IP-Participacoes Fund 3Q16 Commentary – In-Depth Long Amazon Thesis

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IP-Participacoes Fund commentary for the third quarter ended September 30, 2016.

Also see


  • Q3 2016 hedge fund letters
  • Q2 2016 hedge fund letters


In our first-quarter report, we briefly mentioned that we, once again, started buying Amazon shares. In the second quarter we gradually increased that position. In recent months, the company’s shares strongly appreciated and, while we were finalizing this report, reached record highs. We thus reduced our investment. However, given the unique aspects of the business model and the numerous opportunities in the horizon, we still hold a position in the IP-Participacoes fund.


We have monitored Amazon for a long time, in large part due to the influence and perspectives from the IPGlobal fund (current PIPA Global Equities) throughout the years.

In this report, we have gone into more detail than usual. We will explain some of the reasons why, over the past four years, Amazon’s shares have often been part of IP-Participacoes’ portfolio.

We have focused solely on the company’s retail business. The cloud infrastructure division – Amazon Web Services (AWS) – will be addressed in a future report1.

IP-Participacoes Fund – Amazon

“Amazon is guided by four principles: (1) customer obsession rather than competitor focus, (2) passion for invention, (3) commitment to operational excellence, and (4) long-term thinking.” 2

How was this possible? This simple question is perhaps the most repeated one regarding Amazon. We can break it down into three other questions:

I. What competitive advantages sustain Amazon’s growth at such high rates? II. How did the company invest and grow, without leverage, despite posting extremely modest profits? III. Considering an increasingly robust sales platform, what new business lines can the company implement?

We believe the answer to all these questions has the same starting point: customer obsession rather than competitor focus, the first and most important of the company’s four principles.

It is much easier to find companies that excel at these other principles (3M and Google with unquestionable “passion for invention” and Ambev, Danaher and Localiza as role models in “operational excellence”). Yet, it is rare to find a company that has taken customer obsession to such unprecedented heights.

The truth is that, without customers, all other stakeholders are irrelevant. Amazon’s formula is simple: conquer customers with outstanding service and attractive prices and the rest will follow.

Most companies are not like this. What should be a top priority – creating, nurturing and captivating customers – turns into a dispersed effort amidst the corporation’s multiple objectives. Developing outstanding products or services becomes an afterthought. Efforts towards short-term goals become prevalent, such as squeezing suppliers, lobbying politicians, exploring tax inefficiencies, increasing prices without clear equivalence in value, and so on.

Below, we will answer in more detail the questions above. We hope this information clarifies the beauty of Amazon’s business model as well as the reason why we choose to be shareholders.

I. What competitive advantages sustain Amazon’s growth at such high rates?

Some advantages to traditional retailers have contributed to the company’s growth since its early years: (i) a leaner and more efficient operating cost structure, (ii) virtually unlimited product assortment, (iii) a highly convenient purchasing process, (iv) service customization, (v) quick delivery, and (vi) consumer confidence (given the low level of incidents and the agile solutions provided by Amazon when these do arise).

The company maximized these advantages impressively with a special peculiarity. In a world packed with digital platforms, where the largest passenger transportation company does not own vehicles (Uber), the largest hospitality company does not own properties (Airbnb) and the largest media company does not produce content (Facebook), Amazon stands out by combining the advantages of digital platforms (asset light) and the capillarity of the physical world (asset heavy) supported by investments in logistics and distribution.

These advantages grant Amazon another singularity: strong expertise in logistics, IT and retail.

If we examine the greatest retail success stories, we will find highly competent companies in two of those segments, but never all three. Sears, Walmart and Inditex, for example, stand out for their successes in both logistics and retail. Other companies, such as Alibaba, eBay and Rakuten have effectively combined retail and IT. Operating in these three segments with this level of excellence – and focus on customers – is what has led Amazon to consistently stay ahead of the pack.

Amazon has been relentlessly strengthening its main attractions: broad assortment, low prices and quick delivery. It adds to its website new product and service categories year after year, consistently expanding its market reach.

Notably, it developed three business lines that became the engines of Amazon’s explosive growth in retail: Prime, Marketplace and FBA (Fulfillment by Amazon).

Prime and Marketplace

Prime was launched in 2005 in the United States and was later expanded to other countries. For a US$79 annual subscription (currently US$99), Amazon offered free 2-day delivery for a wide range of products.

The idea was simple and effective, as explained by Robbie Schwietzer, the Division’s VP, in 2013: “Once you become a Prime member, your human nature takes over. You want to leverage your $79 as much as possible. Not only do you buy more, but you buy in a broader set of categories. You discover all the selections we have that you otherwise wouldn’t have thought to look to Amazon for.”

The Marketplace allows third-party sellers to list their products on Amazon’s website through a model similar to eBay or Mercado Libre, in which Amazon charges sellers a percentage of the product’s value for connecting them to buyers. When using Marketplace, sellers have access to Amazon’s customers, and the company, in turn, broadens its product assortment. Items can be delivered by sellers themselves, through FBM (Fulfillment by Merchant), or by Amazon, through FBA (Fulfillment by Amazon), which is perhaps the company’s most genius idea – as we will see below.


“FBA completes the circle: Marketplace pumps energy into Prime, and Prime pumps energy into Marketplace.” Jeff Bezos – 2014 Annual Report.

Before FBA, the Prime and Marketplace divisions operated independently. After its creation, the three divisions became highly interconnected and began to maximize each other’s results.

IP-Participacoes Fund Amazon

When independent sellers opt for FBA, they send their products to an Amazon fulfillment center (DC). Amazon is responsible for delivering the products to end customers in addition to managing after-sale operations. The company charges sellers a daily rent per m3 for stocking products in its fulfillment centers (FCs) and makes them available to Prime customers. That is, products will be delivered free of charge in up to two days.

The FBA model introduced a new virtuous cycle for Amazon: the more sellers use it, the broader the product selection – available for 2-day delivery to Prime members – becomes. Prime in turn becomes more attractive for customers, boosting the entry of new members. And the larger Prime’s customer base is the more attractive the FBA service is for sellers. This flywheel effect propels Amazon’s growth and strengthens the company’s sales platform further.

A few figures can help to comprehend the magnitude of what has thus far been accomplished:

  • When Prime was created in 2005, approximately 1 million different products (SKUs3) were available for 2-day delivery.
  • After the creation of FBA in 2006 this figure grew exponentially to 15 million in 2012.
  • By the end of 2015, the Prime system had more than 30 million eligible SKUs.

The table below shows the number of SKUs available in 2015 by type of delivery:

IP-Participacoes Fund Amazon

To support this achievement, Amazon invested heavily in logistics and distribution. The number of FCs shot from 20 to 123 between 2005 and 2015. If we consider all logistics units, such as warehouses in urban regions, product sorting centers and delivery centers – in addition to FCs – there are currently more than 300 locations worldwide dedicated to fulfillment.

In recent years, Amazon has particularly impressed us with the evolution of its logistics system. As we will see below, the Prime Now and AmazonGlobal programs open the door to numerous new opportunities. While Prime Now increases convenience for buyers and provides advantages for sellers closest to them, AmazonGlobal connects more distant sellers to the ecosystem.

Prime Now

The Prime Now service was first offered in Manhattan in December 2014. As in the table above, it enables free delivery of up to 25,000 SKUs to Prime customers in up to two hours, or in up to one hour for US$7.99 per delivery.

From then on, Amazon launched an aggressive campaign to open logistic warehouses in urban regions – the so-called Prime Now hubs. However, by the end of 2015, the number of new cities supplied by Prime Now was limited. It seemed the company was testing the soundness of its service. Once concluded, Prime Now’s rollout happened in a heartbeat. Now, less than two years after its launch and with over 60 fully functioning Prime Now hubs, the service covers 27 metropolitan areas in the U.S., in addition to 18 cities in the United Kingdom, Germany, France and Japan (11 of which are in the U.K. alone).

A two-hour delivery yields immediate consequences: impulse purchases become relevant and higher replacement-rate products can be consumed in larger volumes. Amazon now dives into the food, home cleaning and personal hygiene markets. In the US alone, the sum of these markets is above US$1 trillion.

The beauty of Prime Now is not restricted to these potential new markets. Although incipient, the service also enables neighborhood stores to sell their products to Prime customers.

Imagine you own a natural food store. With Prime Now, Amazon enables you to create a page dedicated to your store at https://primenow.amazon.com/. After this integration, whenever Prime customers near your store visit Prime Now’s website, they can purchase your products.

In other words, a Prime customer purchasing diapers, beer, deodorant and ice cream (yes, you can even buy ice cream!), can also buy healthy products from your natural food store. The truck (or vehicle) departing from the Prime Now hub with the first four items will also collect the order made at your store and deliver everything at the customer’s home.

The example above is already an existing store, as shown in the figure below:

IP-Participacoes Fund Amazon

The integrated neighborhood store model leverages the Marketplace and FBA services. It increases the number of sellers participating in Amazon’s ecosystem, but, using FBA slightly differently: instead of sending products to Amazon’s DC, Amazon collects these from sellers on its way to deliver orders. More sellers, broader assortments and faster deliveries lead to more Prime customers. The virtuous cycle is fueled once again.

The Prime Now model for third-party vendors exemplifies how Amazon’s system develops and grows. The company is almost always the first user of its own services. After gaining critical mass, it makes them available to third parties. Marketplace, FBA, AWS, Echo and Prime Now all followed the same playbook.

See the full PDF below.


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