By Investment Master Class
“I’ve never seen any person develop two really important industries at the same time. Jeff Bezos is the most remarkable businessperson of our age” Warren Buffett
I remember listening to Warren Buffett complementing Jeff Bezos at Berkshire Hathaway’s first live-streamed annual meeting in April 2016. In a more recent interview, Buffett referred to Jeff Bezos and recommended viewers watch the Charlie Rose interview with him [see here]. Below I’ve summarised some of the aspects of the interview I found most interesting …
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THINK BACKWARDS
".. the thing that connects everything that Amazon does is the number one - our number one conviction and idea and philosophy and principle which is customer obsession, as opposed to competitor obsession. And so we are always focused on the customer, working backwards from the customer's needs, developing new skills internally so that we can satisfy what we perceive to be future customer needs. We have a whole working backward process that starts with the customer needs and works backwards. So that is really, if you look at, seems like we are in a bunch of different businesses" Jeff Bezos
'Thinking backwards' or 'inverting' is a commonly undertaken method of analysis by the Investment Masters. In a recent Wealthtrack interview, Investment Master Thomas Russo stated... "Amazon is nothing to do with technology, Bezos is all about customer service. All about the consumer experience. Bezos’s job is to reason back from what steps it will take to improve consumer experience and that directs his investment. That is purely the ‘Charlie Munger’ story. Charlie has said at annual meeting for decades, the way to live your life is through the power of ‘inversion’. Think of what it is you want to create, and reason backwards to come up with most efficient way to get there. That’s Charlie Munger in spades and that’s exactly what Bezos is talking about."
INVENTIVE CULTURE
"We have a very inventive culture, so we like to pioneer invent" Jeff Bezos
The Investment Masters recognise that a common trait amongst successful companies is a culture of innovation. In a study of US firms, James Heskett, a Professor Emeritus at Harvard University's Business School and renowned business culture expert, found "organizations with the best performance were those with values and leadership that encouraged behaviours such as innovation, continuous quality improvement, bench-marking against the world's best, and efforts to import good ideas from anywhere outside the organisation as well as to generate them within". Mr Heskett noted "we deemed these values and behaviours typical of an adaptive culture, one that supports an organisation's ability to adapt to change in the competitive, social and regulatory environment".
THINK LONG TERM
"Willingness to think long-term. I think that is another common thread that runs through every single thing we do" Jeff Bezos
"It's the combination of the risk-taking and the long-term outlook that make Amazon, not unique, but special in a smaller crowd. And then finally, taking real pride in operational excellence, so just doing things well, finding defects, and working backwards." Jeff Bezos
The Investment Masters understand the benefits of taking a long term view. They look out three to five years or more with a view to figuring out the company's likely successful competitive position, what it might be earning, and thus likely to be worth, at that time. Warren Buffett has informed Berkshire's shareholders that he will measure the success of his investments 'by the long term-progress of the companies rather than by the month-to-month movements of their stocks'.
Occasionally, companies may forego near term earnings by investing in longer term initiatives. Thomas Russo makes the point with respect to Berkshire's investment in GEICO .. "when is it sensible to accept lower earnings? When you have the capacity to suffer. Buffett decided to forgo profits at GEICO to take market share from 2% to 11% by spending more on marketing."
Conversely, companies that are subject to short term imperatives, and are unable to adopt a longer term view are likely to suffer over the longer term. The highly successful corporate investor, Henry Kravis of KKR notes .. “The trouble, in my opinion, with corporate America today, is that everything is thought of in quarters. Analysts push them. “What are you going to earn this quarter?” We say to the management of companies, “You are here today. Where do you want to be five years from now, and how are you going to get there?” It may very well mean taking a step backwards. But believe me, in five years, we are going to have a company that is much more productive, efficient, and competitive.”
ROOM FOR IMPROVEMENT
"I am never disappointed when we're not good at something because I think, well think how good it's going to work when we are good at it... There is so much opportunity. Nobody really knows how to do a great job of offering -- apparel online yet. And we have tons of invention and ideas and working our way through that experimental list." Jeff Bezos
COMPETITION
"One of the most unusual things that happened with Amazon Web Services is the amount of runway that we got, which is a gift, before we faced like-minded competition, we had - it appears to me just empirically that if you invent a new way of doing something, typically if you are lucky, you get about two years of runway before competitors copy your idea. And two years is actually a pretty long time in a fast-moving industry so that's a big head start."
"Amazon Web Services got seven years of runway before we faced like-minded competition."
Competition is what destroys corporate returns. As Investment Master, Sam Zell has noted "There's no substitute for limited competition. You can be a genius, but if there's lots of competition, it won't matter. I've spent my career trying to avoid it's destructive consequences". Having a runway without competition allowed Bezos to establish a first mover advantage by building scale which allowed pricing at a level which is uneconomical for potential competitors without such scale.
INNOVATE
"every year, 500, 600, 700, 800 new features and services [are added to Amazon Web Services]"
Companies must continue to innovate. The Investment Master, Phil Fisher stated .. “The company that doesn’t pioneer, doesn’t take chances, and merely goes along with the crowd is liable to prove a rather mediocre investment in this highly competitive age”. Famous Nobel Prize physicist and renowned thinker Richard Feynman said “I think that to keep trying new solutions is the way to do everything”.
THE POTENTIAL OF AMAZON WEB SERVICES [AWS]
"Amazon.com, the retailer needs these things. But pretty soon everybody is going to need these things. And so with a little extra work, we can turn what we were going to build just for ourselves into a service for the world. And that's what we did." Jeff Bezos
Amazon realised the benefits of turning a cost centre into a revenue generator. Ben Thompson of Stratechery, is one of the most insightful commentators on digital businesses and disruption has noted.. "The incredible potential of Amazon Web Services is as clear as its initial prospects in 2006 were, well, cloudy. AWS only came about after Amazon had experimented with more full-service offerings like powering the websites of Target or Toys-R-Us, and there were plenty of skeptics as to whether companies would entrust critical operations to a 3rd party. It soon became apparent, though, that both economics and simplicity were overwhelmingly in the public cloud’s favor, and Amazon was years ahead of everyone.
... the economics of scale achieved by Amazon (and its closest competitors, Google and Microsoft) are so incredible that multi-billion dollar companies like Netflix view it as more efficient to pay Amazon than to build their own data centers. The calculus is even more stark when it comes to any sort of startup: it’s so much easier and cheaper to get started with AWS that the idea of buying your own server infrastructure — an expense that consumed the majority of venture capital in the dot-com bubble era — is preposterous. This is great from Amazon’s perspective: the company effectively has a stake in nearly every significant startup, and for free; if the company succeeds, Amazon will be paid, handsomely, and if they fail, well, Amazon covered their own costs of providing cloud services along the way."
Not only did AWS provide Amazon with a significant revenue opportunity, it highlighted the benefits of opening up parts of Amazon to competition. In a recent article "Why Amazon is eating the world" author Zack Kanter notes "Because of the timing of Amazon’s unparalleled scaling — hypergrowth in the early 2000s, before enterprise-class SaaS was widely available — Amazon had to build their own technology infrastructure. The financial genius of turning this infrastructure into an external product (AWS) has been well-covered — the windfalls have been enormous, to the tune of a $14 billion annual run rate. But the revenue bonanza is a footnote compared to the overlooked organizational insight that Amazon discovered: By carving out an operational piece of the company as a platform, they could future-proof the company against inefficiency and technological stagnation."
AMAZON PRIME MODEL
"You say to yourself, well, what else -- now that I have paid my $99 a year, how else can I use this membership? And so when people join Prime, they buy more shoes, they buy more diapers, they buy more dish-washing detergent, they buy more books and electronics and toys and so on and so on. And so we really want people to join Prime." Jeff Bezos
Amazon benefits from the psychological bias of sunk costs. Amazon Prime is similar to the Costco model - a subscription service. Amazon Prime has the additional benefit that members gets things for 'free' which is likely to trigger reciprocation tendencies. The more people buy on Amazon, the more scale benefits Amazon gets and the larger the competitive advantage. In addition, members feel they have made an investment, so are less likely to 'shop around'.
Richard Thaler, Professor of Behavioural Science at the University of Chicago, touched on the cognitive biases that drive the success of a subscription model in his excellent book 'Misbehaving'. He noted "In order to shop at Costco a customer must become a 'member', which currently costs a household $55 a year. It seems likely that members view the annual fee as an 'investment' and make no attempt to allocate that cost over the various purchases they make during the year. Rather, it serves as a sunk cost, offering up yet another reason to shop at Costco. Similarly, Amazon charges customers $99 a year to become a "prime member" which entitles them to "free" shipping. Again the cost of the membership may well be viewed as an investment that does not "count" toward the cost of a particular purchase".
ARBITRAGING OTHER PEOPLES CAPEX
"So Amazon was a tiny, little company that started with four people, and that -- we could only do, we built Amazon because we didn't have to do any of the heavy lifting. The transportation and logistics infrastructure of U.S. Postal Service which would have been hundreds of billions in CapEx, already existed. We didn't have to build the internet, it was run on, on long distance cables that were actually put in the ground for long-distance phone calls. And we didn't have to build a payment system, the credit card system already existed. So all these things would have been tens of billions or hundreds of billions in CapEx and we got to rest on top of them.. On the internet, two kids in a dorm room can take, change an industry completely" Jeff Bezos
Amazon had a first mover advantage that leveraged a combination of technologies to create a business which would not have been possible without other peoples inventions and capital spending. Amazon falls into a category that Charlie Munger would define as a multi-factor-triggered Lollapolooza effect.
Both Charlie Munger and Warren Buffett recognise the brilliance of Jeff Bezos and what he has achieved with Amazon. Studying successful business people and business models can provide insights into the investment process. As Warren Buffett says "I am a better investor because I am a businessman, and a better businessman because I am an investor."
Further Highly Recommended Reading:
"Why Amazon is eating the world" - Tech Crunch - Zack Kanter
"Amazon's New Customer [Whole Foods]", 'The Amazon Tax", "The AWS IPO" - Stratechery - Ben Thompson
