Amazon: King of Commerce
Competition is a Sin - John D. Rockefeller
Lots of interest in Amazon and the “Race to a Trillion,” (edit: looks like the race is over $APPL) so I thought I’d take a deeper dive...
Disclaimer: I attempted to - vastly - expand my circle of competence for this one, with brand new knowledge of computer science, antitrust law, logistics, etc., so please bear with me.
Back in 1995, Jeff Bezos was offering 1% slices of his nascent e-commerce business for $50,000.
24 years later, that 1% stake is now worth $8.56 billion dollars, a compound annual return of 81.86%. For reference, Rentec’s Medallion Fund did “only” 71.8% (before fees) from 1994-2014.
How did a retailer(!) outperform the world’s most sophisticated hedge fund?
Humble Beginnings
Bezos is the cool one
Born Jeffrey Preston Jorgenson to a teenage mother, Bezos worked as a line cook at Mcdonald’s in high school before attending Princeton as a self described “EECS geek.”
Like many Ivy leaguers, visions of an Oasis brought him to Wall Street (see what I did there?) and D. E. Shaw & Co., where Jeff made SVP by 30.
A very forward thinking and technology savvy firm, deshaw.com was registered in 1992, a full 3 years before Goldman Sachs joined the .com party.
Bezos would regularly meet with David Shaw himself, where the two would brainstorm ideas for businesses to build (example spinouts: FarSight, a precursor to E-Trade born in 1995 and sold to Merrill Lynch; Juno, a free ad-supported e-mail service that went public in 1999).
David Shaw and Jeff Bezos even discussed an idea for something they dubbed “the everything store.”
Shortly after this conversation, Bezos left the comfort of finance and ventured West, founding Amazon.com in Seattle, Washington, on July 5, 1994.
By the end of ‘94, Amazon had $139,000 in assets, lost $52,000, and was projecting to lose $300,000 the following year.
You know how this story goes: Bezos realized his dream, got that forklift, and picked up a few more things along the way...
The Hard Thing About Hard Things
“A brand for a company is like a reputation for a person. You earn reputation by trying to do hard things well.” - Jeff Bezos
I racked my brain trying to think of a harder way to earn a buck than retailing...
- Low barriers to entry
- High fixed costs
- Huge working capital needs
- Fickle customer base
- Low margins
...and came up with nothing (restaurants maybe?).
And Bezos focused on by far the most difficult piece of the system, the logistical nightmare that is moving consumer goods at scale.
To give you an idea of just how difficult, let’s consider the Traveling Salesman Problem:
“Given a list of locations and the distances between them all, what is the shortest possible route that visits each location once and returns to the origin?”
A single person traveling to 10 different locations has more than 3.5 million different paths to take. Add in a few more people with a few more locations, and the number of possible routes quickly becomes greater than the number of atoms in the known universe.
In a typical day, a worker in an Amazon fulfillment center might walk 13 miles, pick 1300 items, from a selection of over 2 million products, in a one million sq ft building… Amazon has several hundred thousand people doing this everyday.
Very interesting video if you have the timeTo paraphrase Bezos, this is “a dynamic traveling salesman problem completed by a decentralized swarm of workers where some of the cities move and disappear.”
Add in time constraints - like 1 day shipping in the case of Amazon Prime, or hourly windows for Amazon Fresh - and the difficulty ratchets up to a whole new level.
The complexity is mind bending.
With existing technology, it’s impossible to brute force - attempt every possible combination - this kind of problem, so organizations employ sophisticated algorithms (and high IQ engineers) to give reasonable approximations.
When we consider Amazon’s operations in that context, success in relatively easy, high margin businesses - content distribution, auctions, advertising, etc. - seems all but assured.
It’s All About The Middle, Man
“The art of good business is being a good middleman. Putting people together. - Layer Cake ( Underrated movie!)*
According to Dr. Shaw: “The idea was always that someone would be allowed to make a profit as an intermediary. The key question is: Who will get to be that middleman?”
Taking a cue from his mentor, Bezos inserted himself into the middle of book buyers and book sellers, took over the most complex part of the system, and began to expand “middle out.”
Over time, as Amazon came to account for a greater and greater piece of book distributors business, Bezo’s lieutenants began to demand increasingly favourable terms.
Then, Bezos skipped the middleman (there can only be one!), and started negotiating directly with book publishers.
According to the man himself, Amazon should “approach these small publishers the way a cheetah would pursue a sickly gazelle.”
Over time, Bezos moved into publishing books directly, eliminating yet another middleman.
You can see this same strategy across every Amazon business line:
Video game streaming, where Amazon purchased Twitch and began selling games direct.
Music
Manufacturing
Fulfillment
I could do a multi-part post on the strategic importance of Amazon Web Services alone, and the sheer magnitude of the operation precludes me from including much in-line…
However, here is a quote from famed Venture Capitalist Chamath Palihapitiya:
"Chamath Palihapitiya" I think Amazon is the most interesting company right now and represents the surest path to a $5T (15-20x from current levels) market cap within 50 years. the reason i think this has nothing to do with e-commerce although e-commerce is their way of dog fooding the real reason: AWS.AWS is a tax on the compute economy. So whether you care about mobile apps, consumer apps, IoT, SaaS etc etc, more companies than not will be using AWS vs building their own infrastructure. e-commerce was AMZN's way to dog food AWS, and continue to do so so that it was mission grade. if you believe that over time the software industry is a multi, deca trillion industry, then ask yourself how valuable a company would be who taxes the majority of that industry.
1%, 2%, 5% - it doesn't matter because the numbers are so huge - the revenues, profits, profit margins etc. i don't see any cleaner monopoly available to buy in the public markets right now.
More comprehensive info on AWS can be found here, on Stratechery. https://stratechery.com/company/amazon/
Resistance is Futile
“Market leadership can translate directly to higher revenue, higher profitability, greater capital velocity, and correspondingly stronger returns on invested capital.” - Jeff Bezos
As I was writing this article, a report came out that Amazon was developing its own network switches a direct threat to Cisco, a $200bb company...
Trying to list all of the areas that Amazon competes in would be… ahem, futile... so let’s look at a few compelling statistics (shamelessly pilfered from this thread):
Since 2010, Amazon has added $64 billion in top line revenue growth, or the equivalent of Nordstrom, Macy's and Sears combined.
52% of households in the U.S. have Amazon Prime subscriptions.
$4.5 billion is AmazonStudios content budget for 2017, or more than every other major media player (HBO, ABC, NBC) except Netflix
Amazon is the most preferred DSP (demand side platform) among digital advertisers, beating Google's DoubleClick & AppNexus
Amazon owns half of all online shopping, and is growing faster than the sector as a whole
Using the Borg cube as the leading picture for this section is particularly apt (if I do say so myself!) given Bezo’s penchant for assimilating (or destroying) other entities.
For example, in 2012, Amazon purchased Kiva Systems, a manufacturer of automatic fulfillment robots..
After contracts ran out with existing customers (read: retail competition), Kiva Systems was renamed Amazon Robotics and closed to outsiders.
The above screen grab is taken from a talk Bezos did at MIT in 2002, where Bezos highlighted his amazing partnership initiatives, allowing other retailers to leverage Amazon’s amazing e-commerce infrastructure!
What Jeff neglected to mention was that Amazon partners with other businesses the way a parasite partners with a host. Of that list, the only retailer that still exists independently is Target.
Let me repeat that:
Of that list, the only retailer that still exists independently is Target.
6 went bankrupt, 2 were picked up by Macy’s and Barnes & Noble (aka bankrupt they just don’t know it yet), and 2 are now controlled by KKR & Paul Singer (a fate worse than bankruptcy).
Revenge of the Nerds
“Your margin is my opportunity.” - Jeff Bezos
Building the 21st century Standard Oil is just Jeff’s day job. To make ends meet, Bezos spends evenings moonlighting as history’s most successful Angel investor, with investments including:
Google (pre-seed!) - AirBnB - ZocDoc - Uber - Domo - Vicarious - Rethink Robotics - Twitter - Workday - Juno Therapeutics - D Wave - Convoy - FundBox - and many more
He also works weekends as the publisher of one of the world’s most respected newspapers - The Washington Post - and building Blue Origin, the Yin to Elon Musk’s SpaceX Yang.
“Jeff Bezos might be the most terrifying businessman in history” - I wrote this here, and I think it’s accurate….
But don’t take my word for it! Listen to what some other people have to say about Mr. Bezos (you may have heard their names before):
Charlie Munger: Jeff Bezos is a different species.
Warren Buffett: Jeff Bezos is the most remarkable business person of our age.
John Malone: And I think Jeff Bezos is gonna be the most disruptive. As the Death Star moves into striking range of every industry on the planet, you’ve just got to take your hat off and envy what he has built.
*Peter Thiel: Bezos is the toughest person in the world to compete with.
Seth Klarman: Discussions in the Baupost conference rooms are increasingly likely to include an assessment of what Amazon executives are discussing in their conference rooms.
Stan Druckenmiller: I think Bezos is incredible.
When a panoply of our wealthiest, most powerful investors are unanimous in their praise, it’s time for the rest of the world to take notice.
(Anti)Trust The Process
And the Troll of the Year award goes to: David Sacks!
Unfortunately for Bezos, one of the people taking notice happens to be the 45th President of the United States, Donald Trump.
Antitrust law is the elephant in the room (for a detailed overview of the topic as it relates to Amazon, I highly recommend this Yale Law Journal article) and the real estate mogul has not been shy in expressing his disdain for Bezos the-would-be Conqueror.
Interestingly, to this date, the only antitrust-style litigation Amazon has been involved in was when a group of publishers + Apple were convicted of colluding against AMZN to keep prices high.
Assuming the Trump administration actually wants to prosecute Amazon, I’m not sure that existing legislation will be effective . There is precedent, with A&P back in the 1940’s & 50’s. The government (mostly) failed to breakup the grocer, when the case was successfully delayed until a pro-business administration was put in office.
Notably, there was an “outpouring” of support from “thousands of consumers” (Note: very cool, in-depth article about a long lost empire).
Given that Prime is now in greater than 50% of American households, a contemporary outpouring of support would be a thing to behold.
And since a supreme court ruling in 1979, courts have taken the view that consumer welfare is the key antitrust metric, and Amazon has delivered year-over-year improvements in prices, selection, customer experience, and innovation across its landscape of products and services.
Even The Fed speculates that Amazon is directly responsible for reducing inflation.
Furthermore much of the government itself is dependent on Amazon through the orgs web services architecture: the CIA has praised Amazon for innovation, noting their cloud infrastructure deal with AWS has been “nothing short of transformational.”
And much of that innovation Amazon supplies via web service comes from lessons learned via solving retail ops problems… given looming conflict with China, I’m not sure U.S. intelligence agencies will permit the crippling of a key asset, especially when the Chinese have something comparable in the form of Alibaba.
The Future Ain’t What It Used To Be
“The greatest achievement of our technology may well be creation of tools that allow us to go beyond engineering – that allow us to create more than we can understand.” - Danny Gillis
The antenna pictured above was designed for NASA by an evolutionary computer design program, and it outperformed every human variant.
Bezos runs Amazon like one giant consumer experiment, and I think he is the first person to use computer science to apply economic principles directly to a correctly defined business objective - maximizing the present value of future cash flows.
Jeff: Technology has been our single biggest investment and the company basically runs on computer science.
Computer generated solutions don’t necessarily look human, and if you think about Amazon in that context, it becomes very hard to predict what happens next.
Leveraging scale, maybe Amazon is able to reduce prices on basic items to the point where it makes sense to give things away - for free - to poor people, and then use the resulting data to improve customer experience at the high end, charging the rich more…
And as the poor get richer from Amazon’s generosity, they are able to spend more…
On Amazon.
Maybe, through the ongoing healthcare initiative with Berkshire and JP Morgan, Bezos’ algos discover that NPV is best increased by providing free healthcare to all Prime members. (For a primer on what this might look like, check this highly interesting post from Steve Jurvetson, the smartest venture capitalist in the game)
Obviously this is all fantastical, but it is fun to speculate…
This Time… Is Different?
I've been inside the sausage factory and know how complex business is in the real world. In that context, a lot of investor opinions display a high level of confidence based on a relatively sparse set of facts - Alice Schroeder
I think that as long as Bezos is at the helm, it will take a paradigm shift - 3d printing? Teleportation? Molecular computing? - or some unforeseeable catastrophe to take down Amazon.
Large, long term trends in the business environment - including the internet, globalization, robotics, machine learning, etc. - all favor scale, and I don’t see how/when the world shifts from this model.
Gun to my head, I’d buy... but I’m not smart enough to go beyond “intelligent” speculation.
I think there could be a real opportunity here to deploy a large amount of capital for anyone with the knowledge to value AMZN correctly.
For the rest of us mere mortals, I think it makes sense to channel Warren Buffett by asking “and then what?” in the context of Amazon.
For the Quantrepreneurs, I think a truly-personalized-price-discrimination algorithm based on predictive analytics would be very interesting, and applicable across a wide range of businesses (and if you like my writing and need a lowly business guy, give me a shout!).
For the life sciences people, there has been tremendous innovation in agriculture of late, and producing food at scale using advanced gene scripts and autonomous drones could be tremendously lucrative.
If you’re a venture guy, I think you could make money on something like Twiggle, a startup that provides tools for e-tailers to better compete.
If you’re in PE, there must be opportunities in liquidations.
And if capital markets is your game, I’m sure there’s dough to be made in distressed debt.
For the time being, I hope you’ll all join me in welcoming our new Bezosian overlord.
All Hail King Bezos
“AHAHAHAHAHAHAHAHAHAHAHAHAHAHAHA!!!” - Jeff Bezos
Good hunting,
CC
P.S.
Update: Long TSLA
I will do a Long TSLA: Aftermath post when the last of my options are sold/expire, but I wanted to do a quick recap.
@thebrofessor mentioned hubris in my Tesla thread. I bought a set of deep OTM TSLA roughly here, on May 25:
Using Bayesian statistics - and building in a large margin of safety - I ballparked the odds of a TSLA short squeeze at 1/100, with a 1000/1 payoff (expected value 10x), and bet 0.5% of my portfolio.
Roughly 3/4s of the way up that large spike, my options were up 10x (sorry I don’t have a screenshot). So I was right!!!...
But hallucinations of instant riches got to me, so rather than liquidating I HODL’d and now I’m roughly even (Theta Decay is a bitch).
Update: I'm up a good amount again, thanks for apologizing Musk!
Stay Tuned.
allow me to summarize, because I've been wrong on Amazon forever (check my thread history).
essentially what every short is hoping for is what I'm hoping for (because I'd like to buy it): eventually the market decides they want amazon to be valued on its bottom line profits and go from a nosebleed valuation to a GARP valuation, which would take over a 50% haircut to come close. the trouble with shorting is you don't have to be right in the direction of your call, you have to right about timing as well.
this is a stretch, but I wonder if this could be something that leads to some litigation. think about it like this, a free market economy encourages competition. if you're a seller of a product or service, in a perfect free market, you ought to be able to sell your stuff however you want. if you provide value, you should attract customers. it shouldn't matter where you have to sell your stuff.
amazon's position as gatekeeper to ecommerce could be seen as a monopoly, and while they improve outcomes for customers, they most certainly don't for entrepreneurs wanting to sell on their platform. now, I'm of the opinion that if you want to be on their platform, you play by their rules, but I'm just throwing that out as an idea.
and then there's the ethical implications. do you want to be known as a company where work is a sweatshop, suppliers and partners are treated like shit, and so on? I have no issue with this, but I wonder if the march to altruistic capitalism could make this a black eye for them.
again, I'm a big fan, but not a buyer, so I'm not the best one to ask
Very well done, makes me want to buy some to be honest.
The way I see it only three things can stop Amazon, the government, a misstep, or a better competitor. A better competitor simply does not exist today and it is not a wise investment strategy to avoid a company because someday someone will probably do it better. Will Amazon make a poor decision that at least slows them down? I would say this is probably the most likely scenario. I did not think the Whole Foods acquisition made the most sense but it wasn't bad enough to really throw a cog into the operation. I'd say a poor acquisition is probably the biggest threat to Amazon but Bezos is, as you've described, one of the most incredible operators in history, so I would not take that bet. As for government intervention, there is no precedent for antitrust when consumers are benefiting. At some point however, will Amazon displace enough workers from the firms it keeps running over where that in and of itself is detrimental to the consumer? I don't know, investing based on potential unprecedented government intervention is not a wise strategy either.
The nightmare scenario for an Amazon bear is that they are able to smoothly transition from high growth to high margins. Honestly as time goes on I become more convinced that they can probably do it. I still look to the R&D line and think that if they scaled that back to like 5% of revenue they'd be much more profitable and be reasonably valued here. Is the high R&D necessary to facilitate the growth, idk, probably some, and probably some goes into more long shot projects. All I know is that at some point the growth has to slow, no company in history has been able to maintain that type of growth over the very long-term. When will the growth slow? Not something I'm willing to bet on. Incredible company and likely to be the most disruptive force that we will see in our lifetimes.
The real question you're likely asking is would I be a buyer of the stock? Not here. I think there's too much dumb money piled into these things that any kind of temporary shift in sentiment could really let some air out of this thing. On a good sell-off, like some serious panic selling, I probably would be a buyer. Another barrier to my entry is that I have to clear all my trades through our CIO and he hates Amazon (particularly bc we are a value shop benchmarked to the SP 500, so we don't own it, and it runs us over every day). That would likely keep me out of it realistically, but bet against it I would never do.
I love this write up.
It's interesting, because I think Amazon is the #1 country in the United States and possibly the entire world when it comes to technology companies.
What I want to address is there there is a tremendous amount of opportunity and almost a sub-startup environment that will produce a ton of 9-figure and potentially 10-figure deals in the works for companies like this. The best way to describe it is that there a ton of "big' companies than command an absolutely massive percentage of market share. I'm thinking Amazon, Salesforce, etc. There are people that are pack leaders in this market (mind you the technology market is still in its infancy since the inception of internet) has a huge advantage.
So being an additional piece of that company (being acquired by them) or working side by side (AppExchange on Salesforce) is worth a ton of money.
Now of course you can't build an Apple out of an Amazon sub-service, right?
Traditionally I'd agree, but if you look at Internet and technology innovation you have a bit of a different strategy and way talent affects your growth and big vision.
A company may come out of starting as an Amazon transportation data algorithm and ALSO solve a huge issue related to transportation as a whole. Definitely in slightly more mature years (think Series C and beyond) since you'll be focused on one specific client or a few handful of clients at first that are huge and specific in their needs. Once you hit the point you can service and have extra capital, start solving the BIGGER picture problems.
Next thing you know this transportation algorithm is so amazing, because you had the chance to deviate and expand the functionality and bring on new clients.
This is where I think you will see a ton of great success as a new market emerges that rewards this type of build up. And with it a ton of opportunity.
Amazon as a whole is safe. They are going to keep doing what they're doing and they will be the Walmart of E-commerce but because of that -- they will grow, grow, grow to not fully identifiable constraints I can point out.
The real next market -- will be those companies that go to solve a problem for larger enterprises, solves that pain, and then uses additional funds to expand the scope of the larger vision.
The only caveat is the B2C side. Because everything I just said was specifically about B2B companies. Only the B2C side you find that virality is sometimes more important than function as first. But even then I think you can see the ones that have the benefit also extend their scope. Such as Facebook and focusing on simply college students and updates to being a personal online connector of life events.
Not sure if any of that makes sense, but it 's the way I see it.