On June 27, 2001 Jeff Bezos sat down for an interview with Charlie Rose. His comments over the course of 30 minutes provide what you need to understand the retail business of Amazon.com. You can watch it here. I've included some transcribed remarks below with a little color commentary.
For some context, this corresponds with the steepest part of the dot-com collapse. Amazon's stock price had been in free-fall for 18 months, declining from $106 in December 1999 to $14 when he sat down with Charlie. And its drop wouldn't end until shortly after 9/11 when it hit a $6 bottom.
Bezos Can Distinguish Between Stock Price and Business Fundamentals
Charlie Rose (CR): Two years ago you were Time Magazine's man of the year. What are you this year?
Jeff Bezos (JB): It's internet poster boy to internet pinata in 12 months! Not an easy thing to do.
CR: Let's talk about it. How's the business?
JB: Actually, the business is better than ever. This is one of those things that is so hard for people who are seeing it from the outside to really understand and internalize. but if you look at 1999, which is the year that the stock was booming, we had 14 million customers shop with Amazon. In the year 2000, when the stock was busting, we had 20 million people shop with Amazon.
...But I do think it's typical for people to separate the stock prices of internet companies (which have obviously come way, way, way off their highs) and the fundamentals of those companies which are actually getting better and better.
CR: What are the fundamentals of Amazon, and how are they getting better?
JB: For example, in Q4 of 99 when our stock was at or near its peak, we had an operating loss of 26 percent of sales. A year later, when the stock was near its 52-week low, we had an operating loss of seven percent of sales. So the operating losses got much, much better. The number of customers...got much, much better. You can basically go through and look at every important operating metric in the company and they've all improved.
[Paul: As we discussed here, there are some very capable CEO's - leaders of important and successful businesses - that seem incapable of separating stock price and the performance of the business. At the very least, they have an emotional and financial tie to the market's price...a tie they have a difficult time unraveling.]
Growing the Business
CR: ...why stray from books?
JB: Charlie, one of the reasons that we've expanded into these new categories is because our customers have asked us to do it.
CR: What kind of relationship do you have with Sony, for example?...Do you have the kind of relationship that an authorized dealer does so you can offer Sony products competitively?
JB: Well we do offer products competitively, but in some cases that doesn't necessarily mean that we're buying them directly from the suppliers. We started our electronics business two years ago, and we're now direct with over 340 different electronics suppliers. We have by far the largest selection of electronic items...in the world...We have over 125,000 items...compared with a huge electronics superstore that might have 5,000 items. We're so new in the business, over time and patiently, we hopefully get relationships with every manufacturer.
[Paul: This is remarkable to think about. In 2001 Amazon was already an important player in electronics retail. But big players like Sony weren't yet dealing with them directly. Amazon makes it a priority to offer the highest selection possible at the lowest price available. One can only imagine the costs they were eating by sourcing through electronics distributors, paying those mark-ups while simultaneously selling cheap.
This has been the Amazon modus operandi...buy your way into the market even if it means taking losses while you help customers learn the habit of buying from you. Then, when you have the customer buying power behind you, go direct to manufacturers for procurement, get better pricing, and enjoy improving margins.
Remember that: growth is expensive for Amazon. It always has a lot of clean-up duty after opening new stores and expanding into new geographies. It hurts corporate profitability. But then, inevitably, Amazon owns the category, has power to buy cheap and in bulk, and becomes profitable while continuing to sell at the low price point.]
E-commerce Is All About Scale...
CR: Looking at the experiences you've had over the past three years, was part of the business plan simply to grow faster? [Bezos nods his head, yes.] Would you change it? In hindsight...would you have had a different business model or strategy?
JB: I don't think so. I think we have...made the right set of trade-offs. One of the things that you have to know about e-commerce is that it's a scale business. What that means is that it's very, very difficult to be a small- or medium-sized e-commerce company.
The difficulty there is because there are big fixed cost investments. You have to write a bunch of software, and it's just as expensive to write that software if ten customers use it as it is if 20 million customers use it...It's difficult to build software that scales and is feature rich...[But] we like things to be hard because then you can get competitive advantage from it.
...And We Had to Manage The Land Rush
CR: The biggest mistake you've made so far?
JB: ...We started investing in a series of smaller- and medium-sized e-commerce companies. Of all the companies that perhaps, in hindsight at least, could have know better, it's probably us. Because we did know that the fixed costs in the business are high.
CR: So what happened?
JB: One of the things we were very convinced of, and indeed was definitely true in the earlier days, is that there was a land rush phase to the internet. And so, when we saw product categories that we thought were important to our future at some point, but they weren't the ones we were going to do first...Pets.com, wine.com, etc....there were a bunch of things that we were invested in that didn't work out. We knew we weren't going to do those things anytime soon, but we wanted placeholders in those industries so that later, perhaps, we could fold these industries back into Amazon.com. So that was driven by...a land rush mentality...It's hard to put a precise date on it, but I believe that for the first four years of our existence, that land rush mentality was correct. And the only reason we exist today is because we...behaved that way. But that started to transition after a certain point, and we didn't see it at the time it transitioned. And it took us a couple years too long.
...That's part of what created the land rush...the huge market cap of the internet sector. So all these companies could get funded. And that's what created one of the imperatives for moving so quickly. Because there were so many start-up companies getting $60 million or more in venture capital. And those companies with that much capital, if that financing environment had continued for any extended period of time...many of those companies might have been able to build the scale to be successful.
[Paul: This makes even more sense in light of a "systematically eliminate risk" comment below. Amazon was broadly criticized for all the investments it made that went bust. The assumption was, I think, that Amazon was spreading its dollars as a way to capitalize on the mania of so many dot-coms being valued higher and higher by the market. Not at all, says Jeff Bezos. Amazon was making the investment with a specific objective in mind...control the expansion of various categories and wield your influence or risk another company getting scale (number of customers, sophisticated e-commerce software, and distribution capabilities) and threatening your chance at achieving ubiquity (more on that topic in a later post).
And what's old is new again. Amazon hasn't really changed their view on preventing viable competitors by bear-hugging them. But because their scale is so much larger, they feel more confident in their ability to just compete upstarts out of business. For those that pose a larger threat - e.g., Quidsi and Zappos - Amazon co-opts by purchasing. You can read a bit more about that here.]
The Amazon.com Model
CR: [Something to the effect of...] Does the Amazon.com economic model work?
JB: I think the model has been demonstrated. If you look at our U.S. books, music and video business, that business has been profitable for quite a while now...And our electronics business, I think one day, is going to be one of our largest and most profitable businesses.
[Paul: I'll write more on this at a later point. Sometime around 2000, Amazon proved that it could turn a profit quite easily. The secret? Just stop growing. As I mentioned above, there are some incredible inefficiencies inherent to growth. When you start selling electronics, it takes time to be a big player. So you don't get to source directly from giants like Sony. But you must have the selection, so you buy it from an expensive middleman and endure losses so you can continue earning customers by selling at the low price point. Then, one day, you reach the tipping point...you have scale, you can purchase directly (and with negotiating power), and you iron out inefficiencies. Now you have customer loyalty, the ability to sell at low prices, and low costs to produce gross margin dollars. Voila! Profitability and competitive advantage!]
Moore's Law & Its Derivatives: The Internet As Superior to Physical Retail
JB: One of the things that's totally different about e-commerce versus physical world commerce is that real estate doesn't obey Moore's Law. Moore's Law says that microprocessor performance doubles for the same price point every 18 months. That's held true for more than a decade. What you're finding now is disk space is getting twice as cheap every 12 months. And bandwidth is getting twice as cheap every nine months. So if you take the bandwidth doubling every nine months and assume it holds constant for the next five years, that means that we can spend the same amount of money on bandwidth per customer that we spend today five years from now but use 60 times as much bandwidth. That's a big, big deal.
JB: I am a dyed in the wool optimist. We live in an era of incredible invention, and what drives the economy is invention...A long time ago people thought it was raw materials that drove the economy, and whichever country had more gold was the richest country.
That's not true anymore.
What drives economies is the education of the people and the innovation that they can then create. And I see a world which - in part because of the internet - is about ready to explode with innovation everywhere.
...It used to be that if you were a genius and you lived in India, it was a little bit harder for you to make an economic contribution to the world. What you do now is create the next great software, and you do it from wherever you are, and you communicate with the world community of software engineers. This is a big deal. And so if you believe fundamentally, and I do , that innovation is what drives world prosperity, I say hang on to your seat.
[Paul: Bezos is often derided as a technocrat. Everyone respects his intelligence, but many see him as just a metric-driven geek who brings no passion to building a vision for the business. Watching and hearing this statement would cause those critics to think twice. Jeff Bezos is driven by big ideas and has passion about enabling the masses with platforms that fuel innovation.]
Confidence to Say...Check & Mate
CR: What could destroy that dream for you? What's the terror?
JB: [Responding unflinchingly and without breaking eye contact.] When I first met John Doerr, who's the person at Kleiner-Perkins who invested in Amazon.com, one of the things he said really stuck with me. It was, "What start-up companies do is they take their precious early capital dollars and systematically eliminate risk." That's what they do; the successful ones.
What people often get wrong, when you're a start-up company, 99 percent of whether you make it to be a more established company is luck. This company, Amazon, we've worked incredibly hard. We've cared for our customers. I'd put us up there against any other company in how much we have bled and sweat for our customers. but we had the planets align for us so perfectly in those early days in terms of the timing and many other things; decisions that we made that were poor decisions that turned out to be the right decision anyway.
In the early days, that's when the company's destiny is really not in its own control. At this point in time, with the brand name that we have...we have so many assets now, now it really is under our control. We don't worry about externalities now. What we worry about now is that we don't do our job. And I'll tell you one of the things in this period that I kind of like is that it's a lot easier in the year 2001 for Amazon.com as a company to be humble, working our butts off, than it was in 1999 when the world believed we couldn't lose.
CR: [Paraphrased] There are two schools of thought. One is that Amazon will become the most spectacular retailer of all time. The other is that Amazon may become the most spectacular failure of the internet era. What's the odds of the first being true versus the second?
JB: Let's put it this way: we get to decide, nobody outside the company can decide that.
[Paul: I don't see many ways to interpret this confidence. Bezos is saying that - AND THIS IS WAY BACK IN 2001! - absent screwing up internally, we've already won. We've eliminated the worst risks. We've eliminated luck as a variable in this. The model is that bullet-proof. It's our to screw up.]