Jeff Bezos - Amazon Shareholder Letters - Seeds for Success

Amazon Annual Shareholder Letter - Jeff Bezos

Annual letters from Amazon’s Jeff Bezos (NASDAQ: AMZN)

From a business and investment standpoint, Amazon.com (NASDAQ: AMZN) has been one of the world’s most successful companies over the last two decades. This encouraged us to review the shareholder letters (1997-2019) of Amazon’s founder Jeff Bezos to learn about his recipe for success. What struck us most about Bezos was how textbook he was, focusing on improving Amazon’s consumer experience and economic moat. Showing hints of a value investor, he would quote Benjamin Graham, denounce Wall Street noise and focus on free cash flows to shareholders. In this post, we’ll review some the big ideas from his letters. This includes his take on Amazon’s long-term orientation, investment framework, economic moat, leadership philosophy and decision-making processes.

It’s all about the long-term

As an owner operator, Bezos emphasised Amazon’s focus on long-term value creation for customers, and shareholders on a per share basis. He disliked decisions that are motivated by short-term profitability or Wall Street noise. Likewise, he described how Amazon would prioritise actions to maximise the present value of future cash flows over actions that make GAAP results look good. His 1997 letter to shareholders is worth reading. It encapsulates much of Amazon’s foundations and his vision for the decades that followed.

What’s good for customers is good for shareholders

In their early days, investors and vendors had believed that Amazon features such as product reviews and instant order updates would hurt company sales. However, Amazon was adamant that these features are important to the customer’s experience, and therefore valuable to long-term shareholders. In Bezos’ words, “what’s good for customers is good for shareholders”. It’s a simple but important rule for good business.

Amazon’s investment framework

Amazon takes an analytical and data-driven approach to program and investment selection. While Amazon rejects projects that cannot deliver acceptable returns, the company will gamble on investment decisions with a high likelihood of building market leadership.

Bezos highlights the possibility of success and failure in every investment, and the opportunity to learn from this. He suggests that the challenge is not in finding new opportunities for Amazon’s expansion, but in prioritising investments correctly. Similarly, Bezos has emphasised his desire to build a lean and cost-conscious culture. He wanted a company that worked hard to spend their capital wisely. A lot of their infrastructure projects looked at ways to scale their distribution and systems capacity cost-effectively. Frugality is actually one of Amazon’s leadership principles.

The intelligent Amazonian investor

Bezos appears familiar with value investing tenets, citing Benjamin Graham in several letters. Like Graham, Bezos reminds his readers that the ‘stock market is a voting machine’ in the short term, but ‘a weighing machine in the long-term’. You’ll also see Bezos emphasise the importance of free cash flows on a per share basis. He also liked to discuss capital expenditures, working capital, cash generative operating cycles and the impact of future share dilution. In his 2004 letter, he educated readers with case study on the potential follies of EBITDA reporting.

Bezos’ three tests of opportunity

Bezos reminds readers that growing meaningful businesses requires a culture of discipline, patience and nurturing. He outlined how a worthwhile investment at Amazon must pass three tests. Firstly, the opportunity must have potential to deliver high returns on capital. Secondly, it should operate in sufficiently large markets. That is, it can become a meaningful part of the company through organic growth. Thirdly, the market has underserved the opportunity but Amazon has the capability to deliver a strong customer experience in its place.

Long-tailed distributions

Bezos understood that all innovations, experimentations and investments involved some risk of failure. He thought about opportunities probabilistically and saw each idea as one part of a portfolio. Bezos reminded readers in his 2015 letter to take bold bets when the probability of high positive returns is high. Unlike the risk-return trade-offs in baseball, the long-tailed distributions in businesses allow for big winners to pay for the cost of many experiments.

Investing in Pets.com

Bezos was also transparent with Amazon’s mistake to invest in Pets.com and Living.com during the Dot Com bubble. Initially, he believed in the gold-rush and diversification benefits. However, he admitted to underestimating the difficulties of building viable new e-commerce companies. While it’s important to make bold bets, Bezos also highlights the importance of knowing when to exit. Amazon refused to inject further capital into both companies as they collapsed.

We suspect Jeff Bezos would score better than many executives on LJ Rittenhouse’ scorecard for effective executive communications. He appears more candid and less generic when communicating strategy, decisions and results to shareholders. The best shareholder letters are the ones that educate you.

Amazon’s economic moat

In the first decade following their IPO, Bezos identified three major challenges to Amazon’s vision. In his words, they were: (1) aggressive, capable and well-funded competitors; (2) risks associated with growth, execution and expansion (geography & product); and (3) large reinvestment requirements for growth and expansion. According to his letters, Amazon would address these challenges by committing to customer experience and initiatives to widen their economic moat.

Obsess over customers

Bezos said it was important to view customers as perceptive and intelligent. He reminded employees to wake up each morning afraid. Not of their competition, but of Amazon’s customers. Customers will remain loyal until competitors offer them better services and products. The evolutionary nature of competition suggest that consumer expectations must rise over time. For this reason, Amazon’s most important criterion for selecting partnerships is its expected impact on customer experience. Bezos would reject partnerships with companies that did not share their focus on pleasing customers.

Pursue scale and market leadership

Bezos’ articulated Amazon’s competitive advantage and strategy across many annual letters. Much of it read like a case study from professor Bruce Greenwald’s book Competition Demystified. Bezos’ believed that Amazon’s economic model rested on their market leadership and scale. This he believed would translate to improved revenue, profitability and returns on invested capital per customer. Even from his first shareholder letter in 1997, he had clear measures for market leadership. This included customer growth, revenue growth, repeat purchases growth, and the customer satisfaction index. I enjoyed revisiting his 2014 and 2018 letter in which he recounted the rise of Amazon’s flagships (Marketplace, Prime and AWS).

Deliver high quality affordably

While academia might argue about the difficulties of pursuing high quality and low cost strategy simultaneously, it was the approach that Bezos wanted for Amazon. He saw demand advantages, cost-advantages and economies of scale as complementary facets to total value creation. Bezos explains how efficiency-side improvements can translate to improved customer satisfaction, customer growth and economies of scale. This then leads to higher returns on invested capital.

Additionally, Bezos paid careful attention to pricing as well, evidenced in his regular price updates to shareholders. He believed that pricing was key to earning customer trust and widening Amazon’s economic moat. Lower prices would allow Amazon to scale and generate greater value for customers and shareholders. Bezos’ focus on pricing is interesting given the topic receives far less attention from other executives in writing.

Leadership the Jeff Bezos way

In the late 2000s, Bezos opened up on the challenges and complexities of managing large companies. For example, in his 2015 letter, he describes how corporate cultures, whether good or bad, are stable, enduring and difficult to change. It is difficult to change because people are self-selective. That is, culture emerges from people, successes, failures and stories that shape the company’s history. His letters offer insight into corporate culture, operational excellence and decision-making.

Amazon’s pioneering spirit

For the reasons above, Bezos wanted ‘improvement, experimentation and innovation’ to underpin Amazon’s culture and ‘pioneering spirit’. He believed these characteristics were critical to enduring success. Bezos also suggests that an end-to-end focus on customer experience offers the least risky path to long-term value creation. Similarly, he believed Amazon’s culture to support small businesses with large potential as a source of competitive advantage. He highlights that every new business or idea needs time to flourish. Kindle for example required three years of planning and work before its very first release.

Customer-driven goal setting

When it comes to strategy and goal setting, Amazon’s management focuses on controllable inputs as opposed to financial outputs. For example, Bezos noted in his 2009 letter that Amazon had specified 452 goals for 2010. Each goal had specified owners, deliverables and completion dates. He noted that nearly 80% of goals would have a direct impact on customer experience, while terms such as revenue, free cash flow and gross profits were mentioned less than eight times.

His point is that companies should start with the customers and derive their goals from there. While listening to customers is critical, good companies will also invent on their behalf. Bezos says it is better to focus on customer needs than outdoing one’s competitors. In this way, you become more proactive to consumer wants, and less reactive or flat-footed to competitive forces.

Similarly, Bezos highlights the value in a customer-needs approach and skills-forward approach to business. The former looks at what customers desire, with solutions designed accordingly. By contrast, the latter looks at new solutions based on the capability that the business currently excels at. While Bezos sees value in both approaches, he warns that disproportionate focus on skills-forward approaches may discourage companies from developing new skills, innovations and experiences. Current skills tend to become outdated sooner or later.

Excellence at Amazon

Operational excellence meant two things to Bezos: (1) Making continuous improvements in customer experience; (2) Improving productivity, margin, efficiency and asset velocity (i.e. revenue on assets). Bezos also believed that (1) and (2) are interdependent. Profitability enables companies to invest in customer experience, which enables even greater profitability – a virtuous cycle.

To achieve operational excellence, it is important for companies to set high standards. Bezos shared several lessons on this in his 2017 letter to shareholders. Firstly, he believed that high business standards are teachable and contagious. It is not intrinsic to any individual. If you allow low standards to creep in, they can spread quickly across the organisation. Likewise, if you introduce a new person into a high performing team, Bezos is confident that he/she should adapt quickly.

Secondly, Bezos suggests that high standards must be domain specific. Good companies will recognise what high standards must look like for each business unit. They then set realistic expectations accordingly. Bezos believed that setting high but achievable standards is important to company culture. High standards can help to boost customer experience, product development, recruitment and retention, and quality behind the scenes.

Talented, versatile and aligned employees

Bezos would highlight the importance of competent and versatile employees, and value in bench strength. He offers three questions in his 1998 letter for finding and hiring extraordinary people: (1) Do I admire this person? (2) Will this person lift the average effectiveness level of his/her group? (3) Under what conditions can this person become a ‘superstar’? Answering these three questions can help us to find great people for the right positions.

He also believed that employee-alignment was critical to company productivity. Amazon offered stock options to majority employees. Amazon has also introduced other initiatives such as pay-to-quit, Career Choice and leaving sharing to keep employees committed and motivated.

Day one thinking with Jeff Bezos

Bezos wanted employees to treat everyday as Day 1 for Amazon. To him, Day 2 meant stasis. With stasis, irrelevance would follow. In his 2016 letter, Bezos gave readers a starter pack for Day 1 thinking. Firstly, you must remain customer obsessed. We should assume that customers are always dissatisfied, even if they do not know it yet. Secondly, we have to resist proxies. Bezos feels large companies tend to lose sight of their outcomes and customers, focusing too much on processes and metrics that proxy for success. Thirdly, large companies need to embrace external trends.

Finally, companies need to be able to make high quality decisions swiftly. He’s shared a few ideas on this throughout his letters. We’ll outline a few to end this post.

Data and value based decisions

Amazon endeavours to be data-driven and analytical in all operating and investment decisions. However, Bezos notes in his 2005 letter that organisations may not always have the data needed to make informed decisions. At the other extreme, a deluge of data may overwhelm the decision maker. Likewise, sometimes companies will focus on the quantifiable, and ignore value-based decisions because they are controversial. Great companies must know how to balance both quantitative and judgement-based decisions. Bezos points out that companies that are not up for such deliberations are likely to stifle long-term innovation and value creation.

Type one and two decisions

Bezos outlines for readers two types of decisions: Type 1 and Type 2. Type 1 decisions have irreversible consequences, while Type 2 decisions have reversible and/or less permanent outcomes. While Type 1 decisions require greater deliberation, Bezos believes that companies should leave Type 2 decisions to high judgement individuals or small groups.

The major risk Bezos sees with large organisations is the tendency to treat every decision as a Type 1 decision. This he believes can slow the company’s responsiveness and rate of innovation. High functioning companies can decentralise decision making, and are more willing to accept and learn from failures.

Decision making with velocity

Bezos believes there are several ingredients that enable large companies to make high quality decisions with greater speed. Firstly, one-size-fits-all decision-making processes are not always optimal. For example, Type 2 decisions may not need as much scrutiny and consultation as Type 1 decisions.

Secondly, Bezos believes that we should be comfortable with making decisions with 70% of the information we would like to have (in most cases). We could be too late if we wait for 90% confidence or information. In all cases, we need to be effective in monitoring and correcting decisions as new facts come to light.

Thirdly, it is sometimes okay to disagree and commit. Often there is not enough information to reach consensus within a group. It is potentially worthwhile to gamble on a portfolio of decisions that others believe in with calculated conviction. You might otherwise reject every worthwhile opportunity if consensus is mandatory.

However, sometimes some groups will be fundamentally misaligned. In these instances, escalation and dispute resolutions are needed to resolve the disagreement. Otherwise, it is the group with the most stamina that wins the decision. This is not optimal decision making.

Jeff Bezos and the seeds for success – Amazon shareholder letters