We Study Billionaires - The Investor’s Podcast Network - TIP716: The Power of Customer Obsession: Amazon’s Secret Weapon w/ Kyle Grieve

Starting point is 00:00:00 You're listening to TIP. Jeff Bezos has fascinated me for a really long time. Not just because he built one of the world's most dominant businesses in Amazon, but because of how he approached problems that didn't even really seem like problems to most people at the time. So today, I'm excited to dive into Amazon's early story. Not just how the company came to be, but what really made a tick, what Bezos embedded in its DNA, and how those early decisions still shape its moat today.

Starting point is 00:00:28 We'll examine the early influences that shaped Bezos's mindset, from Summers spent building machines with his grandfather to his experiences at D.E. Shaw, where he learned the value of secrecy, raising the bar during the hiring process, and surrounding himself with generalist problem solvers. We'll also examine what I believe makes founder-led company so compelling, and how Bezos's willingness to take bold swings, embrace failure, and continually reinvent, helped Amazon build a durable, customer-obsessed business that could take pain in the short-term for a long-term game. Along the way, we'll explore how small things, such as user reviews and one-click ordering have turned into just a massive competitive advantage. We'll also walk through why Amazon Prime

Starting point is 00:01:10 was made specifically to be irresponsible not to be a member and how internal efficiencies gave rise to Amazon Web Services, one of Amazon's biggest success stories of all time. This episode is for anyone who's curious about what it really takes to build something great, how enduring advantages are created, and what we as investors can learn from the early Amazon Playbook. So, whether you're just running your own portfolio, or just want to understand how Amazon became Amazon, I think you'll find some very valuable takeaways here. Now, let's dig into the DNA of Amazon and unpack what helped turn a scrappy online bookstore into one of the greatest businesses of all time.

Starting point is 00:01:50 Since 2014 and through more than 180 million downloads, we've studied the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Now for your host, Kyle Greve. Welcome to the Investors podcast. I'm your host, Kyle Greve, and today I'll be discussing Amazon. And more specifically, I'll be looking at Amazon's DNA. We'll look at Amazon's history from its formulation by its founder, Jeff Bezos, to what he instilled into the business and how he built it into a trillion-dollar behemoth. We'll focus mainly on its first 15 years or so of its existence. We'll examine why Amazon is where it is today by mainly focusing on the rear of your mirror. Now, Amazon can't be discussed without talking about its founder, Jeff Bezos.

Starting point is 00:02:46 He's just as integral to the company story as Walt Disney was to Disney or Steve Jobs was to Apple. Jeff Bezos was a brilliant child from a very, very young age. He was a major fan of science fiction novels and especially he was fond of Star Trek, which we'll go over here in a little bit. He spent his summers on a Texas ranch with his grandfather, who actually helped build the hydrogen bomb. While on the farm, they built things together. When there was a bulldozer that broke, Jeff and his grandfather built a crane to lift the gears out and fix them. They built windmills, they laid pipes, and they discussed scientific concepts like space travel. And during these sessions, his grandfather would take him to the library, where he reportedly read hundreds of books.

Starting point is 00:03:25 Now, another interesting aspect of Jeff Bezos' background was his self-reliance. And this concept, I think, was ingrained by his mother, who had Jeff. in her late teens. This concept deeply resonates with me since learning about Ralph Waldo Emerson's impact on Warren Buffett. I've also been inspired by the idea that self-validation is more important than external validation. Now, you can see how much self-reliance has impacted Warren when he discusses his inner and outer scorecard analogy. Buffett said, if the world couldn't see your results, would you rather be thought of as a world's greatest investor, but in reality have the world's worst track record or be thought of as the world's worst investor when you're

Starting point is 00:04:01 actually the best. For someone like Warren, knowing one's worth despite others' opinions was a value that was very, very high on his priority list. Now, when it comes to Jeff, I think he utilized self-reliance in a somewhat different way. For instance, in a 2017 conference, he said, when things don't work, you have to back up and try again. Each time you back up and try again, you're using your resourcefulness. You're using your self-reliance. You're trying to invent your way out of a box. So Bezos thought of self-reliance as kind of a tool. tool to help him innovate and return to the drawing board when things didn't work out as he initially thought it would. And as we'll see, Amazon has thrown many, many things against the board.

Starting point is 00:04:39 And even though they've had a number of many failures, Amazon's ability to make its success work has more than offset many of its failed ventures. The last thing I want to touch on with Bezos' childhood was his love of electronics. So reportedly, his mom let him turn the family garage into something of a science project lap. And in that garage, he would create booby traps for siblings. Jeff said that his mom would end up driving him back and forth to Radio Shack multiple times just to get the parts that were required to make these traps. So as Jeff became an adult, he learned a few critical lessons. The first one that really stuck out to me was to just focus on what you're really good at. So there was a really interesting story here of when Jeff was

Starting point is 00:05:20 at Princeton. And while there, his initial goal was to study physics. So he was in one of these classes on quantum mechanics and he was trying to solve a very complex problem with friend. They had some problems solving it, so they turned to another classmate for help. And apparently when they went to this other classmate, he quickly did the equation in his head and came to the correct answer. And so after going through this experience, Jeff kind of realized that he would never have an edge in theoretical physics and ended up changing majors to electrical engineering and computer science after. Now, I think this is an excellent reminder for many of our younger listeners. You know, if you can find an area in life where you have an edge, spend as much time there

Starting point is 00:05:57 as possible. Success will come a lot easier than trying to succeed at something you just don't have natural talents for. Now, Bezos's first foray into the professional world of technology after school was working for a business called Fytel in the late 1980s. This business developed private transatlantic computer networks for stock traders. His boss at this firm said that Bezos was not concerned about what other people were thinking, which is obviously a hallmark of contrarian thinking. Now, before landing a job at D.E. Shaw, Bezos had already started working on ideas for his own business. He was always kind of annoyed at what he viewed as company's institutional reluctance to challenge the status quo. And this is something that he and Amazon, of course, are very well known for now.

Starting point is 00:06:38 So let's talk a little bit about D.E. Shaw here because Jeff learned some very, very big lessons, I think helped him shape Amazon from his time at D.E. Shaw. So D.E. Shaw was essentially a quantitative hedge fund. It was started in around 1988 by David E. Shaw. And Shaw believed in technology, which is a philosophy that heavily influenced his company. Now, a really fascinating insight Shaw shared on secrecy was to keep their insight secret to avoid teaching them to current and potential competitors. And even though D.E. Shaw was a quant hedge fund, it operated much differently than its competitors such as Renaissance technologies. So Shaw, in very, very interestingly, he didn't actually bother recruiting. financiers. He looked for generalists and often fish in the waters full of scientists and mathematicians.

Starting point is 00:07:22 And I believe Bezos learned a lot about the importance of hiring people who could continue raising Amazon's bar through his observations of Shaw while working there. Another area which Bezos drew inspiration from D.E. Shaw was in their hiring process. So during the hiring process, they would have an example question during the interview. And for instance, one of them was, you know, how many fax machines do you think there are in the United States? And so, you know, the actual answer to that question wasn't as important as just trying to understand the interviewee's thinking process and understanding their ability to solve problems better. So they'd have a panel of people as part of this interview and after the interview was

Starting point is 00:07:57 completed, they would voice one of four opinions on the interviewee and that was strong no hire, inclined not to hire, inclined to hire, or a strong hire. And so at D.E. Shaw, if just one of the interview panel members had a poor view of a potential recruit, the entire application could be rejected. So, you know, one person could essentially have veto power if they thought that it just wasn't a good hire. But looking at Amazon, I think Bezos drew inspiration from multiple sources, not just D.E. Shaw. So another source was Microsoft, where they had a person who made the final decision on a hire. So the observation bred a new program within Amazon known as the barraiser. And this person is not necessarily the recruiter or even

Starting point is 00:08:35 the hiring manager, but can override the hiring manager's decision to hire that person or not. And this person is put in place specifically to make sure that the bar is consistently raised for new employees. Now, let's get back to D.E. Shaw here. So while there, Sean Bezos began formulating new ideas. You know, as I mentioned earlier, D.E. Shaw, even though it was a quantitative hedge fund, it wasn't just a quantitative hedge fund. So while there, David Shaw viewed his business more of kind of a technology lab that

Starting point is 00:09:02 was full of highly talented problem solvers who could use their talents to solve various problems. So for instance, during the tech race in the 1990s, D.E. Shaw successfully created businesses such as an ad-free email service and an early type of online brokerage for stock traders and bond traders online. So Bezos was highly, highly exposed to the internet craze. And he began to see all these different opportunities that were developing. And Bezos definitely had his own ideas. And one of his ideas, which we all know today, is basically Amazon, which he thought of as the everything store. So in the book, The Everything Store by Brad Stone, Brad writes, several executives who worked at

Starting point is 00:09:40 Desco at the time, say the idea of the Everything Store was simple, an internet company that served as the intermediary between customers and manufacturers and sold nearly every type of product all over the world. This one idea would mark the beginning of Amazon, but Jeff didn't think this was practical just to start off with. So instead of making an Everything store, he focused just on one area of what the Everything store would end up servicing. And Jeff ended up settling on books. So he, reason that books were a commodity and buyers would always know what they would be getting no matter where they bought them from. So even at Shaw, Basil started testing competitors to see if there was a market looking for what he had to offer. So there was one story where a colleague of his

Starting point is 00:10:25 at D.E. Shaw bought a book from an early version of an online bookstore. And when the book arrived, it was just severely damaged during the shipping process. And Jeff realized through this experience that competitors simply hadn't figured out how to sell books competently online yet. As Bezos stued on the idea, he realized that he needed to actually go at it alone. So he ended up quitting his job at Shaw and he moved to Seattle with his then girlfriend. Seattle was an interesting place to base the business. But as you can probably tell, Bezos didn't do things haphazardly. He chose Seattle for a few very, very specific reasons.

Starting point is 00:10:58 The first reason here is that there was a recent Supreme Court ruling that stated that merchants didn't have to collect sales tax where they do not have physical operations. And this ruling reduced the playing field and eliminated more popular states, You know, maybe you would have thought he would set it up in something like California or New York, but he would have been taxed there and therefore he would have had to charge more to his customers. So Washington was just a good choice because they didn't have any state corporate income tax. And Seattle also was home to Microsoft, which had tons of talented engineering graduates that were entering the workforce, and therefore he could easily onboard them into Amazon.

Starting point is 00:11:31 And then lastly, it was just, it was a little bit closer to many of the books distributors. And so in Amazon's early days, they would actually get the distributors to ship the books to Amazon. and then Amazon would then ship it out from there. So it just made more sense in terms of logistics costs. So, you know, it just made a lot of sense for the headquarters to be in Washington and it's still there today. But Amazon really started out in, you know, Jeff's garage. So the story goes that Amazon's first two desks were actually built from two doors and

Starting point is 00:11:58 some wood that cost $60, I think from Home Depot. The business was basically bootstrapped by Jeff Bezos, a couple of other employees, and his parents. And according to Jeff's parents, they didn't actually understand the company very well, but they just invested because they believed in their son, Jeff. Now, Jeff was definitely shooting for the stars with this business, but he also realized that his chances of failing were probably a lot higher than his chances of success.

Starting point is 00:12:22 So Bezos told his parents when they made the investment that there was probably a 70% chance that he'd lose their entire investment. He actually wanted to tell them this because he wanted to know that he could go home for Thanksgiving, even if things didn't end up working out with their investment. Now, I really admire this honesty, and I think it shows. that Jeff was very honest about how unlikely Amazon's success would be at the very, very beginning. Now, the history of Amazon's name is something we're briefly touching on here as well. So Jeff ended up settling on Amazon for a few very rational reasons, which probably won't be

Starting point is 00:12:53 surprised about. So it was an A word, first of all. And therefore, obviously, when search directories were more important than they are now, A was going to be first in the search directory. So there you go. And then, you know, the reason that he focused on Amazon as a word that began with was just that Amazon kind of evoked a scale that he wanted to get to at one point. So, you know, the Amazon River is the largest river in the entire world. And this was just kind of a metaphor for

Starting point is 00:13:19 just Bezos with what he wanted to take Amazon to at one point in the future. And again, you know, obviously he knew that it was probably not the best chance that he would get there, but he ended up doing it incredibly well. So Bezos had a few employees working under him in his garage. And they had to run machines that drew a lot of power into his house. So some of these computers, basically, drew so much power that they had to power them from different circuits in the house, otherwise they'd end up blowing the fuses on Jeff's home and killing his power. So he fixed the problem by running these giant long orange extension cords from all sorts of rooms in his entire house. That was kind of his workaround. I really like this story in particular because I think it

Starting point is 00:13:58 shows the length that someone will go to make their dream become a reality. And I wrote in my notes in the book here that it would be really hard to see anyone other than a founder doing something like this. I mean, you know, how are you going to tell your wife or your girlfriend that, you know, you have all these hideous orange cords running through your entire house unless, you know, unless that business is your baby, it's going to be very hard to do. I know I probably couldn't do that with my wife. So, you know, I just think it's really hard to imagine like a mercenary CEO is just in there to, you know, make a quick buck doing that kind of action at home. I just think that's not really going to happen.

Starting point is 00:14:37 And I think that's part of the reason why, you know, founder-led businesses just end up doing very, very well for the most part, not always, of course, but just comparatively speaking. So looking at some of the data about founder-led companies, I came across a Harvard business review article that showed some of the performances of founder-led companies compared to others in the S&P 500. So this study went from 1990 to 2014. Total shareholder terms were actually three times larger for founder-led companies than for other companies in the S&P 500. Now, I personally enjoy investing in founder-led businesses, although I don't

Starting point is 00:15:10 necessarily consider it a must, you know, but founders will often understand their business better than anybody else. You know, they own significant stock in the business usually, and they tend to embody that company's culture. So having someone with those attributes leading a business is definitely a potent force in creating shareholder value. Now, as I mentioned, Amazon's first goal was selling books in a very, very crowded market. So Jeff's original vision was to sell books simply just better than competitors could. And you know, at the beginning, it worked. At the beginning of the business, they had a bell ring every time someone bought a book.

Starting point is 00:15:44 But it got to a point where that bell was ringing so often that they had to turn it off because otherwise it was just distraction for everyone there. So kind of the way it worked was once the order came in to Amazon, they would order the book from its distributor paying 50% of the listed price. The book would arrive at Amazon. and then eventually they would ship it from Amazon's headquarters to the customer. Now, back then, this business doesn't sound high tech at all, right? I mean, it was a simple website and just sending people books, but, you know, Bezos

Starting point is 00:16:12 really understood that he could use Amazon to improve the customer experience. So to start off doing this, he wanted to find more books that were really, really rare that you couldn't necessarily find in a regular bookstore or even a regular online bookstore. And an additional issue was that Amazon was so small, of course, at the very beginning that they couldn't actually buy the volume of books that were required by some of their distributors to do business with them. So, for instance, a distributor would accept orders of a minimum of only 10 books at a time. So if Amazon didn't have 10 orders for that book, which they probably wouldn't have when they were working out of Jeff's home, it wouldn't be possible to order a book from the distributor. But they found a loophole here, and it was really interesting. So what they would do is they would order the one book that they needed.

Starting point is 00:16:57 and then they found an obscure book. For instance, they found one about Likens, and they knew that the distributor had this book and that it was out of stock. So this was kind of how they could get around it, so they would order one book. They wanted nine books about the Likens that was out of stock, and that's how they got their one book.

Starting point is 00:17:12 Now, another way that Bezos wanted to improve the book buying experience was through user reviews. So in the early days, Amazon employees would actually be the ones who were administering many of these reviews to get the ball rolling. Bezos thought that having a database of user reviews would give Amazon a major competitive advantage over its competitors. So his thought process was that customers would be less likely to go to its competitors' websites with no reviews and instead stay on Amazon.

Starting point is 00:17:38 So Jeff, I think here, understood network effects very, very well. So one issue with these public reviews was how book publishers felt about them. Jeff gave a speech in which he said that he received an angry letter from an executive at a book publisher. And this angry executive stated that Jeff Bezos's job wasn't to be able to. to trash the books that they were providing them, but to actually just sell them. Basil said he actually saw his job a lot differently than that. He said, when I read that letter, I thought, we don't make money when we sell things. We make money when we help customers make purchase decisions.

Starting point is 00:18:08 Now, this is just a profound statement and I think really shows how misunderstood Amazon was. Jeff was creating his own market that just didn't exist at the time. And legacy businesses would act in defiance that their method was the best, even if you weren't following their rules, you know? So if you weren't following their rules, they would say that you're doing something wrong. But Jeff knew where his edge was. He knew that the key to making Amazon a great company was to simply make the customer happier. Now, from my experience, Amazon is still one of my top expenses. I really appreciate its user reviews. When I'm trying to find a new product and that I want to buy, I love browsing the reviews and seeing what other users are saying.

Starting point is 00:18:47 It very, very often guides my purchasing decisions. So the fact that I can go on Amazon and see thousands of reviews on a product make it just easier for me to make a really informed decision. I can see if there's negatives about a product. A lot of times that's what I'm looking for, seeing what bad things people say. And if I see something that doesn't resonate with me, then I just don't buy that one and look for something else. Now, this whole review system is really interesting because sometimes I really wonder how many

Starting point is 00:19:12 of these other businesses are just kind of gaming the system with reviews done by probably their own employees or maybe they're just outsourcing to some sort of company to give reviews. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord, and every conversation you have is with people who are actually shaping the future. That's what the Oslo Freedom Forum is. From June 1st through the 3rd, 2026, the Oslo Freedom Forum is entering its 18th, year bringing together activists, technologists, journalists, investors, and builders from all over the

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Starting point is 00:23:30 Back to the show. So sometimes, for instance, I'll look at a company like Timu. and see that they have a ton of their products. Nearly every one of their products seems to have four and a half, five-star reviews. And they have thousands and thousands of these reviews. And so, you know, I've bought stuff on Timu. And while it's very well priced, it's very rare, I would give anything I've ever gotten from them a five-star review. It's just the quality is just not as good.

Starting point is 00:23:53 So sometimes I wonder if all the reviews are being generated from employees or from some sort of third-party service that reviews things for you and just automatically gives you a five-star rating. And there's some other example of this. You know, there's other smaller shoe sites I've seen, like based off advertising, for instance, off of Instagram where I see, you know, maybe they have like a thousand reviews for one of their product, but then zero reviews for different products on the exact same site. And this has always been kind of hard for me to understand. And it actually really lowers my trust with a business because I consider that manipulation. I mean, if you have two products for, let's just say for an example, you have two products.

Starting point is 00:24:27 One has a thousand reviews. One has zero. It kind of seems like it's very, very obvious that you're probably manipulating. the numbers of reviews on one to some degree, or you just have one product that, I don't know, maybe you just don't sell it. It just seems like a very, very weird sales strategy. So, you know, this is just to say that I have a very high degree of trust in Amazon's reviews than I do for most other companies. And I also like that you can filter bad reviews on Amazon and how they literally will show you bad reviews, not at the very, very top, but like they have

Starting point is 00:24:58 their own area of bad reviews. They're not just hiding them so that you don't look at them. I really appreciate that. Now, another innovation that Amazon brought to the market was one-click ordering. If you've used Amazon, you're probably familiar with this feature. So today, it's called the just buy now button instead of the add-to-cart button. And if you click it, you're basically just all set to go. This feature really feeds into Jeff's obsession with improving the customer experience. So the reasoning for it was that Jeff wanted this feature because he felt like it would make

Starting point is 00:25:27 it easier for customers to buy things from Amazon. Now, I think this feature probably is taken for granted now. You know, it was formulated in the late 1990s and Jeff knew that the feature served a few purposes at that time. So the first was that I had just delighted Amazon customers by removing some of the friction of filling out fields during the buying process. And the second one is that it would increase Amazon's competitive advantage against competitors and hopefully widen its mode a little bit.

Starting point is 00:25:52 So I use Amazon's buy now feature maybe 25% of the time when I shop for just like one item. I think it's excellent. and it definitely reduces the time needed to get to my desired items. But speaking from personal experience, I'm not sure it's a huge reason that I would buy from Amazon over a competitor. Generally, what draws me to Amazon is it's cheap prices and fast and free shipping. So while the buy now feature is good, I wouldn't choose Amazon over a competitor just because of it. And, you know, there's obviously at the time that it was created, it was so that you wouldn't

Starting point is 00:26:23 have to fill out fields, but there's now, there's technology, you know, your address can be saved in things like Google Chrome or in LastPass and just pretty much instantly fill it out for you. So of course, it still takes longer than the Buy Now feature, but it doesn't take that long. And I don't think that technology existed when Jeff first formulated the one click. So I can see how it would have been a lot more valuable, you know, call it 15, 20 years ago than it is today. Now, interestingly, with that one click buying Amazon needed to get patent for the technology behind it. And they trademarked the name one click. And the tech was so good that actually Apple licensed it from them for use in the iTunes store and the Apple store. And the technology was

Starting point is 00:27:03 rejected by European regulators, even though Amazon appealed it in 2001 and 2011. And the patent has expired in 2017. So I think, you know, it's not a huge part of Amazon. That's probably why for me, from my standpoint, it's just not that big of a deal anymore. Now, let's get back to Amazon in the book. So once Amazon started doing really, really well, which was surprisingly fast with their books, Jeff realized that he would need to add additional products outside of books and start diversifying. So after all, this was obviously his original dream for Amazon to be the everything store, not just a bookstore. But he first wanted to verify that it could work and that he could get it up and running in the first place. And he clearly did.

Starting point is 00:27:42 So the next additions to what Amazon would sell would be music and DVDs. So interestingly, Amazon's mantra in its early days was to get big fast. And Jeff knew that getting bigger would give him all sorts of excellence. scale advantages that could then be passed on to Amazon's customers. He also had a really, really good understanding of the internet as we talked about it from his days at DE Shaw. And his thought process were that the internet retail was kind of a winner take most type of market. So Amazon relentlessly spent on R&D as a byproduct of growth and was willing to take a loss for multiple years. But, you know, with most smaller growth companies, capital is required to continue fueling growth. So in

Starting point is 00:28:21 In 1998, Amazon raised about $326 million in a junk bond offering, and the following year, they raised another $1.25 billion. Now, remember that we are in the peak euphoria phase of the market and are approaching the dot-com boom here. So Amazon definitely chose the right time to raise capital when it was cheap and plentiful. Interestingly, even in the early 2000s, Warren Buffett and Lou Simpson of Geico purchased Amazon's bonds and did really well on them. Now, I find this really fascinating because it shows that Warren and Lou understood Amazon

Starting point is 00:28:49 well enough to be highly convinced that they would get their coupon and principle back from Amazon, but weren't interested in owning its equity. But I suppose, you know, these are just two different things and you don't have to be comfortable owning both if you don't want to or if it's not in your circle of competence. Now, before Warren Buffett made his order for Amazon's bonds, he wrote Jeff a letter that praised him for expensing stock options. He wrote, It took particular courage on your part, and that will be recognized and remembered. If I could show my appreciation by stepping up my book orders, I would. But you're all already getting all of my business. So in Bezos's first letter to public shareholders, he wrote,

Starting point is 00:29:24 we will make bold rather than timid investment decisions when we see sufficient probability of gaining market leadership advantages. Some of these investments will pay off, others will not, and we will have learned another valuable lesson in either case. Additionally, the letter stated that Amazon would prioritize long-term thinking and free cash flow generation over short-term profitability. Now, when we look back today and see what Bezos wrote, it's easy to want to beat ourselves up for not taking part in the Amazon IPO or even buying shares at the bottom of the tech bubble, if you're old enough, obviously, and investing long enough. But Amazon's financials weren't pretty during this time.

Starting point is 00:30:01 Adjusted operating income, even adding back R&D expenses, remain negative. And this number wouldn't turn positive until 2003. So an investor looking at this business might have a hard time wrapping their head around and whether or not the company would make a good investment. The only way I personally could see an investor justifying an investment into Amazon in the early 2000s was to make very, very particular assumptions with a high degree of certainty.

Starting point is 00:30:23 So there's three here that I had. So the first one was that they were likely to continue growing revenues in, let's call it, you know, the 20s to 30%, which is obviously very, very high. They'd have to continue spending prodigiously on R&D, which obviously create a lot of value, but in terms of gap accounting obviously was pretty hurtful to their income statement.

Starting point is 00:30:42 And they would actually have to continue in terms of R&D. They'd have to continue seeing very, very good returns on that R&D spent. But here's the thing. Amazon was a very young company in the late 90s in the early 2000s. And so assuming R&D expenses would continue making as good returns as they ended up doing is just kind of a tough assumption to make, unless you just understood the business very well and understood maybe some of the R&D expenses that they were putting capital into.

Starting point is 00:31:10 And obviously some people did understand the business very well. very, very well. But I think investors, for the most part, just ended up taking a pass because the company just wasn't easy enough for them to understand. Now, Amazon hit many investments out of the park, which could have convinced investors that they would continue to do so. But they had several failures as well. They splurged on acquisitions, but some of the integrations with new companies have been an issue with, for instance, key personnel that were unwilling to acclimatize themselves to Amazon's culture or just didn't want to be part of Seattle's weather. Also, during the tech boom, they invested several millions of dollars into dot-com businesses, things like pets.com,

Starting point is 00:31:46 gear.com, windshopper.com, greenlight.com, and homegrocer.com. And Amazon lost hundreds of millions of dollars on these investments. And hundreds of millions doesn't seem like anything for Amazon now, but it was very, very big for them at that time. So assuming that all these investments would work out that they were making just seems like a very, very complicated assumption. And on top of that, you know, R&D was very significant amortization. expense. And Amazon just, you know, it's not like a constellation software. So adding back amortization of intangible seems like a very, very massive stretch to do to make the adjusted numbers look better. I mean, you could argue that you could add back a portion of R&D

Starting point is 00:32:28 and give them some credit for previous acquisitions or R&D that ended up working. But again, you know, this just all depends on your understanding of the business's inner workings and what assumptions you're comfortable with making. But let's get back to another one of Amazon's most significant launches, which was the Kindle. So Bezos was keenly aware of the forces of capitalism. Apple did a huge number to Amazon's CD sales when they launched iTunes. Now, this plays well with Jeff's view on inventing and wandering, which is the name of another book about Amazon that explores a number of his shareholder letters and different

Starting point is 00:33:00 discussions. But what really interested me here about Jeff's observation on Apple was how it forced him to really understand the strength of innovation. And the Kindle was one such innovation, which has worked. worked out incredibly well. So I myself have had three different Kindles over the years. So I've had experience as a user here for multiple years and I've seen how the product has improved over the years. So with Jeff's observation on the power of digital content, he knew that he had to get ahead of the game in moving towards digital content from analog. So in 2004, 78% of Amazon's revenue

Starting point is 00:33:32 came from books, movies, and music. These were all areas that were very, very ripe for disruption by moving towards digital. Jeff and Amazon knew that building the Kindle to what Jeff wanted would end up cannibalizing part of their book business. But I guess the assumption was that they'd rather keep their share of books, whether in analog or digital form, rather than losing a part of it to a digital-only competitor. Jeff ended up transferring one of his top employees in books to focus on killing his own business in books. So Jeff told him, I want you to proceed as if your goal is to put everyone selling physical books out of a job. Amazon cloned its ideas from Apple and Palm to get their initial prototype of the Kindle. Eventually, Amazon's engineers were tapped

Starting point is 00:34:12 with building a crude electronic reading device. Jeff wanted the device to be so easy to use that a grandmother could operate it, and he demanded that books be transferred to the device wirelessly rather than via a computer, via USB wire. So as the device was developed in secrecy, there were a number of issues that were popping up. So some of Kindle's earlier competitors were just really bad products, and part of the reason for that was that they had very, very limited book catalogs. Let's say you bought an e-reader, but then realize that you couldn't buy a book that you wanted to read on that e-reader.

Starting point is 00:34:46 Therefore, that would make that e-reader essentially useless. So Amazon's goal was to have 100,000 titles, including about 90% of New York Time bestsellers, ready to read and buy by the time the Kindle launched. Now, just this one little initiative launched a whole new set of problems, but I think here displayed a lot of Amazon's monopolistic powers. So Amazon at this time was a big part of the overall book selling ecosystem, and obviously publishers knew that. They cherished their relationship with Amazon simply because Amazon brought them a lot of business. But as Amazon began scaling up, they began having more and more power with their suppliers,

Starting point is 00:35:21 and they could start asking for more favorable terms than they were able to demand when they were a smaller company. So one such strategy that Amazon could employ was to actually pull books from its automated personalization and recommendation system for a multitude of reasons. So obviously, if they pulled it, this would decrease sales specifically to a publisher that would sell them that particular book. And Amazon could literally pull this lever whenever they wanted to. And so it was reported that this one lever could reduce sales by up to 40%. And so since Amazon was all about improving the customer experience often by cutting costs, these benefits had to be paid by someone else.

Starting point is 00:35:57 And in Amazon's case, it was the publishers who were paying for the better experience for Amazon's customers by basically being forced into compressing their margins. And the time came when Amazon was so powerful that its suppliers just needed Amazon more than Amazon heated them. Now, this is just an excellent position as a business owner because you get lower input costs. Now, I mentioned earlier here that Kindle was top secret. So while Amazon was trying to get publishers to go digital, they couldn't actually tell them why, which made it a lot harder for publishers to want to play ball with Amazon. However, they eventually got the Kindle prototype, and in 2006, they began showing it to publishers.

Starting point is 00:36:33 Apparently, it was just ugly. So in the Everything store, Bradstone describes it as a cream-colored bastard child of Blackberry and a calculator. But over time, the product ended up improving and the publishing executives actually liked what they ended up seeing. So once they started liking what they saw in the end product, publishers began digitizing their content. And the ones who decided not to digitize their content or didn't want to do it fast enough,

Starting point is 00:36:58 obviously would be injured by Amazon because like I just said, Amazon can manipulate their sales through the use of their algorithms. And this is just interesting because Amazon's points on innovation come really strong here because they essentially invented the e-book industry. Maybe they weren't the very first e-book that was out, but they popularized it and made it a lot more user-friendly. But then, of course, like I mentioned in previous stories about Amazon's innovations, there are always obstacles that would arise. So talking specifically about the Kindle, Jeff wanting to, of course, make the user experience as good as possible, wanted to just charge about $9.99 for all e-books. And of course, this aligns with him trying to make the best possible customer experience.

Starting point is 00:37:42 So if you're interested in why he chose that $9.99 number, it just came from basically cloning Steve Jobs with charging $99 for a song. Amazon kind of figured that the average book they bought at wholesale price was about $15. So if they wanted to charge $9.99, they'd be taking a loss on every single book that they sold And they were okay with this because Jeff knew that he was just adopting users into Amazon's ecosystem. They would spend money elsewhere on higher margin products and make up for the lower margin Kindle products. Now, this was all well and good, but the suppliers had to be made happy as well. So publishers and writers were just not pleased about selling their books at such low prices just to appease Amazon's customers.

Starting point is 00:38:24 And since the project was kept secret, the publishers weren't even aware of the Amazon pricing model until the Kindle was released. And once it was released, publishers were confused whether that pricing was discounted specifically for the launch of the Kindle or if Amazon was planning on keeping that pricing in perpetuity. Now, once it was clear that Amazon was just going to keep the pricing at 999 in perpetuity, they were basically forced to roll with the model even if they disagreed with it. Now, this is where I think Amazon really started ramping up its network economies. So let's put ourselves into the shoes of a publisher for a moment here. Let's say Amazon made up 60% of our sales. Amazon would pay us $15 for each book. Now, obviously, we wouldn't like this move by Amazon charging only $999 because it's going

Starting point is 00:39:09 to affect the other 40% of our business. If Amazon can sell digital copies of our books for $10, then what happens to our other customers who are buying our books and then selling them for $20 or $30? They would definitely be affected by the competitive pricing, meaning our remaining 40% of revenues would end up probably shrinking and increase our reliance and concentration specifically on Amazon. Now, as there's all of this, we basically have to bend our knees to whatever Amazon's whims were. If they wanted to buy books for $14, we wouldn't have much of a choice, but to just say yes. Now, this is just an interesting area because if you look at Amazon, I think the perception of the

Starting point is 00:39:47 business is different if you're a customer versus if you're doing business on Amazon. Obviously, see, as a customer, I love Amazon because all the initiatives that they do, you know, with Jeff trying to make the customer experience as optimized as possible, it works. I mean, I agree. I love Amazon. I spend a lot of money on there. But, you know, if you try to put yourself in the shoes of a seller, whether that's like a third party seller or even a supplier to Amazon, you know, it probably becomes a little harder to like Amazon. I mean, Amazon has so much power that if, like I just kind of mentioned with that one example, if they want to say, hey, hey, you know, the last five years we've been buying your books for $15.

Starting point is 00:40:26 If you want to keep doing business with us, we're going to buy it for $14. And, you know, that's kind of a hard pill to swallow because, you know, I'm not a book publishing specialist, but I would assume that's obviously going to compress your margins. And it kind of sucks to have to swallow that pill. But if you have Amazon, like I just mentioned it as well, as your biggest source of revenue, you basically have no option, but to just say yes, that you have to do it. So it's an interesting kind of dichotomy of looking. at Amazon through both the customer and the suppliers view.

Starting point is 00:40:56 So Kindle, you know, at its beginning was a losing initiative when it was first kicked off. So even if you fast forward to 2012, Amazon admitted that it was losing money specifically on the physical Kindle device. And yet today, that product is still being sold. Now, this is an interesting strategy that very few businesses can take part in. You know, even though the Kindle itself doesn't make money, it's impossible to say how many new Amazon customers are brought into this ecosystem who own a Kindle. And so this led to another area of Amazon success, which was initially seen as something like a lottery ticket, which was Amazon Prime.

Starting point is 00:41:31 So Amazon Prime was launched in 2005, and it was meant to offer unlimited two-day shipping for only $79 a year. And it's crazy to think that 20 years later, the prices are still just $99. And if you adjust for inflation, it's actually clear that Amazon Prime is cheaper now than it was in 2005. But let's examine why Prime was developed in the first place. So its ethos was similar to that of Amazon, which was to increase customer loyalty by making their experience better than anywhere else. And Jeff's problem was the idea of Prime, like many other of his ideas, was just uneconomical. So it's impossible to know what Amazon pays for shipping. But I've looked it up and some research suggests that on average, looking at USPS, a parcel cost about $4 to ship.

Starting point is 00:42:16 Now, expedite shipping, which is what Amazon wanted to do, can cost about $9. So even today, if you buy pen items on Amazon, Prime essentially just pays for itself. Now, when discussing Amazon Prime, Bezos said, we want to make it irresponsible not to be a Prime member. And it's pretty clear with the cost savings that you get from being a Prime member that he succeeded in that goal. Prime worked very, very well, even though they made a loss on shipping. So Amazon Prime members on average doubled their spending on the site. And as part of their increased spending, customers diversify their product mix, further strengthening Amazon. his customers. And as Amazon grew, they started blaying on additional perks for Amazon

Starting point is 00:42:56 members, the most popular today being streaming video. As Amazon added these additional features, it became harder for customers to justify churning out. Let's look at how Prime helped improve Amazon's monopoly in e-commerce. So there are three primary ways I think it helped widen Amazon's moat. The first one was in logistics and warehousing dominance. So to support Prime, Amazon's logistics had to improve and they effectively became their own version of Fed. Now, competing with Amazon's logistics was very expensive, and therefore, a few competitors had the capital even to try to compete if they wanted to. And then as Amazon scaled, they just demanded concessions on shipping costs similar to what they did with book publishers. And this further

Starting point is 00:43:36 creates barriers to entry as smaller competitors would not be afforded these similar reduced rates. So the second one here is locking in consumers. So, you know, customer lock-in can be healthy or unhealthy. And in Amazon's case, I think it was healthy as Amazon's goal was to create a customer delight and not force them into shopping with them if they had a good alternative. So Amazon was able to lock in customers via convenience monopolization, where it was nearly impossible to find a competitor who offered the same amount of value and convenience as Amazon. And the third one here is forcing merchant compliance. So Amazon ended up welcoming third-party sellers who basically had to opt into fulfillment by Amazon to be eligible for Amazon Prime. And this made it so that

Starting point is 00:44:17 Amazon could let third parties own their inventory while Amazon would take care of all their fulfillment and logistic needs. Now, this was a significant advantage for Amazon as it gained crucial data on third party products. It could then try to compete with. Now, Amazon had some controversy specifically over this third point, which helps them end just how good of a business Amazon is specifically for its customers. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up and customers now expect proof of security just to do business. That's why VANTA is a game changer. VANTA automates your compliance process and brings compliance, risk, and customer trust together on one AI-powered platform.

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Starting point is 00:48:07 So let's say you want to buy a water bottle for your toddler, something that I've done recently. Some third-party merchants can post their products on Amazon. You'll notice when you make a search query that you'll see a bunch of items at the very top that say sponsored. To be eligible for sponsored items, you must have a buy box, which means that you're a good seller, you're able to keep your stock full, you have a good number of positive use, and you continue bringing new products to the table. You get your products to the top of a search query if you have the buybox. Now, this is great if you're a high-performing seller. However, the problem that was brought to light is that Amazon gathers data on these items and all other items. Now, the data collected is supposed

Starting point is 00:48:45 to be proprietary, but according to a resource that I found on the Wall Street Journal, Amazon can use the sales data from these third-party retailers to help guide Amazon's own selling. And with Amazon scale, they can then look for similar products. And obviously, since they get favorable terms from their suppliers, they can then undercut third-party sellers using fulfillment by Amazon. Now, from an owner's perspective, if you own Amazon or own their shares, this is obviously an excellent source of potential sales into the future. Amazon can not only see what is selling well, but since they take care of fulfillment, they have additional logistics information, which can then help them determine the margins that they will make on a specific

Starting point is 00:49:20 product. If a third-party seller sees Amazon selling the exact same product or a similar product for a better price, they're basically forced if they want to keep selling their items to drop prices and lower their margins in order to compete with Amazon. From a customer's perspective, of course, this benefits you, you know, if Amazon or a third-party seller wants a customer's business, I think a lot of times on Amazon, they're just going to go to whoever provides the most value. And obviously, Amazon has been at the top of the game in providing customers with a lot of value for almost its entire existence. Now, Amazon Prime is an excellent example of an analogous business unit that was created by Amazon. But let's move on as something that seems much different,

Starting point is 00:49:58 but has made a ton of value for Amazon, and that's Amazon, web services. So in 2002, a book publisher visited Jeff Bezos and showed him a tool that would visit Amazon's websites every few hours, and then copy the ranking of this specific publisher's books and the ranking of its competitors. So this publisher suggested to Bezos that Amazon create application program interfaces, APIs, that would quickly harvest data on Amazon's products that others could build upon. Amazon eventually settled on developing these APIs, which allowed other websites to publish sections of Amazon's catalog on their websites. This was an open source tool, and Jeff thought the market could surprise Amazon with new and innovative use cases of it. Now, if we fast

Starting point is 00:50:39 forward today, Amazon Web Services is a much different service. Today, it's best known for things like web hosting, content delivery, data storage, backup, archiving, applications development, data analytics, machine learning, enterprise IT, and migration. So clearly, you know, Amazon Web Services has evolved from its initial use case into another being entirely. And the reason is interesting. So Amazon had its own internal struggles in the early 2000s. And a big struggle was that compute power was one of the limiting factors in the ability of members of Amazon to test out new products and services. So engineers were performing these repeatable and time-consuming tasks, such as creating

Starting point is 00:51:19 databases, finding storage, and getting compute power. In the following few years after this, Amazon realized that standardizing and modularizing each of these components would save Amazon's employees a ton of time. time. And since they had these APIs available to others, they could also be used to save others time as well. So AWS was officially launched in 2006 and was based on three foundational services. The first one being file storage, the second one being scalable computing power, and the third one being messaging between applications. Now, while this doesn't really seem like a massive innovation today, it was an absolute game changer at the time. It allowed developers to rent

Starting point is 00:51:56 compute power and storage on demand, bypassing expensive servers and hardware management. Amazon did a great job of keeping this segment's growth and profitability up to one's imagination. So I mentioned at D.E. Shaw, he kind of took part in these similar secretive business practices. So in 2009, they had a line on their annual report called Other. And this one line bunched AWS with other Amazon services in a consolidated manner. So I then looked for Amazon Web Services just through the fine function. And I had to fast forward all the way to the first quarter of 2015, nearly 10%. 10 years after AWS started just to see the actual economics of the unit.

Starting point is 00:52:37 So in that quarter, AWS generated $1.57 billion in revenue and 265 million in operating income with about a 17% operating margin. So Google and Microsoft had their own kind of versions of AWS, but they weren't really popularized until around the time that Amazon started publishing that segment's financials. I find this corporate strategy both fascinating and frustrating. So, for instance, I own Tencent for a time. Now, while I could develop different scenarios for what their different segments were doing, Tencent does an excellent job, I think, intentionally of keeping their financials pretty vague for investors.

Starting point is 00:53:14 So for instance, Tencent's cloud business is inside of its FinTech and Business Services segment. While this is great from a business standpoint, potentially hiding a business's potentially most high-margin business in spite of specific segments, it can be really, really, really, aggravating as an investor. You know, if I want to learn about a specific company, but there's certain parts of that company that are kept in a black box, it's really, really hard to get comfortable with making an investment. It kind of forces you to place your trust in management. And believe me, this is not a China problem. I've seen this in European and North American businesses as well. So for instance, there's been times where I've wanted information and reach out

Starting point is 00:53:53 to management only to get an answer along the lines of, you know, we know the answer to your question, but it's not public information. Therefore, they can't share it. So, for instance, I own a trust, engineering, and manufacturing company. And I've always been interested in knowing how many board feet they are making and what the pricing is for what they sell it for. But it's just not a number that I've been able to find and management doesn't share it because it's not publicly available information. So essentially I have to rely on other numbers and my trust in the management team.

Starting point is 00:54:19 Now, let's get back to Amazon's growth story here. So Amazon has obviously had a great deal of organic growth, but they've also grown through a few very important acquisitions. So one of the most value creative acquisitions they made was with Whole Foods, which I think everyone's going to be familiar with. And they bought that for about $13.7 billion, which helped Amazon experiment with brick and mortar stores. However, I'd like to focus here on two acquisitions that made in an earlier date, which was

Starting point is 00:54:46 Zappos and Quidzy. So Zappos was an interesting business. Its CEO, Tony Shea, wasn't the founder, but was one of its earliest investors and obviously believed very, very much into the company. So he injected $1.5 million of his own money at one point. selling off his own assets to fund the cash infusion. So Shea built a fascinating culture as well inside of Zappos where he actually offered employees $1,000 just to quit on their first week on the job. So he figured that employees who took that offer weren't right for the business and this was his

Starting point is 00:55:15 way of filtering them out. I think Bezos would have liked Tony because they both believed in optimizing the customer experience. Managers who underpromise and over-deliver tend to be great managers and it appears that Shea followed that mantra. So for instance, Zappos would promise customers about five to seven days of free delivery, but could often reduce that to two days in major urban areas. So Bezos began courting Zappos in 2005, trying to understand if he could maybe acquire it. The initial buy price that he assumed that they'd be looking for was about $500 million. Now, Jeff didn't want to pay that. So he ended up getting a team together at Amazon to create a separate website, which was called endless.com that sold shoes very, very similar to what

Starting point is 00:55:55 Zappos was doing. So Amazon offered overnight shipping and free returns. And this was an interesting maneuver specifically done to undercut what Zappos was doing and would end up costing Amazon money. To entice customers even more, Amazon decided to pay them $5 to order from them on top of what they were already getting just to further injure Zappos. But even with these initiatives, Zappos continued to grow, but it was hit very, very hard during the great financial crisis. So Zappos required funding for their inventory. Now Zappos had some early investors, including Sequoia, and they wanted to exit their investment, which was putting further pressure on them to find a buyer for the business. Amazon then swooped in with an all-shared deal

Starting point is 00:56:34 for about $900 million. Now, I have no idea if those shares were held onto, but today they would be worth $23 billion. From this experience, Amazon learned how they could gobble up competitors by using very, very particular business tactics. If Amazon could run a business unit at a loss, it could pressure competitors to either wither into bankruptcy or just simply sell out to Amazon. However, since Amazon was putting pressure on the smaller guy, Amazon came from a place of strength, while the acquired would come from a place of weakness. So another very good example of this is Quidsey. So Quidzy ran several successful dot-com businesses like diapers.com. The founders of Quidsey admitted to learning a ton from Jeff Bezos and modeled much of their business off of Amazon. Now, Amazon here

Starting point is 00:57:16 used a similar tactic of dropping prices to levels that were just impossible to compete with dropping by up to 30%. So Quidzy threw these price drops, started experimenting with changing prices and then checking what the prices of Amazon's basically clone products were. And it was very interesting because as soon as Quidsey would change their prices, Amazon's prices would change basically immediately. And this was a product of Amazon's pricing bots. So in the Everything Store, Bradstone points out that Quidsey executives took what they knew about shipping rates factored in Procter and Gamble's wholesale prices and calculated that

Starting point is 00:57:48 Amazon was on track to lose $100 million over three months in the diaper category alone. Amazon ended up offering about $540 million for Quidsey, with a 48-hour response window and clarified very specifically that Amazon would inflict further pain on the business if they didn't sell to them. Now, the sell window here was made specifically because Walmart was already engaged in its own due diligence on Quidzy, and Amazon didn't want to lose out on that deal. So it became clear here that Amazon had some very, very significant advantages that it can employ to take control of its competitors. The option for its competitors were to be driven out of business or to join Amazon. Many companies face this reality, and if they

Starting point is 00:58:25 don't move fast enough, the deal can be able pulled, and they'll walk away with nothing, which was what Amazon intended to do had Quidzy not taking Amazon's offer. Now, let's shift here more to some of Amazon's organic growth initiative. So Amazon Echo and Alexa were other areas of innovation that Amazon worked incredibly hard to develop. So Alexa, in case you don't know, is kind of Amazon's version of Apple's Siri. So Echo is the device that you speak to to ask questions, play music, or even order items directly from Amazon. Now, I haven't discussed many of Jeff Bezos's personal preferences, but he's a Trekkie, which means he loves Star Trek. Now, one area of Star Trek that he enjoyed was the ability

Starting point is 00:59:06 to speak to a computer from various places. And in Amazon's case, that would be the ability to talk to a device from the comfort of your own home. One of the most significant controversies of this product, similar to Google Home, was that these devices constantly listen to all the conversations that you have. In Amazon's case, they felt they had to take this route because it improved the product. product's usefulness. The downside is that Amazon can potentially listen to all conversations where the device is, even when the prompt word is not used. So Amazon took measures to try to minimize this, but some data shows that Amazon has been able to leverage this information specifically for targeted advertising. So there was a study at UC Davis that showed that Amazon processes

Starting point is 00:59:44 user interactions to derive user interests. For instance, Amazon concluded that the fashion and style persona was interested in beauty, personal care, and clothing, but also that the inferred interests are, in fact, used for ad targeting. Some of the personas like health and fitness and fashion and style received up to 30 times higher advertising bids than the baseline persona. So I once worked as a smart home integrator using cutting edge technology. And there was an analog to Echo and Google Meet that was meant more for controlling your smart home than access to information, you know, like asking what the weather is going to be. And this product was priced at about four to five times higher than anything from Amazon or Google. But one of the

Starting point is 01:00:24 bigger selling points of the item was that it specifically did not track data. So from what I heard, they had to charge a lot more, specifically because the device wasn't subsidized from additional ad revenue on the back end from advertising. So if you're being bombarded with ads about things that you speak about, it might be because smart devices like Amazon Echo or Google Home are hearing keywords and feed them into the algorithms specifically to target you with advertising. So I personally have actually never used the Amazon Echo, only the Google Home. And while there are similar devices, I never used Echoes because I never really felt comfortable ordering something specifically with my voice. It's not that I don't like Amazon's products, but if, let's say I wanted pens, for instance,

Starting point is 01:01:04 I enjoy looking at some of the reviews and finding the specific pen that I want. And it might not necessarily be the cheapest, for example. But from my research, Amazon will use prior purchases to guide their suggestions to you. So if I asked it for pens, perhaps it would see that I like my Muji half millimeter pens and then ask me to confirm ordering those exact pens. Now, back to the echo. As far back as 2016, Jeff wrote in the annual letter, Our vision for Alexa is ambitious. We want to create an assistant that is so powerful that you wouldn't imagine going back to life without it.

Starting point is 01:01:37 As of 2023, reportedly 500 million Alexa enabled devices have been sold globally. So it's been an excellent way for Amazon to integrate its customers' lives into its ecosystem. This is similar to other products that I've already discussed today, such as the Kindle and Amazon Prime. Now, all of this is to say that Amazon is really an incredible business. Jeff built a business with a culture of innovation that embedded itself deeply into its customer's shopping preferences. Many companies claim to have their customers' interests first, but their actions speak otherwise.

Starting point is 01:02:11 In Amazon's case, I think part of its success has been its laser-like focus on optimizing customer experience. As you've heard today, Amazon has sometimes been willing to cut the head off of the Hydra because they know another head would grow back and be even stronger. A business that can harm itself in the short term to improve itself in the long run is very, very rare. So if your company is incapable of this, like 99% of businesses out there, it's just not a business strategy that can easily be emulated. As you saw with Zappos and Quidze, those businesses didn't have the scale and alternative revenue streams to take on a company like Amazon. You can argue that Amazon is

Starting point is 01:02:45 utilized unfair business practices. Amazon has had many lawsuits throughout the years, and I assume they're going to have many, many more in the future. But when it comes down to it, Jeff built a business with naturally embedded advantages that are very, very difficult to compete with. Businesses with scale like Costco and Walmart have these advantages too. However, smaller companies trying to compete with them simply don't. Amazon's army of engineers can pretty easily emulate businesses that can try to come in and utilize new technology or strategies to compete with them. But the problem is estimates have numbers of engineers inside of Amazon at about 50 to 70,000. So suppose a new technology is starting to disrupt a product or service that Amazon offers. In that case, they can easily divert

Starting point is 01:03:24 resources to create a competitive product and have the resources to do so. And if that doesn't work, they can always just take a loss on a product and make life so miserable for a competitor that they'll be forced to sell to Amazon or to an inferior competitor. Amazon has spent half a trillion dollars on R&D since it went public. There's not that many businesses worldwide that have spent that much money to improve their products and services. You must contend with that kind of R&D spend if you want to compete with Amazon. Now, as a competitor, you'd have to imagine that your exit strategy would be to either create a product that just doesn't compete with Amazon or make a product so good that Amazon will want to buy you out. Other businesses like Google and Microsoft have been

Starting point is 01:04:04 able to compete with, for instance, Amazon Web Services. However, they can also spend hundreds of billions of dollars on R&D, an advantage that most competitors lack. Now, I personally haven't noticed my own spending on Amazon decreasing. If anything, it's increasing, as I find that. that I can buy more and more items at excellent prices on Amazon, and all from the comfort of my own home. Additionally, Amazon's return policy is superb. So I recently bought the Kindle Scribe and was having some issues with it. After speaking to an agent, I was very, very promptly sent a new unit and sent the defective unit back.

Starting point is 01:04:35 It was a very, very easy and painless experience. Now, contrasts this with a clothing brand that I used to buy that had no affiliation with Amazon. So with this clothing brand, I purchased a pair of pants. and after only wearing them twice and not in like a rough manner whatsoever, they began pilling. So I ended up emailing them and telling them about this. I think this was only after about two weeks of wearing it. And they said that this was just a natural part of their apparel and that there was nothing

Starting point is 01:04:59 that could be done about it. Well, that was the last time I ever shopped with that brand. And I highly doubt that Amazon would have treated my complaint similarly, which is probably why I just keep returning back to Amazon. Now, part of the reason that Amazon has such competitive pricing is that it is very similar to Costco. You know, they can both purchase large volumes of products from their suppliers. If Amazon wants to buy products from a supplier, they can negotiate better rates than nearly

Starting point is 01:05:22 anybody on the planet because there are exactly zero, that's right, zero e-commerce businesses that get as much traffic to the website as Amazon. According to similar web, Amazon is the 13th most visited website in the entire world. Therefore, Amazon's network effects are just massive compared to its competitors. So even if we take the supplier out of the equation and look at third-party sellers, you're basically just doing yourself a disservice by not posting your product on Amazon. Because if you have the scale, there basically are no competitors out there who is going to get the amount of eyeballs on their site that Amazon can offer. Now, while Amazon is a very moody business, it can't disrupt all industries.

Starting point is 01:06:00 The luxury industry comes to mind as an industry that doesn't really seem to fit Amazon's market. So I searched for Louis Vuitton and Armes on Amazon.com and it didn't come up with any items. So my guess is that these brands just don't want their inventory to be associated with Amazon's brand and therefore they just refuse to do business with Amazon. However, Amazon does own other websites outside of Amazon.com. So perhaps it could take market share with an unaffiliated website. But you know, the thing about luxury goods is that the product's price is usually not the primary reason that people buy it. It's because of the symbol that owning the product provides. Amazon is really focused on making things simple, cheap, effective, and fast.

Starting point is 01:06:41 And oddly enough, many luxury companies take the exact opposite approach and have had tremendous, tremendous success. For instance, if you look at Ferrari, they make customers wait for up to two years to buy a car. They charge well over $350,000 just for their entry-level products. And they cater to driving enthusiasts, not just the general population. So an example of this is that some of their cars have no air conditioning or automatic windows, simply because it would make the car heavier, but they don't care because Ferrari is meant to go fast. And then lastly here, you know, if you even want to buy one of Ferrari's high-end models, you actually need to own multiple lower-end Ferraris just to warn an offer on a higher-end model.

Starting point is 01:07:21 So, you know, just going through that, you know, does that sound like it resonates with Amazon's business model or philosophy? To me, it doesn't at all. But, you know, there's obviously a ton of adjacent industries that Amazon could continue scaling into or could just continue scaling into the products and services that it's already in, which it seems to be doing very, very well. Now, to conclude here, I think Amazon story is just a masterclass in competitive advantage. It teaches us that great businesses don't just find product market fit.

Starting point is 01:07:49 They build stronger systems over time. If you're an investor searching for long-term compounders like myself, the lesson here isn't to just look for the next Amazon. It's a look for companies with similar DNA. Things like having a long-term orientation, having a founder's edge, and a relentless focus on delivering more and more value. because in the end, the market may misprice a business for years, but it won't misprice greatness forever.

Starting point is 01:08:14 That's all I have for you today. If you want to interact with me on Twitter, please follow me at Irrational MR, KTS, or on LinkedIn under Kyle Greve. If you enjoy my episodes, please feel free to let me know how I can make your listening experience even better. Thanks again for tuning in.

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We Study Billionaires - The Investor’s Podcast Network - TIP716: The Power of Customer Obsession: Amazon’s Secret Weapon w/ Kyle Grieve

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