Gorilla Mode

The Engine


In our earlier essay, we discussed Bezos’ “Day One” mentality for Amazon’s culture. In brief, “It is always Day One.” But where does the momentum come from?

ACTIVE DATA

If you have an Amazon account, the company may know quite a bit about you, including any information activity collected through:

  • Your User Profile
  • Your Order History
  • Your List(s)
  • Your Stored Data, such as photos you store on Amazon
  • Your Browsing History, including how much time you spend on any given page, your IP address, buttons you click and more
  • Your Search Queries, including the terms you entered and what products you ended up viewing and later purchasing
  • Your Ratings & Reviews on products and services
  • Your Responses to surveys, contests, and any other response-oriented prompt
  • Your Geographic Location when using the mobile application
  • Your Uses of and preferences within Prime Video, Prime Music, Audible, Kindle, and any other content-oriented service
  • Your Alexa prompts, but note that apparently Alexa only records up to 60 seconds of audio and only after prompted to protect your in-home privacy

As consumers, we don’t seem to care that the company knows this. Privacy is exchanged for service. We like Amazon’s use of the information to improve our experience, giving us better product recommendations, allowing us to purchase without re-entering information, and notifying us when there are price changes on items we’ve said we want to buy. The data collection seems to be for the benefit of the consumer.

“We [are always making] personal recommendations for people… Of course, [we] have to keep your purchase history to do that… One of the reasons we always greet you by name when you visit our site… [is so] you know you’re not anonymous on our site… To the degree you can combine transparency with what the consumer benefit is… [the better],” is how Jeff Bezos explained it.

But data collection also has value for Amazon as a company. Think about what Amazon knows about the bulk of consumers. On the merchandising side, they don’t just know which products sell, in what volume and at what price point. They know how many people have a given product in their wish list, how many times and in what ways they interacted with the product page before buying, how long it sat in their cart, the percentage of people who considered it but ultimately didn’t buy, and what people thought about the product after purchase.

This information translates into a deep understanding of products, inventory, and market size. It’s a company’s dream but it’s Amazon’s reality. In imperceptible ways, Amazon incrementally improves the user experience.

More daunting for competitors, though, is what Amazon knows demographically and psychographically about its customer base. It would be fascinating to hear an Amazon insider explain how many customer profiles the company caters to. The segmentation of populations from pet lovers to new moms is something most companies have to narrow down to a handful or less; Amazon likely caters to thousands, if not tens of thousands, of niche target audiences and has the inventory ready to fulfill their specific desires.

Amazon knows when its Amazon Marketplace sellers are struggling to fulfill demand or, by contrast, selling at scale with great margins. If you were them, what would such data suggest? Opportunity.

This creates a highly customized shopping experience for consumers. Amazon can anticipate needs, wants, trends, fascinations, and frustrations. Where others ask, Amazon knows. Where others guess, Amazon has data. Where others survey their users, Amazon checks their shopping carts. In a world where people lie, this info is priceless.

R&D

It is estimated that in the fourth quarter of 2016 Amazon became the largest known corporate spender on research & development in the world on a trailing twelve month basis (TTM), a position previously held by Volkswagen AG. According to Q1 2017 financial reports, the company spent $4.8 billion on R&D just in that quarter, putting them at $17.4 billion in TTM spend. Who can compete with that?

All this spending is funneled into their public financial reporting through a vague heading: “Technology & Content,” which is described in their reporting as:

“Technology costs consist principally of research and development activities including payroll and related expenses for employees involved in application, production, maintenance, operation, and development of new and existing products and services, as well as AWS and other technology infrastructure costs. Content costs consist principally of payroll and related expenses for employees involved in category expansion, editorial content, buying, and merchandising selection.”

Reading between the lines, this is a big umbrella for continued experimentation and growth. R&D dollars matter because there’s inherently higher risk. As Bezos phrased it in the 1997 shareholder letter,

“Given a 10 percent chance of a 100-times payout, you should take that bet every time. Failure and invention are inseparable twins. To invent you have to experiment, and if you know in advance that it's going to work, it's not an experiment.”

Dollars spent are not the only metric, and certainly not a guarantee of success. Although Bezos admits there have been billions of dollars in failures, the data, creativity, and technical sophistication likely play large roles in contributing to Amazon’s effectiveness in R&D.

It’s hard to speculate on what Amazon is working on behind-the-scenes at any given time. Apparently they worked on Echo and Alexa for four years before any product announcement was made. Now, Bezos has said over a thousand people are working on artificial intelligence (AI) projects just related to Echo and Alexa. The scale is hard to fathom. Just that division alone would be one of the largest AI companies in the world.

What may be most remarkable is how they continue to build these technically advanced projects, while also working on seemingly boring advancements like the Treasure Truck, private label fashion brands, auto parts, and physical Amazon Books stores.

At first glance, the Amazon Books stores seem counterintuitive to Amazon’s original premise. They are small shops in highly trafficked cities with only around 5,000 book titles on the shelves, all facing outwards to encourage exploration (and also taking up expensive physical real estate). How are the titles chosen? Amazon.com data. Why add overhead and expense of physical operations? Bezos put it this way:

“It’s about satisfying a very different need. It’s about browsing. It’s about discovery… there are many discovery methods online... Tons of serendipity… Wandering around is a unique opportunity for serendipity.”

The stores are, of course, differentiated in meaningful ways. For one, they don’t accept cash. Customers pay with a credit card or, of course, charge it to their Amazon Prime account.

It turns out people have a seemingly endless supply of needs and wants. Amazon’s R&D programs are attempting to understand and satisfy all of them.

MARKET INTEGRATION

For most companies, an opportunity to gain dominance is through either vertical or horizontal integration. Most companies can only execute on one or the other relatively well, if they can set aside capital to invest in either. Amazon, though, has successfully done both, and in impressively strategic fashion.

Can you imagine how nimble, large, and efficient a company would have to be to acquire new products daily, while continuing to manage inventory and logistics to fulfill its existing promises to customers? Well, what if you could deputize thousands of other people do it for you? Oh, and by the way, those people share the risk (a.k.a. inventory costs). This is Amazon Marketplace, Amazon’s primary and somewhat self-functioning horizontal integration strategy.

Today, “there are a hundred-thousand businesses on Amazon where the businesses make $100,000 or more a year.” Amazon also helps support these businesses operationally, including doling out $1 billion in small business loans between June 2016 and June 2017. What would be the funding, valuation, and expectations of this finance division if it was a stand-alone business?

When you own the customer relationship, everyone needs you. Amazon has been able to leverage this with third party sellers in such a way that proves to be a win-win for those that select the right products and fulfill on Amazon’s promise to its customers. That said, their partnerships can include so many rules and guidelines that some companies feel like they can’t control their own brand. And pricing is always a battle.

When you own the customer relationship, you can also set the terms. For Amazon, this means that they are both your enabler and your competitor. Enter private label goods, strategic sourcing, and services they know their customers value.

Starting with Amazon Prime, you can view a list of benefits that speaks to all the Amazon-owned and operated things you will benefit from as part of the relationship, including streaming of free music, free movies, and free television series. These benefits strengthen Amazon’s relationship with the customer.

Meanwhile, Amazon is also constantly analyzing ways in which a perceived middle man - even if that’s the brand of a third party seller on Amazon Marketplace - can be cut out for the benefit of the customer, namely through a reduction in price and/or better fulfillment (e.g. faster delivery, bigger quantity).

This customer-first approach has led to the creation of dozens of Amazon private label brands. AmazonBasics sells things like batteries and iPhone chargers. There’s Happy Belly for non-perishable foods like trail mix and nuts. There’s Amazon Elements for nutrition supplements and baby wipes. There’s Pinzon for bed and bath linens and other needs. There’s Presto! for household cleaning products. And there are also more than a dozen Amazon clothing labels covering everything from basic t-shirts to high-end menswear.

Journalist Jeff Jones described Amazon’s primary target for going direct well in a 2013 Fortune article:

“Amazon’s sales skew heavily towards “hard-lines,” things like media, electronics, home and garden, and toys. Most best-selling hard-line products are produced by large manufacturers that market them heavily and distribute them broadly through multiple retail channels. They are essentially commodities, identified by a standardized Universal Product Code (aka, U.P.C.). An example is a Canon digital camera; once Canon’s ads convince you that you might want a Canon camera, you know you can shop for it pretty much anywhere. And for most commodities, price is the key differentiator. Consumers know that Amazon almost always has the lowest prices, along with free and fast shipping.”

If it is a basic, undifferentiated product in which you rely on the brand for some sort of perceived increase in value, Amazon can change things in a big way. In the process, your margins likely get close to zero.

Contemplating this, you may start think artisanal-level customization is the only alternative. Amazon’s okay with that. But sell it through Amazon Handmade rather than Etsy; that’s where you’ll find “our hundreds of millions of customers worldwide.”

You may also consider services a better bet. Well, Amazon also built a marketplace to compete with Angie’s List, Zaarly, and brick and mortar retailers like Best Buy that try to sell the service market or added value through human touch points. It’s called Amazon Home Services, and there you can find service providers for everything from house cleaning to ceiling fan installation to plumbing. Every provider listed has been through a six-point criminal background check, licensing has been evaluated where appropriate, and most of the pricing is upfront (rather than an estimate). Also, services are backed by the company’s 100% Happiness Guarantee.

In short, if your target market includes individual consumers, there’s a chance Amazon is or intends to have its hand in it. By the way, Amazon has dozens of other names trademarked, just waiting to be launched.

LIFESTYLE INTEGRATION

With the consumer, Amazon has pursued an immersive experience. They’ve sought to establish themselves as the source of lifestyle convenience, rather than just a provider of goods.

This is where so many of the Amazon Prime benefits come into play. Obviously the streamable content serves as a source of personal entertainment. One thing that differentiates Amazon is that they view their $4 billion per year in spending on content and programming in the profitable context of their relationship with the customer, something HBO and Netflix can’t do.

Perhaps more intriguing is the most recent introduction of artificial intelligence through Echo and Alexa. Back to Bezos’ interview with Charlie Rose for a brief description of what Echo and Alexa are and do:

“Echo is a small black cylinder that... has seven microphones on the top and has a speaker inside and a digital signal processor and some other computer inside. It's WiFi-connected to the Cloud. And Alexa, the agent -- the artificially intelligent agent that lives in the Cloud will talk to you through Alexa -- through Echo.

“One of the interesting things about Echo, the device, is it uses those seven microphones to do something called beam forming. And so basically it can hear you very well even in a very loud kitchen environment. For example, you have the dishwasher running and you have the sink running water and maybe somebody is playing the television set in the living room. And Alexa can still hear you because of that digital signal processing.

“So you can say, Alexa, what time is it? Alexa, what is the weather today?... And people really -- it's just been a big hit.”

What makes Amazon’s entrance into AI concerning for other businesses is that it ties the company that much closer to the consumer’s everyday existence. If Alexa is your personal assistant, she’ll be the one to play you a song and order more soap… Amazon soap.

Like the company has done in so many sectors, they are miles ahead of the competition. Various sources estimate that Amazon Alexa-enabled devices own between 71 and 82 percent of the market share for smart speakers.

Alexa also has numerous extension and application opportunities. There are companies trying it out for warehouse inventory management and in secretarial roles within offices. Amazon internally is working on technology to integrate other formats like home security systems and smart glasses with Alexa.

BALANCE SHEET

Perhaps the biggest driver of the company’s continued growth is that they never seem to show a profit. Between 2008 and 2016, Amazon paid $1.6 billion in federal taxes, while Walmart paid $64 billion; look to the stocks, though, and you’ll see that Amazon stock has added more value than Walmart’s entire market cap.

There is plenty of cash, but it gets reinvested. On a Q3 2016 earnings call, Amazon CFO Brian Olsavsky said the focus is on investing in areas where they see “significant customer traction.” Fortunate for them, shareholders are willing to value the company based off of growth rates rather than posted profit.

To understand how the continual lack of profit, but ever-growing cash flow of Amazon compounds to drive the business forward, just look at some simple graphs of the company’s top summary financials, like the ones in this Recode article.

Every year the company has more cash. And every year that cash gets invested into making the company even more competitive. I’m telling you, it’s the Borg.