us the book and then we'd reship it. So we didn't even really have inventory. And so once you start buying product, building warehouses to put it in, you do need capital. And so obtaining capital in different ways has been, yeah, very important for Amazon. And so I think it would have constrained growth.

I mean, I know a lot of companies these days, they want to stay private as long as they can, and it does depend on their business model. If you've got a business model that doesn't require a lot of capital, then that's a viable thing. But Amazon's business model, particularly as it grew, did require capital. Makes sense. I feel like Amazon exhausted all the options. Yeah. Instead, they went big.

Yeah. Yeah, you know, we did two kind of events relating to that financing and so forth. One, we had that famous meeting with Barnes & Noble back in pre-IPO where the Riggio brothers came to Seattle and, you know, wanted to do some kind of a joint deal with Amazon. And they weren't actually offering to acquire, but they said, well, you can build our website and your own, and we can both have websites, or we could do it jointly. We could jointly own it. And Jeff, I think, rightly decided he didn't want to do that.

And then they filed a lawsuit the day before or three days before the IPO because we were using the phrase, the world's biggest bookstore. I mean, there are lessons in all that for anybody wanting to go public that your competitors sometimes do try to take it. But really, neither they nor anyone else really made a run at us. And partly because I think a lot of traditional companies always thought we were overvalued. And so that was actually a benefit. Now, why nobody tried it when we were $5 in 2001, that's when they should have tried.

I'm not sure they would have succeeded. But everybody becomes pessimistic at the same time. everybody becomes pessimistic the same time everybody becomes optimistic at the same time it's interesting that you know amazon obviously um uh it would be a shocker if anybody would buy amazon today i i seriously doubt that's even possible but um amazon as an acquirer it feels like has kind of internalized those lessons uh And I think about the Zappos acquisition during the 2008 recession, 2008, 2009, or the or the Quidzy acquisition, which both of which are written about extensively in the everything store. It almost feels like Jeff and the company taking that lesson to heart that when there are good businesses targeting large markets and for whatever reason are out of favor or in the midst of a recession, that's the time to go shopping.

You don't always have that luxury, but it would be nice if you could. Should we move on to tech themes? Let's do it. Ben, you want to kick it off? Sure. So in this part of the show is where we analyze, you know, specifically looking at the IPO or acquisition that we're talking about, what tech themes can we extrapolate, either from a true technology perspective, or sort of from an investment technology perspective. And there's a few here. I mean, I think the biggest one that

we've already touched on is the flywheel. When I think about Amazon is just like the canonical colloquial example of how to build the world's best flywheel business where so many things feed into so many other things and fuel the business. But, you know, that wasn't really part of the IPO, as Tom told us earlier, that didn't really get formalized until 2001. So, you know, as we think about lessons learned from the IPO, it's a lot about, you know, timing your timing company creation correctly around new waves. The internet was you have to believe that something is going to

be a wave and be a little more contrarian than other people. I think that that's evidenced by the investors that passed in the earliest stages thinking that it was too risky. The big thing for me is you have to

believe wholeheartedly that you're on the precipice of a wave. And it's not possible to create, you know, a top 10 in the world business without being on without being riding a massive wave. And I think for me, the the flip side of that coin that I think really shines through in reading about and reading this history of Amazon at that time is the long term thinking that Jeff and the company and the board had. Even in those early days, you know, you have to if you believe you've identified a wave like that, if it truly will become as big as you think it will, it's going to take a long time, you know, decades. You know, Jeff is famous, you know, in I don't know if this is when he introduced the phrase, but in that shareholder letter in 1997 said, you know, it's a day one for the internet and for Amazon. And that that perspective is is really rare. Lots of people say they have it, but to actually behave that way and make investments accordingly is quite impressive.

It also applies even today when you talk about new projects or initiatives at Amazon or other companies. And I know Jeff likes to say it often takes 10 years to prove it. And so you've got to make, after you go public, it's equally important to, one, continue to innovate. Don't stop innovating just because you feel like you're at the top of the mountain. You're not going to survive if you don't keep innovating. And the other is maintain that long-term thinking. An IPO gives you the opportunity to do that because you then have the money to do it. You have to somewhat ignore what the market is doing though. That's

another important part after you go public, I think. Yeah, it's interesting you bring up Amazon today as just an observation from the outside. One trend that I think we can observe from Amazon is actually doing corporate innovation well. I've long held this belief that every really great company has one multi-billion dollar innovation in them. And it's usually their founding insight. And they build that business and they try desperately to build other ancillary businesses around it. And some are bigger and some are smaller. Sometimes you get a Microsoft that has an Office and a Windows in them.

But usually... You think about Google, right? And not that there aren't great businesses within Google, but it's search. Yeah, I mean, it's 90% on Google display ads or search ads. That's most of the revenue. So the thing that's amazing to observe in Amazon is an incredible DNA for experimentation and small teams and doing things in a lean way. And as we've observed, there's already been one business that's on the scale of Amazon's

original retail business with AWS. Or bigger, perhaps. Yeah, yeah. And it'll be fascinating to continue to watch the company and see what else. I wanted to ask quickly, obviously, this happened much later than the IPO story, but about AWS, the listeners to our show might also listen to Ben Thompson and James Alworth's podcast, Exponent. of that at Amazon and perhaps how much DNA came from Microsoft into Amazon in terms of thinking about AWS as a true platform. And Ben and the show, they posit that this great Bill Gates quote, that a platform is when other participants on top of you realize the vast majority of the economics in the industry, and you only collect a small percentage. It's not like a high-margin Google-like business.

How much thinking on that level happened at Amazon during that creation? Well, I don't think we thought we were kind of following a Microsoft model, although I think from the beginning, everybody in Amazon recognized that Microsoft had the potential on the cloud to be the most important competitor in that, as they have become. But the difference, in a way, was platforms were somewhat considered static in the sense that you built a platform and then every couple of years you revised it or you sent out new software or machines. And the Internet was so much constant iteration. that, I mean, I have never heard this from Jeff or others, but it seems to me with AWS, the difference in a lot of ways, why it's succeeded and been able to take this lead and keep it, partly as being first when others bailed back, but the constant iteration of AWS. I mean, it's like revising your internet site. They had 600 new features this year or something. Well, in the old days, platforms didn't do that.

You know, you came out with Windows 8 or 10, but it was two or three years of massive coding. So I think the world even on that has changed a lot. Right. That's a great point. One other question before we move out of trends and themes is, as you're looking at companies that are pitching Madrona for investment in recent history, what are things that you learned from Amazon being so successful that you sort of look for in other companies as a pattern matching based on Amazon? Well, you know, every company isn't going to go public and every company isn't

in it probably for the long term. But I really do prefer founders who have a long-term vision and at least in the beginning say they're going to stick with it. And I think it's almost genetic though. And you don't know it until it happens. And there are lots of reasons to sell your company and your market didn't turn out quite what you thought, but you're going to get a good price. But what I really hope is that a founder, if he's riding the wave, as you say, or has other reasons, doesn't sell out when he could be in it for the long term. And again, it's somewhat personality. And I think I was very fortunate that Jeff was in this for long term. And again, it's somewhat personality. And I think, you know, I was very fortunate that Jeff was in this for long term. And so even at moments when he could have gone out and sold the

company, he wasn't interested. He wanted to build something for the long term. And, you know, when you think about a lot of the great companies, they've had founders who really wanted to accomplish something kind of beyond making the profit. We're going to change how people think about software. We're going to change how people do search. So I think that doesn't guarantee a successful company. But I always like that longer term, they're thinking about it and hopefully going to seek it. Cool. Thanks.

Should we wrap up? Yeah. You want to grade it? Yeah. I mean, this is, uh, in some ways this is tough.

I'm, I'm, I'm thinking of the end, the coda to the everything store, which is, um, uh, joy Covey,

uh, and, uh, the letter that she wrote to, to Brad, an email that she wrote to Brad stone. And she was one of the key sources for the book. After having done all the interviews and just reflecting back on her time at Amazon and then the experience of talking about the story. And she said, you know, Jeff and the company kind of like he knew in the very beginning exactly where he was going.

And, you know, so much as we talk about on the show, so many startup stories and IPO stories and M&A stories are twists and turns and wild rides. And it feels inevitable that the company would have went public when it did, especially, you know, just hearing the story now. It was completely rational. It made sense that it gave the company the scale and the capital and the visibility that it needed to grow and outpace competitors. So in some ways, I mean, I guess I think I give it an A. I do give it an A, but this might be like the least controversial or thought provoking decision we've had so far on this show for me. Yeah, it's funny. I was just thinking the same thing. There's actually not a lot of analysis that needs to go into it. I mean, you look at the scale of Amazon today and even the scale in the years shortly after the IPO, the only way that they could have achieved the outcome that they did

was by going public. And I think that one reason why we had so much trouble in that earlier section of what would have happened otherwise is it just doesn't seem like there was a lot of choice. It feels like unnatural to think about an alternative history here. Right. And, you know, as someone who works on early stage startups, a lot of the time there's all these like really vague questions around, okay, we think we have an idea in the space and we're learning as we're going and, you know, oh, should we be a platform provider or should we be the, you know, business

that sits on top of it? Or should it all be combined? Or should we be a horizontal or a vertical business in this space? And you even go back and forth long after you started the business, kind of playing both sides there. And it just doesn't seem like Amazon had any ambiguity over what the long-term vision of the company was, at least the retail business. So, Tom, hearing that, do you agree or are you laughing at us saying like, oh, easy to say from this vantage point? Well, on the one hand, I don't think any of us really did understand what Amazon could become. But I think the fact that Jeff and several of us thought the internet was going to be a very big deal, and there was lots of potential. And who knew where this could take you? And I think that often happens with technology where you realize that something is going to be very big.

But knowing the details, you know, that today AWS would have come out of that, there was no way to predict that or think about that in those days. But again, you know, that fits very well when you look back and say what the assets of Amazon were, but also what the technology development. So I think Joy is right in the sense that it was in some ways inevitable. I'm just not sure we knew how inevitable it was, but it took, you it took fabulous commitment to innovation and really hiring good people. So you should not neglect that for inevitability. Right. Okay. With that, carve-outs.

And it will be interesting to think how many of our carve-outs will be available on or in some way served to you by Amazon. I'm sure. Is Amazon's in delivery there somewhere? No matter what your carve-out is, Amazon is involved in it. That would be interesting to look back at our previous carve-outs and figure out, are there any that are not served to you either on AWS or be able to be shipped to you? Or we'd have to pick something that's basically not a physical good. A physical good that's on some very, very stubborn retailer

that retails only on their own site. So I don't know. A site that is not hosted on AWS. Or uses technologies as part of the site that are not hosted by AWS. It would practically be impossible. Yeah. I guess that's why Amazon deserves that A that we mentioned a few minutes ago. So, my carve-out is a band called The Album Leaf.

I actually went to their show last night here in Seattle. I've been a longtime fan of the band. They're some of the best working music that you can imagine. It's a lot of percussion. It's a lot of very, like, mellow synth,'s it's got a little bit of a punch to it so it's kind of hard to describe but um check out the album leaf they're they're on spotify i'm sure they're on amazon and uh great band cool that's uh i'll do i'll do a quick side carve out then made me think um jenny and i went to the stevie Nicks show this weekend in Seattle, and she was awesome. Her 24-karat gold tour, so great.

Songs, you know, some of her hits, some of Fleetwood Mac's hits. But mostly, and what I enjoyed the most was just songs, you know, from the vault, as she called them, that, you know, people don't know. Super great. My official carve-out, though, is there's a great article that we'll link to in the show notes. Very fun. There's a seminal paper in Harvard Business Review from the mid 90s, right around when Amazon was being started by Brian Arthur, and it's called Increasing Returns and the New World of Business. And it's somewhat academic in topic, but the thesis is that in an internet world where distribution costs are very low and your accessible market is everyone, you can

actually, you know, this old economic theory of diminishing returns that the bigger you got, you know, the classic example is coffee plantations. You know, the more coffee you produce, you're going to go to worse and worse, less and less fertile ground, and your coffee is going to get worse and worse. And so you get diminishing returns on the internet. You actually get increasing returns that the bigger you are, the bigger you get and the better your customer experience becomes. Uh, and, uh, that contributed to sort of the spiritual antecedent to, um, to aggregation theory and amazon and many of the things that have happened super fun uh thing that came out is um it turns out that cormac mccarthy the author uh the novelist who you know wrote all the pretty horses and no country for old men and

many other you know pulitzer prize winning author um brian arthur the economist who wrote the article he went to cormac m MacArthur for help writing this piece. And so Cormac basically dismantled the whole piece. They reassembled it together. And when you read it, it reads extremely cogently, not like a typical academic paper. And this story came out recently. Very fun. Oh, well, I should appropriately say that on my Amazon Christmas gift list that actually I've given to my wife is the Undoing Project book by Michael Lewis.

And I think a lot of us, you know, I like to read books on new technologies. Machine learning is, you know, a popular subject around Madrona, and we've been reading books on things like that. But here's one that's not particularly focused on numbers or technologies, but a different kind of technology, which is the psychology of people, which, again, is super important in business. So I think I look forward to reading it. Yeah, I haven't read it yet either, but I can't wait. The book's about Danny Kahneman and Amos Tversky, Nobel Prize winners for basically developing behavioral economics. wait um danny kind of the books about danny kahneman and amos toversky uh nobel prize

winners for basically developing behavioral economics and uh um daniel uh kahneman uh was and is now an emeritus professor at princeton and uh and michael lewis is a esteemed princeton alum as well and um i uh i took kahneman's course when i was in school there and uh sadly it was the first year that he had retired and he didn't teach it. So somebody else did, but I took his course and had a huge impact on me and looking forward to reading the book. We want to thank our longtime friend of the show, Vanta, the leading trust management platform.

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