Following the news of Amazon’s acquisition of Whole Foods, I wonder if there is a company leader that isn’t questioning if and how Amazon will compete in—and transform—their market. I’ve joked that there’s no other company that could acquire a gamer-focused live-streaming platform and a grocery store chain, let alone have each universally praised as “strategic.” The 800-pound gorilla (perhaps a better analogy would be The Borg) keeps gaining weight, and it feels like no industry will be left untouched.

Their ever-expanding reach, interests, and focus has led to add an Amazon-specific due diligence section to our acquisition process. It’s not only a question of whether Amazon will create a private label offering in the same sector and force margin out of existence. Their presence impacts inventory requirements, capital expenditures, financing, talent flow, and much more. We often ask:

  • What percentage of market demand is currently generated on the Amazon platform, and what are the trends?
  • How easy would it be for Amazon to create a competitive product?
  • Is the category large enough to entice Amazon into it?
  • What relationship protection does the company enjoy with suppliers that would keep Amazon from cutting out the business?
  • Particularly in the Northwest, is the company reliant on talent that Amazon covets?
  • If the company chose to engage with Amazon meaningfully, what impact would it have on working capital requirements?

We continue to see both brands and private label manufacturers gain substantial revenue, while losing margin and having to hold much higher inventory levels to gain the business. ‘Tis the Amazon Way. For companies with less weight than Amazon, these forces can represent an existential risk. Income statements look great, while cash flow is terrifying. These businesses are “making” a ton of money while struggling to pay the rent.

Jeff Bezos never attempted to hide his plan from anyone. In his 1997 letter to shareholders, which he still attaches to annual letters, he was straightforward about the then-online bookseller’s aim:

“But this is Day 1 for the Internet...

“Our goal is to move quickly to solidify and extend our current position while we begin to pursue the online commerce opportunities in other areas…

“We will continue to focus relentlessly on our customers…

“From the beginning, our focus has been on offering our customers compelling value. We realized that the Web was, and still is, the World Wide Wait. Therefore, we set out to offer customers something they simply could not get any other way, and began serving them with books. We brought them much more selection than was possible in a physical store, and presented it in a useful, easy-to-search, and easy-to-browse format in a store open 365 days a year, 24 hours a day. We maintained a dogged focus on improving the shopping experience…”

There aren’t any silver bullets to offer private companies trying to figure out a next move in the context of an Amazon-led economy. But in our evaluations of companies and discussions with their leadership, we have recognized some notable patterns.

Among small- to mid-sized private B2C companies, there seem to be four modes in dealing with the Amazon threat: those operating as though it’s business-as-usual, those operating in some stage of grief, those who have decided to dance with the devil, and those who have doubled-down.

Mode: Business-As-Usual

These leadership teams refuse to believe Amazon is a threat, and perhaps they’ve been correct to date. We talked to an auto parts supplier last year who insisted as much. We passed on the opportunity as, for us, the best defense is a good offense, and no defense is, at best, ominous. Then, in January of this year, “Amazon’s Next Frontier To Conquer? Auto Parts,” was published. Our fear for the company was realized within a year. It’s like Taleb’s Thanksgiving turkey. All is good until it’s not.

Mode: Stages of Grief

Some companies are still working their way through the five stages of grief. They’ve had success, are proud of what they’ve accomplished, and are trying to come to grips with the new normal of Amazon. Some are still in denial (see above), while most have moved past anger into some combination of bargaining and depression. They’re searching for a reasonable solution that allows them to remain independent, while consistently making concessions to survive. It’s a no-man’s-land of business strategy—temporarily workable, but not sustainable long-term.

Mode: Dance With The Devil

These teams have decided to go all-in with Amazon and most are currently booming as a result. If you can get the operators to be honest, it feels like a deal with the devil. They’re almost completely reliant on Amazon for discovery, distribution, and payment. One algorithm change and they could lose 60% of their business overnight. Or worse yet, Amazon could directly compete with their own product. Their margins are constantly shrinking and their inventory levels are booming.

Mode: Double-Down

The leaders doubling down admit the threat and achievements of Amazon. In fact, they often speak of the gorilla with respect. Yet, they can articulate competitive advantages on which they have doubled down in belief that it will protect their moat. These advantages may be in the form of supply exclusivity, intellectual property, customer service, or something else. But they know what it is and are actively investing in it. Only time will tell if their strategy plays out as planned.

It’s important to note that what Amazon takes, it also gives. There are tons of businesses built on the platform and an entire ecosystem of helpers for those engaged with it. If you understand the ranking algorithm, can create a competitive product, and get it to an Amazon distribution center consistently, you can grow a big business relatively quickly. That’s the nature of creative destruction. One businesswoman’s loss is another’s gain.

The existence and strategic moves of Amazon consistently surprise and delight customers, while surprising and terrifying existing businesses. Just look at Blue Apron for a recent, high profile example. Only those who, like Bezos, focus relentlessly on their customers will survive.

In his 2016 letter to shareholders, Bezos described this approach, which is a bedrock of Amazon culture, as Day 1 and Day 2:

“I’ve been reminding people that it’s Day 1 for a couple of decades…

“Day 2 is stasis. Followed by irrelevance. Followed by excruciating, painful decline. Followed by death. And that is why it is always Day 1.”

As an investor with a permanent time horizon, we want to partner with sellers who have maintained a Day 1 focus, are doubling down on their competitive advantages, and are relentlessly focused on serving their customers, regardless of Amazon’s potential impact. It’s a rare combination, but the only one with a chance of enduring for decades, or longer.