Diversions

What Amazon Can Teach Us About Strategy

October 22, 2013

front doorJeff Bezos’s annual shareholder letters for the period between 1997 and 2012 are an invaluable educational resource for entrepreneurs and business owners. During those fifteen years, Amazon grew from a promising face in the crowd to one of the four largest players in the Internet marketplace – mostly due to consistent application of strategic principles outlined in the very first of those annual letters.

Perhaps the most consistent principle throughout these letters is the elevation of long-term strategy over immediate profit. To some, this seems impractically vague at first glance, even somewhat idealistic, but it grows from iterating two concrete operational steps:

  • Select the right metrics against which to judge success
  • Identify and execute new tactics which improve those metrics

There’s much, much more to be learned about business strategy from Amazon’s lifetime performance and Bezos’s refreshingly direct letters – one could write a book about the Kindle, itself, which you could purchase, read, and review on your Kindle – but we’ll focus on these two points for now.

Amazon vs the Cult of Shareholder Value

One of the key points of Bezos’s first letter to shareholders, written in 1997, is that the company will not allow immediate reactions from Wall Street, or short-term profits, to guide its investment decisions. Or, as he put it in 2012:

Jeff_Bezos'_iconic_laughAs I write this, our recent stock performance has been positive, but we constantly remind ourselves of an important point – as I frequently quote famed investor Benjamin Graham in our employee all-hands meetings – “In the short run, the market is a voting machine but in the long run, it is a weighing machine.” We don’t celebrate a 10% increase in the stock price like we celebrate excellent customer experience. We aren’t 10% smarter when that happens and conversely aren’t 10% dumber when the stock goes the other way. We want to be weighed, and we’re always working to build a heavier company.

Much ink has been spilled over the ways a myopic focus on shareholder value as the key metric of success can destroy a business. (For an overview, see this Washington Post piece; the Post, which Bezos recently acquired, is further offered into evidence.) Bezos, intimately familiar with Wall Street and hedge fund architecture, made a very deliberate decision not to iterate those business models at Amazon. Instead of per-transaction profit or earnings per share, Bezos chose free cash flow as a key performance metric, as that gave a much more accurate read of a business’s real health and long-term viability.

“I know of a couple who rented out their house, and the family who moved in nailed their Christmas tree to the hardwood floors instead of using a tree stand,” Bezos wrote, in his 2003 letter to Amazon shareholders. “Expedient, I suppose, and admittedly these were particularly bad tenants, but no owner would be so short-sighted. Similarly, many investors are effectively short-term tenants, turning their portfolios so quickly they are really just renting the stocks that they temporarily ‘own.’”

Decisions which raise the stock price of a company in the short term can undermine its actual value in the long term, making it a poor metric for success. Instead, Amazon structured itself to capture greater cash flow by increasing its customer base.

Amateurs Study Tactics, Professionals Study Logistics

When confronted with a tactical decision, it’s a common mistake to focus on targets which yield short term benefit while inadvertently undermining your long term strategic goals. In Amazon’s case, this meant – partly – eschewing traditional means of increasing short-term profit, while aggressively pursuing refinements and innovation in areas which increased their value to the marketplace.

Chess-kingMany contemporary businesses regard personalized customer experience – in terms of outreach, communication, and purchase price – as preferred targets for cost cutting. Witness, for example, the declining quality of sales and support staff in many of Amazon’s contemporaries, or the seemingly illogically high price points for many common goods and services. If service can be outsourced to a call center, it typically is, while prices remain essentially fixed regardless of supply-side cost reductions.

Instead, Amazon focused on delivering innovations which enabled consumer price reductions, while positioning the company to deliver more a consistent, quality customer experience. For example:

  • Reviews and recommendations personalize the experience of every unique customer
  • Opening Amazon.com as a marketplace and platform to third parties increases selection
  • Logistics improvements reduce unit costs while decreasing turnaround time

No traditional company could afford to sell at Amazon’s prices, especially not while hiring a trained salesperson – one familiar with the entire purchasing history of not only the specific customer, but of all others who share their tastes – to guide each visitor through their retail inventory. Nor would a retail store offer shelf space to its competitors, for customers to compare price and quality. Amazon does exactly that, however, with incredible results.

From Bezos’s 2002 shareholder letter:

With customer experience costs largely fixed (more like a publishing model than a retailing model), our costs as a percentage of sales can shrink rapidly as we grow our business. Moreover, customer experience costs that remain variable—such as the variable portion of fulfillment costs—improve in our model as we reduce defects. Eliminating defects improves costs and leads to better customer experience.

Zappos_fulfillment_centerAmazon’s leadership recognized that logistics and fulfillment costs could increase with growth, whereas customer experience costs remained relatively flat by comparison. As such, targeted logistics improvements – such as randomizing the warehouse location of goods, to increase the odds of any two items in an order being physically proximate – would yield increasing returns, and any fulfillment process defects they eliminated would deliver immense savings over time.

Whereas another company may have pocketed the difference, Amazon pursued a strategy of cutting consumer prices in response to logistics improvements.

The result? Instead of short term profit, Amazon’s strategic policy of valuing long-term advantage over short-term profit – in this case, slashing prices in response to reduced operating costs, while improving selection and customer experience – lead to remarkable growth. Their customer base and product offerings expanded into nearly all sectors of the online marketplace.

In short, Amazon chose to drive for ubiquity over profit, and was rewarded with both.