In his 2005 letter to shareholders, Jeff Bezos discussed how decisions are made at Amazon.com Inc. (AMZN, Financial). As he explained in the letter, the easier decisions are based on data: “The heavy lifting is done by the math”. However, there are other, judgment-based decisions that are not so easy.
To illustrate how a data-based decision is made, he refers to the development of a new fulfillment center. The data going into the model includes:
- History of seasonal peaks.
- Anticipated product mix, including dimensions and weight (for sizing the facility).
- The sorting space requirement.
- Proximity to customers (to shorten delivery time and reduce transportation costs).
Data covering these issues and more can be plugged into a model, which then spits out results that can be ranked along one or more factors. As Bezos said, “The above decisions require us to make some assumptions and judgments, but in such decisions, judgment and opinion come into play only as junior partners.”
Sometimes, there is no historical or other data that can be applied and experimenting in advance is not possible. In these cases, judgment becomes key. Bezos cites the decision to continuously lower prices as an example. A decision such as this is counterintuitive; math-based decision-making would conclude that raising pricing and profits is the optimal strategy.
The problem with math-based decision-making is that it is a short-term perspective. In other words, this quantitative approach can be estimated for a week or a quarter, but it is essentially useless when management looks forward five to 10 years. For example, in the long run, continued efficiency improvements will translate into lower costs and subsequently lower prices for consumers. That, in turn, will lead to more revenue, larger amounts of free cash flow and making Amazon more valuable for shareholders.
A second example of judgment-based decision-making comes from inviting third parties to compete with Amazon, on Amazon’s own turf: the product detail pages. Bezos says “well meaning” people feared third parties would cannibalize the company’s existing business. Amazon’s own buyers feared the move would make inventory forecasting more difficult, and it could be stuck with excess inventory. However, Amazon executives had committed to the principle of giving customers the best prices and went ahead with the idea (and collected a commission on the third-party sales). As we now know, that was to be a powerful and successful decision.
Bezos observes that math-based decisions get widespread support from the beginning, while judgment-based decisions will be controversial until put into practice. In what may be a swipe at some less-adventurous companies, he says institutions unwilling to accept controversy must make only math-based decisions, subsequently limiting their own innovation and long-term value creation goals.
He wraps up the 2005 letter by referring again to the foundational principles set out in the original 1997 letter. Those four principles are: (1) focus relentlessly on customers, (2) make investment decisions based on long-term market leadership considerations, (3) continue to analytically measure programs and effectiveness of investments and (4) make bold rather than timid investment decisions.
Decision-making is raised again in the 2015 letter to shareholders, where Bezos talks about Type 1 and Type 2 decisions. He first warns about sclerotic decision-making in large organizations, where they adopt a “one-size-fits-all” approach, to the detriment of speed and inventiveness. To explain this idea, he defines Type 1 and Type 2 decisions.
- Type 1 decisions are irreversible; there is no opportunity to reverse course once a Type 1 decision is made. Because a company is locked into a position by this kind of decision, the process must be made methodically, carefully and slowly. Type 1 decisions, then, are slow and cumbersome.
- Type 2 decisions are reversible, and if wrong can be undone relatively quickly and easily.
Bezos points out that as organizations get bigger, they become more inclined to make Type 1 decisions because of scale. In the 2006 letter, he wrote, “I remember how excited we were in 1996 as we crossed $10 million in book sales. It wasn’t hard to be excited—we had grown to $10 million from zero. Today, when a new business inside Amazon grows to $10 million, the overall company is growing from $10 billion to $10.01 billion.”
Bezos believes an important part of his mission is to ensure his now-enormous company does not become a Type 1, stagnating company.
The subject of decision-making also makes an appearance in the 2016 letter to shareholders. In it, he laid out several recommendations for “high-velocity decision making”:
- Never use a one-size-fits-all process; many decisions are reversible, two-way doors.
- Make decisions without complete information—70% is fine, because if you wait for 90%, you are being too slow.
- Use the “disagree and commit” strategy, which means being prepared to move ahead even if there is no consensus; Bezos says sometimes he is the one to concede to the rest of the group and move on with them, despite his reservations.
- Recognize what he calls “true misalignment issues” quickly and escalate them. For example, teams may have fundamentally different views, and that misalignment will not be solved with more meetings. Without escalation, such situations tend to be resolved by ceding to the team with the most stamina, rather than the one that is right.
Given what Bezos has accomplished, it is clear he was not only a man with a mission, but also a man who knew how to execute the strategy and tactics that made the mission possible. The latest proof is in his analyses of how decisions should be made. He is a leader who understands process as well as objectives.
Do a search at Amazon for “decision making” and you’ll receive an avalanche of book titles. For the man who made all those books available, simplicity appears to be as important as comprehensiveness. As we’ve seen, Bezos has boiled down decision-making into a couple of powerful containers: data-driven decisions as opposed to judgment-based decisions, and Type 1 versus Type 2 decisions. In addition, he has recommendations to help others make decisions more quickly.
With these pairs and combinations, Bezos gave his management team a set of powerful tools for building what became one of the world’s largest retailers.
Disclosure: I do not own shares in any company listed, and do not expect to buy any in the next 72 hours. I do list books for sale on Amazon.com and other online book retailers.
