For many of us, it is startling to realize how quickly Amazon.com Inc. (AMZN, Financial) became such an overwhelming retail force.
It first began operating as an online bookstore in 1994. Just three years later, in 1997, it went public. And then it really took off, grabbing market share in many retail sectors. There were a few failures, of course, but Amazon had so much momentum it could shrug off the failures and move on to new ventures.
Where I say “momentum” above, I might also have said “cash flow.” Amazon founder and long-time leader Jeff Bezos has created a juggernaut based on cash flow and a long-term perspective.
While cash flow and a commitment to the long term are the two main pillars of Amazon’s growth, there are other critical matters that contributed to the company’s success. Bezos articulates these matters in his annual letters to shareholders, which began in 1997.
The quick summaries below provide a reference guide to them and an overview of Bezos’ thinking on the issues that mattered to him most as he built Amazon. Combined, they outline the main points of his philosophy about business:
1997- the long term: For a company new to public markets, Bezos bravely announced its basic measure of success will be the amount of shareholder value created over the long term. Not this quarter, not this year, but over five years or more. This letter also introduced us to the idea of obsessing over customers, and the many improvements the company had made to enhance the customer experience.
1998- Hiring: Amazon doesn’t hire to simply fill vacant positions, it also hires to raise the collective IQ of the team. Non-warehouse employees will face up to 20 hours of grueling questions. In this letter, Bezos also explains a portion of the business model, how Amazon can leverage bits and bytes successfully. That wasn’t just talk, he had ramped up to a billion dollars in sales with only $30 million in inventory and $30 million in plant and equipment.
1999: What do Amazon shares represent? Bezos first took this question at a Stanford University event, and it gave him a platform to explain to the world that you are buying a piece of the company’s platform. That comprises a brand, customers, technology, distribution, capability, deep e-commerce expertise and a team committed to customer service.
2000- Online vs. brick-and-mortar: Bezos led off this letter by announcing Amazon was suffering because of what we now call the dotcom bust. But he remained optimistic and went on to explain a key difference between an online sales platform and brick-and-mortar retail. Technology allows Amazon to transform the cost-basis of its retail business, while physical stores can only make tweaks around the edges. Also in this letter, discussion about making “bold” bets on future expansion.
2001- The platform and customer service: Bezos links these two elements through services such as “Instant Order Updates” and “Look Inside the Book,” where the platform provided the power to provide enhancements to customer service at little long-term cost. In this letter, he also addresses the cash flow issue, explaining why Amazon chooses to emphasize cash over more conventional metrics such as net income and earnings per share. Bezos is committed to growth, so he would prefer to keep cash in the business as opposed to paying it out to shareholders.
2002- Lower prices and better customer experiences: In traditional retail, operators try to balance prices and the customer experience by varying staff levels. Bezos writes that online stores such as his do not face that tradeoff. He says, “We transform much of customer experience—including unmatched selection, extensive product information, personalized recommendations, and other new software features—into a largely fixed expense.” In other words, Amazon can deliver lots of information to customers without added staffing expenses.
2003- Long-term owners: Bezos explains the customer-shareholder connection, noting that as they design the customer experience, they have the interests of long-term owners in mind. More specifically, by enhancing the customer experience, they see greater rewards for patient shareholders. For example, many objected to customer reviews (especially the negative ones) when Amazon first began providing them. But, in the long term, reviews make customers more loyal and thus increase the value of the company.
2004- Look beyond income: Returning to the earnings versus cash flow issue, Bezos says earnings do not directly translate into cash flows; shares are worth only the present value of their future cash flows, not the present value of future earnings. Future cash flows involve not only earnings, but also working capital and capital expenditures. In addition, “Cash flow statements often don’t receive as much attention as they deserve. Discerning investors don’t stop with the income statement.”
2005- Data decisions and human judgment decisions: Bezos profiles the differences between data-based decisions and human judgment-based decisions. Most decisions can be made with data, and they are the easiest to make. However, data is not always available, so it is not helpful for long-term decisions. He adds the foundation of decision-making are these four principles, outlined in the 1997 letter, focus on customers; seek long-term market leadership; measure programs and effectiveness analytically; and make bold rather than timid decisions.
2006- Entering new businesses: Amazon has several hurdles that must be cleared for new business opportunities to survive screening. They are growth, high returns on capital, large market segments, scalable enough to make a material difference and the opportunity must be currently underserved. Bezos also explains why (to that date) why Amazon had not ventured into physical stores (not able to meet the conditions above).
These are the first 10 of Bezos’ letters to shareholders, the remaining eleven letters will be summarized in part two.
If you read only one of these 21 letters, Bezos wants it to be the first one, from 1997. He has appended the 1997 letter to every subsequent annual letter because the message is so central and important to his philosophy. The subject of that letter: the long term.
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 at other online book retailers.
