Amazon: from a book store, to the everything store, to running the internet
Amazon has grown rapidly to become so much more than a e-commerce company
Amazon has been one of major success stories of the digital era. Since launching in 1994 as an online book retailer, Amazon has grown to become the world’s largest e-commerce and cloud computing company with a market capitalization of ~US$400B and over 260,000 employees worldwide. Over Amazon’s 23-year history, there were several factors that I believe have been critical to its success.
The first of these was Jeff Bezos’s foundational decision to initially launch the e-commerce platform with an exclusive focus on books as an area to build competency and capability, before expanding into other product categories. The selection of books was a clever decision because books are a ubiquitous, commodity product that have universal appeal, are easy to ship and do not need to be touched before being purchased (especially important in the late 90s when e-commerce was still a novel concept to many consumers). The success in books gave Amazon the capability, experience, and customer understanding to grow its e-commerce platform into a business that today offers almost 500 million products in the US and is estimated to handle 20-30% of all US retail spending.
Additionally, as with other tech giants, Amazon has also continued to invest in R&D to uncover new areas of the opportunity. In 2015, Amazon’s R&D spend was $12.5 billion, 11.7% of net sales. This has enabled Amazon to innovate and diversify its presence as a technology company beyond just e- commerce by expanding into cloud computing (Amazon Web Services), digital voice assistants (Alexa) and video on demand (Prime TV), among other things. On the e-commerce side, Amazon undertook a lot of incremental innovation to not only expand their product range but also add new services such Subscribe & Save, Prime Pantry, Amazon Fresh, Prime Now, Prime Music and so on. Amazon’s Echo and Alexa, the first standalone piece of hardware dedicated to digital voice assistance and natural language processing, is an example of radical innovation. Amazon Web Services, the first and largest cloud computing service in the world, established the entire cloud computing business and is another example of radical innovation.
Jeff Bezos and the senior management team at Amazon have been able to support this extremely high degree of reinvestment in the company through a mix of financial discipline and conditioning of the market over time. Since its inception, Jeff Bezos has been very consistent in maintaining that Amazon’s revenue growth will be prioritized over profitability and that capital will continue to be reinvested into the business to achieve growth. He has also successfully been able to condition analysts and investors to accept and understand that it is not that Amazon is fundamentally unprofitable and that, if he wanted to, substantial profits could be turned on at the flick of a switch. Amazon did not post its first profit until 2003, and even then, it was only very marginal. Even in 2015, Amazon, on $107 billion of net revenue (which was up 20% year-on-year), recorded a mere $600 million of net profit, implying a profit margin of only ~0.5%.
Amazon’s business model is driven by one of its most important leadership principles, ‘customer obsession’. Amazon creates value for its customers by focusing on providing low prices, flexibility, convenience and high levels of customer service across an enormous range of products. Amazon captures value in a variety of ways, depending on the product or service group. On the e-commerce side, Amazon captures value directly through selling products and by charging for its Prime subscription (which entitles customers to a variety of premium services), driving down costs through economies of scale at its fulfillment centers, and leveraging customer data to improve purchasing predictability and market products. In a similar vein, Amazon Echo speakers and Alexa voice-assistant, provide customers with a way to interact with the internet through voice to make their lives even more convenient. Amazon captures value from Alexa in the form of upfront hardware revenue and customer data which it can use to sell more products. Finally, AWS creates value by enabling an “infrastructure-light” approach to quickly launching internet business and, in turn, captures value by providing customers with a bevy of pay-for-what-you-use cloud computing and storage solutions.
Great perspective on what has made Amazon so successful over the past 20+ years!
One thing I have found fascinating about their diversification efforts is just how interconnected they are, despite not always appearing so. For example, it isn’t immediately obvious that a retailer is well-suited to run a cloud computing service. But my understanding is that AWS started as an internal project to standardize and better manage Amazon’s private server infrastructure. Along the way they realized how compelling it would be to sell access to the system, and so we got AWS.
Relatedly, I have read that Amazon is also very stringent about using APIs for internal communication. Because the e-commerce operations must use APIs to exchange data with Alexa, the Alexa team has a strong incentive to develop and document a robust API. And that API, now open to a proliferation of third-party “skills,” has enabled new functionality that strengthens the ecosystem and Alexa’s value proposition. Following this pattern, Amazon has effectively set up several of its business units as major “customers” of other units; in so doing, the firm’s customer obsession has benefited Amazon’s partners and customers.
Amazon has created a really strong value prop through their retail, cloud and increasingly their media subscriptions. They spend a ton on R&D, as you noted, to drive innovation. However, Amazon, like Google, is focused on so many long shots. Some only integrate with the business tangentially.
We tend to see an expansion and contraction cycle over time with businesses and the methodology around focus. Big conglomerates divest to focus and then little companies build themselves into big conglomerates to buy growth. I wonder where amazon is on this cycle.
Great post. I agree with you that Amazon is an overall winner in the e-commerce business. But it’s been very difficult for Amazon to break into some of the emerging markets such as China. Will its business model work in terms of competing with strong local rivals such as Alibaba?
Amazon is a great example of a company that was born during the dawn of the digital age. Whats really interesting is that although they have been selling books online for more than 20 years, they recently started to migrate into physical retail, the very space they disrupted. Their new bookstores are a physical representation of their online store, with books facing cover up, cards with reviews, and omni-channel purchasing options (physical, online, kindle, audiobook). This may all be a grand experiment, but it shows that digital hasn’t quite replaced the desire to touch and browse a book that a traditional store offers.
Amazon has built a global juggernaut of a business, and has created formidable entry barriers for competitors as well. Fulfilment of customer demand entails huge logistical capabilities and supply chains that Amazon has built and perfected over time. Amazon is constantly innovating, such as with last-mile delivery mechanisms using drones, and envisages continuing making substantial investments into the future. Till recently it was difficult to analyse Amazon’s numbers and business, and it’s only when they started breaking out the AWS numbers that the street appreciated the enormous operating leverage in the business.
Thank you for the post YY, Amazon is definitely a role model for e-commerce business. It’s ability to not only develop their core business, but also launch other lines of business is really fascinating. I believe they have a great future based on the current trends in the industry.
They started with the “old media” – books, the good that was rapidly moving towards digital and literally disappearing, and were able to develop the core competence of e-commerce to project it on the other goods sold in the Internet. Right now the sales of goods and services are rapidly migrating to the Internet and very soon will substitute even supermarkets and convenience stores. If Walmart, Target, CostCo and such don’t restructure their business towards the e-commerce, they will lose customers and thus revenues.
Amazon is really good in value creation, may be not so good in value capture so far, but this is a matter of time. After the migration occurs, the company that has a platform between sellers and user and buyers, will have it all.