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.