Tuesday, July 31, 2012

Steve Yegge's Google Platforms Rant (With Amazon Pearls Dribbled In)

I couldn't find a way to link to this Google+ posting from the resources page, so I decided to cut and paste it here. Steve Yegge is a programmer at Google and a former Amazonian. I'm sure I'm breaching all sorts of etiquette by doing this, but I rationalize it by saying I want to make sure this piece - with all its pearls about Amazon's transition to service oriented architecture and Jeff Bezos' mercurial ways - is preserved for posterity. 

Steve Yegge originally shared this post:
Stevey's Google Platforms Rant

I was at Amazon for about six and a half years, and now I've been at Google for that long. One thing that struck me immediately about the two companies -- an impression that has been reinforced almost daily -- is that Amazon does everything wrong, and Google does everything right. Sure, it's a sweeping generalization, but a surprisingly accurate one. It's pretty crazy. There are probably a hundred or even two hundred different ways you can compare the two companies, and Google is superior in all but three of them, if I recall correctly. I actually did a spreadsheet at one point but Legal wouldn't let me show it to anyone, even though recruiting loved it.

I mean, just to give you a very brief taste: Amazon's recruiting process is fundamentally flawed by having teams hire for themselves, so their hiring bar is incredibly inconsistent across teams, despite various efforts they've made to level it out. And their operations are a mess; they don't really have SREs and they make engineers pretty much do everything, which leaves almost no time for coding - though again this varies by group, so it's luck of the draw. They don't give a single shit about charity or helping the needy or community contributions or anything like that. Never comes up there, except maybe to laugh about it. Their facilities are dirt-smeared cube farms without a dime spent on decor or common meeting areas. Their pay and benefits suck, although much less so lately due to local competition from Google and Facebook. But they don't have any of our perks or extras -- they just try to match the offer-letter numbers, and that's the end of it. Their code base is a disaster, with no engineering standards whatsoever except what individual teams choose to put in place.

To be fair, they do have a nice versioned-library system that we really ought to emulate, and a nice publish-subscribe system that we also have no equivalent for. But for the most part they just have a bunch of crappy tools that read and write state machine information into relational databases. We wouldn't take most of it even if it were free.

I think the pubsub system and their library-shelf system were two out of the grand total of three things Amazon does better than google.

I guess you could make an argument that their bias for launching early and iterating like mad is also something they do well, but you can argue it either way. They prioritize launching early over everything else, including retention and engineering discipline and a bunch of other stuff that turns out to matter in the long run. So even though it's given them some competitive advantages in the marketplace, it's created enough other problems to make it something less than a slam-dunk.

But there's one thing they do really really well that pretty much makes up for ALL of their political, philosophical and technical screw-ups.

Jeff Bezos is an infamous micro-manager. He micro-manages every single pixel of Amazon's retail site. He hired Larry Tesler, Apple's Chief Scientist and probably the very most famous and respected human-computer interaction expert in the entire world, and then ignored every goddamn thing Larry said for three years until Larry finally -- wisely -- left the company. Larry would do these big usability studies and demonstrate beyond any shred of doubt that nobody can understand that frigging website, but Bezos just couldn't let go of those pixels, all those millions of semantics-packed pixels on the landing page. They were like millions of his own precious children. So they're all still there, and Larry is not.

Micro-managing isn't that third thing that Amazon does better than us, by the way. I mean, yeah, they micro-manage really well, but I wouldn't list it as a strength or anything. I'm just trying to set the context here, to help you understand what happened. We're talking about a guy who in all seriousness has said on many public occasions that people should be paying him to work at Amazon. He hands out little yellow stickies with his name on them, reminding people "who runs the company" when they disagree with him. The guy is a regular... well, Steve Jobs, I guess. Except without the fashion or design sense. Bezos is super smart; don't get me wrong. He just makes ordinary control freaks look like stoned hippies.

So one day Jeff Bezos issued a mandate. He's doing that all the time, of course, and people scramble like ants being pounded with a rubber mallet whenever it happens. But on one occasion -- back around 2002 I think, plus or minus a year -- he issued a mandate that was so out there, so huge and eye-bulgingly ponderous, that it made all of his other mandates look like unsolicited peer bonuses.

His Big Mandate went something along these lines:

1) All teams will henceforth expose their data and functionality through service interfaces.

2) Teams must communicate with each other through these interfaces.

3) There will be no other form of interprocess communication allowed: no direct linking, no direct reads of another team's data store, no shared-memory model, no back-doors whatsoever. The only communication allowed is via service interface calls over the network.

4) It doesn't matter what technology they use. HTTP, Corba, Pubsub, custom protocols -- doesn't matter. Bezos doesn't care.

5) All service interfaces, without exception, must be designed from the ground up to be externalizable. That is to say, the team must plan and design to be able to expose the interface to developers in the outside world. No exceptions.

6) Anyone who doesn't do this will be fired.

7) Thank you; have a nice day!

Ha, ha! You 150-odd ex-Amazon folks here will of course realize immediately that #7 was a little joke I threw in, because Bezos most definitely does not give a shit about your day.

#6, however, was quite real, so people went to work. Bezos assigned a couple of Chief Bulldogs to oversee the effort and ensure forward progress, headed up by Uber-Chief Bear Bulldog Rick Dalzell. Rick is an ex-Armgy Ranger, West Point Academy graduate, ex-boxer, ex-Chief Torturer slash CIO at Wal*Mart, and is a big genial scary man who used the word "hardened interface" a lot. Rick was a walking, talking hardened interface himself, so needless to say, everyone made LOTS of forward progress and made sure Rick knew about it.

Over the next couple of years, Amazon transformed internally into a service-oriented architecture. They learned a tremendous amount while effecting this transformation. There was lots of existing documentation and lore about SOAs, but at Amazon's vast scale it was about as useful as telling Indiana Jones to look both ways before crossing the street. Amazon's dev staff made a lot of discoveries along the way. A teeny tiny sampling of these discoveries included:

- pager escalation gets way harder, because a ticket might bounce through 20 service calls before the real owner is identified. If each bounce goes through a team with a 15-minute response time, it can be hours before the right team finally finds out, unless you build a lot of scaffolding and metrics and reporting.

- every single one of your peer teams suddenly becomes a potential DOS attacker. Nobody can make any real forward progress until very serious quotas and throttling are put in place in every single service.

- monitoring and QA are the same thing. You'd never think so until you try doing a big SOA. But when your service says "oh yes, I'm fine", it may well be the case that the only thing still functioning in the server is the little component that knows how to say "I'm fine, roger roger, over and out" in a cheery droid voice. In order to tell whether the service is actually responding, you have to make individual calls. The problem continues recursively until your monitoring is doing comprehensive semantics checking of your entire range of services and data, at which point it's indistinguishable from automated QA. So they're a continuum.

- if you have hundreds of services, and your code MUST communicate with other groups' code via these services, then you won't be able to find any of them without a service-discovery mechanism. And you can't have that without a service registration mechanism, which itself is another service. So Amazon has a universal service registry where you can find out reflectively (programmatically) about every service, what its APIs are, and also whether it is currently up, and where.

- debugging problems with someone else's code gets a LOT harder, and is basically impossible unless there is a universal standard way to run every service in a debuggable sandbox.

That's just a very small sample. There are dozens, maybe hundreds of individual learnings like these that Amazon had to discover organically. There were a lot of wacky ones around externalizing services, but not as many as you might think. Organizing into services taught teams not to trust each other in most of the same ways they're not supposed to trust external developers.

This effort was still underway when I left to join Google in mid-2005, but it was pretty far advanced. From the time Bezos issued his edict through the time I left, Amazon had transformed culturally into a company that thinks about everything in a services-first fashion. It is now fundamental to how they approach all designs, including internal designs for stuff that might never see the light of day externally.

At this point they don't even do it out of fear of being fired. I mean, they're still afraid of that; it's pretty much part of daily life there, working for the Dread Pirate Bezos and all. But they do services because they've come to understand that it's the Right Thing. There are without question pros and cons to the SOA approach, and some of the cons are pretty long. But overall it's the right thing because SOA-driven design enables Platforms.

That's what Bezos was up to with his edict, of course. He didn't (and doesn't) care even a tiny bit about the well-being of the teams, nor about what technologies they use, nor in fact any detail whatsoever about how they go about their business unless they happen to be screwing up. But Bezos realized long before the vast majority of Amazonians that Amazon needs to be a platform.

You wouldn't really think that an online bookstore needs to be an extensible, programmable platform. Would you?

Well, the first big thing Bezos realized is that the infrastructure they'd built for selling and shipping books and sundry could be transformed an excellent repurposable computing platform. So now they have the Amazon Elastic Compute Cloud, and the Amazon Elastic MapReduce, and the Amazon Relational Database Service, and a whole passel' o' other services browsable at aws.amazon.com. These services host the backends for some pretty successful companies, reddit being my personal favorite of the bunch.

The other big realization he had was that he can't always build the right thing. I think Larry Tesler might have struck some kind of chord in Bezos when he said his mom couldn't use the goddamn website. It's not even super clear whose mom he was talking about, and doesn't really matter, because nobody's mom can use the goddamn website. In fact I myself find the website disturbingly daunting, and I worked there for over half a decade. I've just learned to kinda defocus my eyes and concentrate on the million or so pixels near the center of the page above the fold.

I'm not really sure how Bezos came to this realization -- the insight that he can't build one product and have it be right for everyone. But it doesn't matter, because he gets it. There's actually a formal name for this phenomenon. It's called Accessibility, and it's the most important thing in the computing world.

The. Most. Important. Thing.

If you're sorta thinking, "huh? You mean like, blind and deaf people Accessibility?" then you're not alone, because I've come to understand that there are lots and LOTS of people just like you: people for whom this idea does not have the right Accessibility, so it hasn't been able to get through to you yet. It's not your fault for not understanding, any more than it would be your fault for being blind or deaf or motion-restricted or living with any other disability. When software -- or idea-ware for that matter -- fails to be accessible to anyone for any reason, it is the fault of the software or of the messaging of the idea. It is an Accessibility failure.

Like anything else big and important in life, Accessibility has an evil twin who, jilted by the unbalanced affection displayed by their parents in their youth, has grown into an equally powerful Arch-Nemesis (yes, there's more than one nemesis to accessibility) named Security. And boy howdy are the two ever at odds.

But I'll argue that Accessibility is actually more important than Security because dialing Accessibility to zero means you have no product at all, whereas dialing Security to zero can still get you a reasonably successful product such as the Playstation Network.

So yeah. In case you hadn't noticed, I could actually write a book on this topic. A fat one, filled with amusing anecdotes about ants and rubber mallets at companies I've worked at. But I will never get this little rant published, and you'll never get it read, unless I start to wrap up.

That one last thing that Google doesn't do well is Platforms. We don't understand platforms. We don't "get" platforms. Some of you do, but you are the minority. This has become painfully clear to me over the past six years. I was kind of hoping that competitive pressure from Microsoft and Amazon and more recently Facebook would make us wake up collectively and start doing universal services. Not in some sort of ad-hoc, half-assed way, but in more or less the same way Amazon did it: all at once, for real, no cheating, and treating it as our top priority from now on.

But no. No, it's like our tenth or eleventh priority. Or fifteenth, I don't know. It's pretty low. There are a few teams who treat the idea very seriously, but most teams either don't think about it all, ever, or only a small percentage of them think about it in a very small way.

It's a big stretch even to get most teams to offer a stubby service to get programmatic access to their data and computations. Most of them think they're building products. And a stubby service is a pretty pathetic service. Go back and look at that partial list of learnings from Amazon, and tell me which ones Stubby gives you out of the box. As far as I'm concerned, it's none of them. Stubby's great, but it's like parts when you need a car.

A product is useless without a platform, or more precisely and accurately, a platform-less product will always be replaced by an equivalent platform-ized product.

Google+ is a prime example of our complete failure to understand platforms from the very highest levels of executive leadership (hi Larry, Sergey, Eric, Vic, howdy howdy) down to the very lowest leaf workers (hey yo). We all don't get it. The Golden Rule of platforms is that you Eat Your Own Dogfood. The Google+ platform is a pathetic afterthought. We had no API at all at launch, and last I checked, we had one measly API call. One of the team members marched in and told me about it when they launched, and I asked: "So is it the Stalker API?" She got all glum and said "Yeah." I mean, I was joking, but no... the only API call we offer is to get someone's stream. So I guess the joke was on me.

Microsoft has known about the Dogfood rule for at least twenty years. It's been part of their culture for a whole generation now. You don't eat People Food and give your developers Dog Food. Doing that is simply robbing your long-term platform value for short-term successes. Platforms are all about long-term thinking.

Google+ is a knee-jerk reaction, a study in short-term thinking, predicated on the incorrect notion that Facebook is successful because they built a great product. But that's not why they are successful. Facebook is successful because they built an entire constellation of products by allowing other people to do the work. So Facebook is different for everyone. Some people spend all their time on Mafia Wars. Some spend all their time on Farmville. There are hundreds or maybe thousands of different high-quality time sinks available, so there's something there for everyone.

Our Google+ team took a look at the aftermarket and said: "Gosh, it looks like we need some games. Let's go contract someone to, um, write some games for us." Do you begin to see how incredibly wrongthat thinking is now? The problem is that we are trying to predict what people want and deliver it for them.

You can't do that. Not really. Not reliably. There have been precious few people in the world, over the entire history of computing, who have been able to do it reliably. Steve Jobs was one of them. We don't have a Steve Jobs here. I'm sorry, but we don't.

Larry Tesler may have convinced Bezos that he was no Steve Jobs, but Bezos realized that he didn't need to be a Steve Jobs in order to provide everyone with the right products: interfaces and workflows that they liked and felt at ease with. He just needed to enable third-party developers to do it, and it would happen automatically.

I apologize to those (many) of you for whom all this stuff I'm saying is incredibly obvious, because yeah. It's incredibly frigging obvious. Except we're not doing it. We don't get Platforms, and we don't get Accessibility. The two are basically the same thing, because platforms solve accessibility. A platform is accessibility.

So yeah, Microsoft gets it. And you know as well as I do how surprising that is, because they don't "get" much of anything, really. But they understand platforms as a purely accidental outgrowth of having started life in the business of providing platforms. So they have thirty-plus years of learning in this space. And if you go to msdn.com, and spend some time browsing, and you've never seen it before, prepare to be amazed. Because it's staggeringly huge. They have thousands, and thousands, and THOUSANDS of API calls. They have a HUGE platform. Too big in fact, because they can't design for squat, but at least they're doing it.

Amazon gets it. Amazon's AWS (aws.amazon.com) is incredible. Just go look at it. Click around. It's embarrassing. We don't have any of that stuff.

Apple gets it, obviously. They've made some fundamentally non-open choices, particularly around their mobile platform. But they understand accessibility and they understand the power of third-party development and they eat their dogfood. And you know what? They make pretty good dogfood. Their APIs are a hell of a lot cleaner than Microsoft's, and have been since time immemorial.

Facebook gets it. That's what really worries me. That's what got me off my lazy butt to write this thing. I hate blogging. I hate... plussing, or whatever it's called when you do a massive rant in Google+ even though it's a terrible venue for it but you do it anyway because in the end you really do want Google to be successful. And I do! I mean, Facebook wants me there, and it'd be pretty easy to just go. But Google is home, so I'm insisting that we have this little family intervention, uncomfortable as it might be.

After you've marveled at the platform offerings of Microsoft and Amazon, and Facebook I guess (I didn't look because I didn't want to get toodepressed), head over to developers.google.com and browse a little. Pretty big difference, eh? It's like what your fifth-grade nephew might mock up if he were doing an assignment to demonstrate what a big powerful platform company might be building if all they had, resource-wise, was one fifth grader.

Please don't get me wrong here -- I know for a fact that the dev-rel team has had to FIGHT to get even this much available externally. They're kicking ass as far as I'm concerned, because they DO get platforms, and they are struggling heroically to try to create one in an environment that is at best platform-apathetic, and at worst often openly hostile to the idea.

I'm just frankly describing what developers.google.com looks like to an outsider. It looks childish. Where's the Maps APIs in there for Christ's sake? Some of the things in there are labs projects. And the APIs for everything I clicked were... they were paltry. They were obviously dog food. Not even good organic stuff. Compared to our internal APIs it's all snouts and horse hooves.

And also don't get me wrong about Google+. They're far from the only offenders. This is a cultural thing. What we have going on internally is basically a war, with the underdog minority Platformers fighting a more or less losing battle against the Mighty Funded Confident Producters.

Any teams that have successfully internalized the notion that they should be externally programmable platforms from the ground up are underdogs -- Maps and Docs come to mind, and I know GMail is making overtures in that direction. But it's hard for them to get funding for it because it's not part of our culture. Maestro's funding is a feeble thing compared to the gargantuan Microsoft Office programming platform: it's a fluffy rabbit versus a T-Rex. The Docs team knows they'll never be competitive with Office until they can match its scripting facilities, but they're not getting any resource love. I mean, I assume they're not, given that Apps Script only works in Spreadsheet right now, and it doesn't even have keyboard shortcuts as part of its API. That team looks pretty unloved to me.

Ironically enough, Wave was a great platform, may they rest in peace. But making something a platform is not going to make you an instant success. A platform needs a killer app. Facebook -- that is, the stock service they offer with walls and friends and such -- is the killer app for the Facebook Platform. And it is a very serious mistake to conclude that the Facebook App could have been anywhere near as successful withoutthe Facebook Platform.

You know how people are always saying Google is arrogant? I'm a Googler, so I get as irritated as you do when people say that. We're not arrogant, by and large. We're, like, 99% Arrogance-Free. I did start this post -- if you'll reach back into distant memory -- by describing Google as "doing everything right". We do mean well, and for the most part when people say we're arrogant it's because we didn't hire them, or they're unhappy with our policies, or something along those lines. They're inferring arrogance because it makes them feel better.

But when we take the stance that we know how to design the perfect product for everyone, and believe you me, I hear that a lot, then we're being fools. You can attribute it to arrogance, or naivete, or whatever -- it doesn't matter in the end, because it's foolishness. There IS no perfect product for everyone.

And so we wind up with a browser that doesn't let you set the default font size. Talk about an affront to Accessibility. I mean, as I get older I'm actually going blind. For real. I've been nearsighted all my life, and once you hit 40 years old you stop being able to see things up close. So font selection becomes this life-or-death thing: it can lock you out of the product completely. But the Chrome team is flat-out arrogant here: they want to build a zero-configuration product, and they're quite brazen about it, and Fuck You if you're blind or deaf or whatever. Hit Ctrl-+ on every single page visit for the rest of your life.

It's not just them. It's everyone. The problem is that we're a Product Company through and through. We built a successful product with broad appeal -- our search, that is -- and that wild success has biased us.

Amazon was a product company too, so it took an out-of-band force to make Bezos understand the need for a platform. That force was their evaporating margins; he was cornered and had to think of a way out. But all he had was a bunch of engineers and all these computers... if only they could be monetized somehow... you can see how he arrived at AWS, in hindsight.

Microsoft started out as a platform, so they've just had lots of practice at it.

Facebook, though: they worry me. I'm no expert, but I'm pretty sure they started off as a Product and they rode that success pretty far. So I'm not sure exactly how they made the transition to a platform. It was a relatively long time ago, since they had to be a platform before (now very old) things like Mafia Wars could come along.

Maybe they just looked at us and asked: "How can we beat Google? What are they missing?"

The problem we face is pretty huge, because it will take a dramatic cultural change in order for us to start catching up. We don't do internal service-oriented platforms, and we just as equally don't do external ones. This means that the "not getting it" is endemic across the company: the PMs don't get it, the engineers don't get it, the product teams don't get it, nobody gets it. Even if individuals do, even if YOU do, it doesn't matter one bit unless we're treating it as an all-hands-on-deck emergency. We can't keep launching products and pretending we'll turn them into magical beautiful extensible platforms later. We've tried that and it's not working.

The Golden Rule of Platforms, "Eat Your Own Dogfood", can be rephrased as "Start with a Platform, and Then Use it for Everything." You can't just bolt it on later. Certainly not easily at any rate -- ask anyone who worked on platformizing MS Office. Or anyone who worked on platformizing Amazon. If you delay it, it'll be ten times as much work as just doing it correctly up front. You can't cheat. You can't have secret back doors for internal apps to get special priority access, not for ANY reason. You need to solve the hard problems up front.

I'm not saying it's too late for us, but the longer we wait, the closer we get to being Too Late.

I honestly don't know how to wrap this up. I've said pretty much everything I came here to say today. This post has been six years in the making. I'm sorry if I wasn't gentle enough, or if I misrepresented some product or team or person, or if we're actually doing LOTS of platform stuff and it just so happens that I and everyone I ever talk to has just never heard about it. I'm sorry.

But we've gotta start doing this right.

Monday, July 30, 2012

The Productivity Loop (Walmart's Feedback Loop)

This is the fourth post in a series about Amazon's Feedback Loop, the mechanism most responsible for the company's success. See also the previous posts, The Growth Levers in Retail: Price, Selection, ConvenienceUnlocking the Broad Middle (Hint: Price Is the Key); and Sam Walton, Panties and Power Laws.

After three hours of high-energy corporate pep rally, Walmart's CEO - Mike Duke - strides onto stage to bat clean up. The setting is the company's 2011 annual shareholders' meeting, emceed by Will Smith and featuring a cavalcade of senior executive speeches and heart-warming vignettes on the dedication of Walmart associates. 

Whether from Doug McMillon of Walmart International, Brian Cornell of Sam's Club (now departed), or Eduardo Castro-Wright (now departed) of walmart.com, each manager preceding the CEO has used his stage time to extol the virtues of what they call the Productivity Loop: Operate for less through every day low costs (EDLC), which leads to...Buy for less from suppliers, which leads to...Sell for less to customers with every day low price (EDLP), which leads to...GROWTH! And the loop circles around the unifying theme of "Saving people money so they can live better."
Walmart's Productivity Loop
It's a steady drumbeat, and it's loud. Audience members will not leave this meeting foggy on the takeaway points. Yet it's not limited to one meeting. Review any public presentation by a Walmart executive (you can find them here) and you will see that each returns to these same ideas over and over and over again.

Back at the shareholders' meeting, Mike Duke comes on stage, keeping the streak alive with yet another speech about the productivity loop. As he highlights the connection between EDLP and EDLC, he walks to the podium and grabs a well-worn copy of Sam Walton: Made in America, opening it as if he's preparing to read chapter and verse from scripture itself.

Duke says (and I'll paraphrase to a degree),

I picked this book off my shelf and read it again this week, for what must be the third or fourth time. And let me share with you what Mr. Sam has to say about EDLC...'We exist to provide value to our customers, which means that, in addition to quality and service, we have to save them money. Every time Walmart spends one dollar foolishly, it comes right out of our customers' pockets. Every time we save them a dollar, that puts us one more step ahead of the competition - which is where we will always plan to be.'

Duke closes the book and holds it up solemnly for the auditorium to behold. They clap reverently at Mr. Sam's immortalized words just before the current CEO sums it up with this statement: 

No one controls costs better than Walmart because we do it for the right reason. It's for our customer.

Walmart's productivity loop is grounded in the premise that price drives sales volume (as Walton demonstrated with his panties power law). The feedback loop's cardinal trait is recursiveness. As it repeats and churns, the inputs grow larger and stronger, compounding each other in ways that are more exponential than arithmetic. Churning the loop doesn't result in 2 + 2 + 2 +2 = 8, it results in 2 raised to the fourth power (2 x 2 x 2 x 2 = 16). Having lower costs let you charge lower prices. Lower prices lead to a higher volume of sales. The more sales you have, the more you can reinvest in ways to lower prices further. The more you churn it, the bigger that number gets and further away you pull from your competition. 

That's the power law in play. That’s how Walmart grew at such a torrid pace, earning the patronage of the broad middle.

We'll consider a specific example of how Walmart churns its productivity loop to its advantage (and the disadvantage of competitors) in the next post.

Wednesday, July 25, 2012

Sam Walton, Panties and Power Laws

This is the third post in a series about Amazon's Feedback Loop, the mechanism most responsible for the company's success. See also the previous posts, The Growth Levers in Retail: Price, Selection, Convenience and Unlocking the Broad Middle (Hint: Price Is the Key).

Sam Walton understood the power of price better than anybody. From the earliest days of Walmart, he decided price would be the lever he pressed the hardest. He pressed it with a fanatic's zeal.

In those early days, even before it was called Walmart, Walton unearthed a truism about low prices. He found that in lowering prices, sales didn't just bump up a little bit. The bump was dramatic. It was disproportionate to the discount, as if the relationship between price reduction and volume of sales followed some sort of power law. Cutting your price 30 percent didn't increase sales by a corresponding 30 percent...it might triple them. Walton saw that deep price cuts at his first five-and-dime store had the effect of not only drawing customers from the competitors across the way, but it also opened the purses of shoppers who might not otherwise buy his product. They couldn't pass up the bargain. It was as if he uncovered a secret of human nature.

Which brings us to an important discussion of panties from Sam Walton: Made in America:

If you're interested in "how Wal-Mart did it," this is one story you've got to sit up and pay close attention to. Harry [a wholesaler with whom Walton did business in the beginning]was selling ladies' panties - two-barred, tricot satin panties with an elastic waist - for $2.00 a dozen. We'd been buying similar panties from Ben Franklin for $2.50 a dozen and selling them at three pair for $1.00. Well, at Harry's price of $2.00, we could put them out at four for $1.00 and make a great promotion for our store.
Here's the simple lesson we learned...say I bought an item for 80 cents. I found that by pricing it at $1.00 I could sell three times more of it than by pricing it at $1.20. I might make only half the profit per item, but because I was selling three times as many, the overall profit was much greater. Simple enough. But this is really the essence of discounting: by cutting your price, you can boost your sales to a point where you earn far more at the cheaper retail price than you would have by selling the item at the higher price. In retailer language, you can lower your markup but earn more because of the increased volume.
Low prices were the key to growth, and Walton built a retail empire predicated on that simple, parsimonious concept. Everything flowed from low price. It drew more customers and increased volume of sales. It delivered that broad middle and all its glorious growth. 

As long as Walmart could keep the lowest price, it could pull customers away from Kmart in towns where they went head to head. It could also open shop in the smallest of Southern hamlets, selling pallet upon pallet of cheap merchandise in markets every other retailer thought too small to support a store. Walton knew that, as long as he kept low prices, no one could challenge him. And so he built a culture around it and shared with the world his strategy - brazenly - almost daring others to follow suit.

They didn't follow. They couldn't. None could give up those nice fat markups, those comfortable margins that propped up big executive salaries, bloated corporate overhead, and layer upon layer of bureaucracy. And so the small discounters fell by the wayside, the great Sears started collapsing under its own weight, Kmart fell further and further behind. Woolworth faded into history. Walmart turned itself into the hegemonic power of all the traditional retailers. 

Walton's price insight was the catalyst. His fanatical pursuit of it was the clincher. He saw that power law in play and he constructed methods to reduce price as doggedly as he could. He liked the growth and what it brought. And so he created the first feedback loop, something Walmart called (as it still does today) the productivity loop.

The more this feedback loop churned, the further Walmart pulled away from the competition, creating such an advantage that no traditional retail foe would be able to catch up. 

Not on price anyway.

Next, we'll discuss Walmart's feedback loop.

Monday, July 23, 2012

Unlocking the Broad Middle (Hint: Price Is the Key)

This is the second post in a series about Amazon's Feedback Loop, the mechanism most responsible for the company's success. See also the previous post, The Growth Levers in Retail: Price, Selection, Convenience.

In the previous post in this series we discussed the growth levers for retail, that retailers must decide how to allocate their resources among price, selection, and convenience (the levers) in the unending competition for customers. 

In a retailer's utopia, it would have enough resources to push simultaneously on all the levers. For the retailer that offers the lowest price, the widest selection, and the best convenience will win the most customers. When you win the most customers, you get the most growth. 

But traditional storefront retail just won't allow that perfect combination. It's held back, for one reason among many, by real estate constraints. Convenience is driven primarily by location, location, location. Every retailer wants to be as close as possible to the most customers, so those shopping locations that provide that access carry steep rents. But if you're forced to pay too much for rent, you can't afford to lower your prices or expand your selection. You'll still win some less price-sensitive shoppers who prize convenience most of all, but others will drive past your store on the way to your competitor in the suburb that offers cheaper prices. So we're back to the trade-offs. 

(We'll see later that in web-based retailing, the constraints are very different; the trade-offs less demanding; the ability to invest in all the levers, while hard, is not just a pipe dream. Amazon knows this very well.) 

While you get to the most customers by striking the right balance among price, selection, and convenience, the lowest common denominator of the growth levers is price. If you must choose one to define your service in the mind of the buying public, price will earn you the most business. 

Let's say the world of consumers can be depicted in a bell curve distributed according to how important price is to their buying decisions. The vast majority of shoppers fall in the broad middle part of the curve. 

Those with the highest price sensitivity (the left side of the curve) are so driven by price that they will forego convenience and selection in pursuit of the best bargains. They drive miles from their homes to shop at Aldi, they don't mind generic brands, and they will walk into your store with fists full of coupons if you allow it. It's a big enough population that businesses like Aldi can thrive by catering to the desire for the deepest discounts, but it's not big enough to sustain massive growth. 

The right hand side of the curve shows declining price sensitivity. Here I'll point to Whole Foods (Whole Paycheck?) shoppers. While they trade low price for a wide selection of organic food, they really stray from the Growth Levers altogether because they're motivated by variables such as brand loyalty, good customer service, and retailers that tailor experiences to their particular wants. (Together, those three represent another category of levers we'll consider later in the discussion). This population, with its low price sensitivity, gives certain retailers the chance to charge higher prices and earn large margins. But it sits on the downward slope of the bell curve, has fewer consumers, and therefore can't offer the growth opportunities of the middle. 

The bulk of consumers fall into that Broad Middle of the curve. This group is very price sensitive, but it doesn't rein absolutely supreme (i.e., they aren't going to drive across three counties to save $10 on items they could buy at a more convenient store). While you must have the right selection and decent convenience, price will win the day, earning you access to the broad middle and the opportunity to grow into this fattest part of the market. 

Price is ultimately the lowest common denominator, that lever which provides the greatest opportunity for growth.  Why? Next we'll highlight Sam Walton's discovery of power law relationship between low prices and high sales volume.

Friday, July 20, 2012

Costco and Paradox of Choice vs. the Growth Levers

Tweet About Growth Levers Post

After tweeting about my post The Growth Levers in Retail: Price, Selection, Convenience, I received the following reply:

Tweet Reply
I'm pretty sure Mike is referring to the CNBC special, The Costco Craze (it originally aired in late-April) in which a marketing expert explains to host Carl Quintanilla the concept of "paradox of choice." It was popularized several years ago by psychologist Barry Schwartz who authored a book with the same name. The idea is this: while people tend to believe that options are great (and the more you have the better), the reality is that we tend to be overwhelmed by too many. It creates stress. In many cases we would prefer not to have a choice; that our decisions be made for us. In the shopping environment, that stress can lead to indecision and consumers walking away from a purchase altogether. Mike is absolutely right about that.

Marketing Experts Like New Marketing Ideas

Retail dogma has long held that the more selection you can make available to customers, the better. Schwartz's research encouraged us to revisit that concept from the shopper's perspective. 

Now marketing experts love a novel concept, and when they find a new theory they tend to go looking for places to either a.) apply it, or b.) prove it. That has certainly been the case with the paradox of choice. Many an expert has sought out retail examples to prove the point that limited selection leads to a better shopping experience and more sales.  Their favorite cases to cite are Costco, Trader Joe's and Aldi's.

Costco carries about 3,800 individual stock keeping units (SKUs) per store, Trader Joe's carries about 3,000, and Aldi carries 1,400.* 

By contrast, Walmart Supercenters carry upwards of 150,000 and the average large-chain grocery store, like Kroger, carries 30,000 to 52,000 SKUs.

Average sales per SKU (calculated by dividing number of SKUs into gross sales and a good signal for efficiency and how quickly they sell their stuff), are $18.4 million for Costco, nearly $3 million for Trader Joe's, and $5 million for Aldi.  

For Kroger it's around $2.6 million, and for Walmart it's about $2.5 million.** 

Marketing experts see those numbers and are quick to give credit to the paradox of choice, their theory du jour, for the low-selection retailers racking up such high sales per item. Especially with Costco. Less selection, they argue, leads to a more pleasant shopping experience that drives higher sales. But I think they're too quick to go with the sexy theory when the numbers - and the rational for these retailers opting for a low-selection strategy - are adequately explained by the concept of the growth levers (the retail dogma). And especially by the importance of price.

Retailers Must Decide Which Levers Get Their Investment Resources

More About Lower Price Than Beating the Paradox of Choice

Consider the following quote from recently retired Costco CEO James Sinegal:* 

We carry a 325 bottle of Advil for $15.25. Lots of customers don't want to buy 325. If you had ten customers come in to buy Advil, how many are not going to buy any because you just have one size? Maybe one or two. We refer to that as the intelligent loss of sales. We are prepared to give up that one customer. But if we had four or five sizes of Advil, as grocery stores do, it would make our business more difficult to manage. Our business can only succeed if we are efficient. You can't go on selling at these margins if you are not.
Those margins to which he refers are 11 percent gross and three percent net, meaning operating expenses account for only eight percent of revenue. That's insanely low.  (Yes, Costco's profit margin is only three percent!) Contrast that to Walmart's 24 percent gross margin and 19 percent operating expenses.

The only way Costco can survive on those margins is if it buys in bulk. And it can only buy in bulk if it can sell in bulk. And it can only sell in bulk if it limits its selection to a handful of items. This allows Costco to offer the absolute cheapest prices on its items.

But because it relies on a narrow selection, Costco will never be the place you go for everyday shopping.  That's the trade-off in investing in one growth lever over the others. This is not a critique of its business. They embrace this fact, even if they're constantly priming their selection to find ways to get you in the door more. My family makes one Costco run a month, grabbing some things in bulk to save a few bucks on our weekly Trader Joe's runs. Costco can't replace Trader Joe's for us because Trader Joe's offers a wider food selection. They both serve their role. They co-exist quite well. And they're both excellent businesses. 

Walmart serves its role too, with the objective to be the place for one-stop shopping. It will not be able to compete with Costco on price for the same items because its selection is so much wider, its purchasing volume per SKU so much lower, and therefore its costs per item higher. But because it has so much more selection, it's more likely to get you in the door on a more frequent basis than Costco. 

(I should disclose that we've found no overall cost-savings in our grocery bill since adding Costco to our rotation about a year ago. Indeed, we spend just as much at Trader Joe's, so Costco has just made our bill go up 20 percent a month. Oh well. We like their almond butter.)

Concluding Thoughts

Mike's objection is an important one to raise. Let's challenge the dogma of retail's traditional growth levers.   But in this case, I think the marketing expert's enthusiasm for the paradox of choice is being applied ex post facto in an attempt to explain why Costco offers a lower selection. The reduced selection is not the reason for their success. The success stems from the low prices they're able to offer by virtue of having less inventory to buy, handle and store.

But paradox of choice remains a very cool theory, and I'm certain the marketing experts will find many more scenarios upon which they can graft it.

* Information provided by Barry Berman's Competing in Tough Times.

**These are 2008 or 2009 numbers (also gleaned from Berman's book) but I'm sure they hold approximately true today, too. A more important note is what a rough calculation this represents. SKUs are calculated on a per store basis, but most retail chains will offer items at certain stores but not others. This probably has much more impact for Walmart and Kroger than it does for Costco, Trader Joe's and Aldi. Still, I think the illustration has merit.) 

Thursday, July 19, 2012

EBay, Mr. Market, and Amazon's Q2 Results

Mr. Market is a funny dude. At this writing AMZN is trading up about five percent on the day. The reason? eBay.

Well, eBay plus lofty expectations that Amazon's current positive trend continues through its Q2 earnings announcement next Thursday. A look over the last few quarters of the relationship among earnings expectations, actual earnings, and Mr. Market's reaction...let's just say it shows an interesting dynamic.

The eBay Angle

eBay announced its Q2 results last night and exceeded every consensus expectation on the metrics Wall Street uses to gauge its performance. (See Scot Wingo's always well-informed discussion of the results at eBay Strategies here.) Mr. Market has pushed its price up over 10 percent on the day, touching - ever so briefly - its own 52-week high.

One of those important Wall Street metrics is eBay's Gross Merchandise Value (more or less its auction and marketplace revenue) growing at 15 percent, which pretty much matches the growth rate of the overall e-commerce market.

So here comes Mr. Market's logic...

Since Amazon has been crushing the e-commerce growth rate, outpacing it 2:1 with Q1 results in April when Amazon increased revenue 34 percent. And...with eBay showing it can match industry growth in the most recent quarter, then there must be some good tailwinds for e-commerce right now. Ergo...Amazon is going to kill it with Q2 results next Thursday! So let's bet on Amazon! 

Well, Mr. Market, you may be right. I'll grant that Amazon will probably outpace industry growth yet again. But what happens if earnings - once again - don't follow revenue growth? Moreover, what if earnings  (gasp!) disappear altogether for Q2 as Amazon has suggested is a distinct possibility?

Going Back in Time (But Just a Little)

Let's go back in time to look at Mr. Market's previous reactions to Amazon's earnings. We'll use some charts based on Wall Street analyst estimates of Amazon's performance (provided here by Businessweek) and go backwards from most recent.

Last quarter, Q1 results, Amazon surprised Mr. Market by earning .28 cents per share. This after his consensus estimate was .07. The stock shot up about 15 percent in the two trading sessions immediately following the news. It was the second such positive report, which leads us to...

Q4 of 2011 Amazon reported .38 cents per share. Mr. Market has expected .18. A 110 percent upside surprise. The stock actually fell seven percent on the news. Maybe that's because Mr. Market still had not recuperated from the hangover caused by the previous quarter's different kind of surprise...

In Q3 of 2011 Mr. Market had high hopes for Amazon. He was expecting .25 per share after Amazon had posted a hefty .41 cents per share in the previous period. He was hoping for the trend to continue, and in anticipation of it he had run up the stock price by about ten percent since the last earnings announcement. Amazon only earned .14 cents per share. Mr. Market's great hopes were dashed, and he punished Amazon, sending its stock price plummeting from about $225 to about $200 within a couple days. It went as low as $173 before starting to climb back up again.

Over this past year, Amazon has been nothing if not volatile. Google Finance is quick to highlight its 52-week range as 166.97 - 246.71. That's a wide spread, indicative of Mr. Market and this game of expectations he likes to play...and the bi-polar extremes that take over depending on whether Amazon has lived up to his expectations.

Q2 2012 and the Profitability Bias

Well Mr. Market's expectations for next week's results are not too lofty. At least as conveyed by the consensus estimates. It's at .03 cents per share (though the range is quite wide: .17 cents on the high side and .23 LOSS on the low side).

But the reaction today to eBay's results suggest to me that there exists loftier expectations than he's letting on to with the estimates. I think he secretly expects HUGE revenue numbers that will wow investors into paying even more for the privilege of owning shares.

I wouldn't bet against that happening. But even if the big revenue numbers come in and earnings disappoint, this faith in Amazon's upward performance trend is going to be dashed. And Amazon losing money in Q2 is a very real possibility. (Its guidance from the Q1 press release said this: "Operating income (loss) is expected to be between $(260) million and $40 million, or between 229% decline and 80% decline compared with second quarter 2011.") We know how heavily the company is investing in growth, and how willing it is to let those growth costs eat up profits. (See Amazon's Rapid Sales Growth...Buying the New Business?)

So, even if revenue growth blows us away, losses tend to shake investors' faith. Why? The profitability bias. It's almost as if we have an instinctive visceral reaction to seeing losses in a business that was previously showing earnings. We just can't help but think more losses are coming, that there's something wrong with the company, and that the losses will extend into future quarters. We have very weak stomachs for these things. Even if we know the business has staying power, is investing heavily in initiatives to make even better profits in the future, or is just going through a temporary funk. We just get spooked. We overreact and send the price down.

That's the basis for the Shleifer Effect (discussed in such detail on Adjacent Progression). 

Note that I'm making no predictions for Amazon's results next week. I am, however, highlighting the appearance of high expectations combined with the POSSIBILITY (nothing more than that) of Amazon not satisfying those expectations. Plus, we've seen what happens to the stock price when Mr. Market's expectations are dashed.

I'll end with this incredibly inappropriate teaser...

Amazon finished today at 226.17. That's almost exactly where it was immediately prior to the Q3 2011 update when it disappointed and proceeded to fall to its year lows over the next three months.

Wednesday, July 18, 2012

The Growth Levers in Retail: Price, Selection, Convenience

Amazon's Feedback Loop
If we were forced to reduce the secret of Amazon's success to one simple concept, this would be it: Amazon churning hard on the Feedback Loop featured above. 

This is absolutely critical to understanding Amazon. And not just retail. I mean every business line it's in. So I'll dedicate several posts to breaking it down, and then building it back up again. 

Stick with me on this. It will be worth it. 

The Growth Levers in Retail: Price, Selection, Convenience

In the world of retailing three variables are responsible for driving the lion’s share of growth. Price, Selection, and Convenience. Price is self-evident. When comparing apples to apples, customers want the lower-priced apple. Selection means the retailer offers the products the customer wants. And convenience means the shopping experience is streamlined, not confusing, not complex, and requires as little exertion from the customer as is humanly possible. 

Growth Levers in Retail

Think of these variables as levers a retailer can push, but that pushing each lever requires an investment of capital and other resources (e.g., management attention, supply chain capabilities, real estate acquisition, etc.) that diminishes your ability to invest in the other levers. You can choose to invest heavily in lowering the price of your products, marking them up less than your competitors. But that leaves you fewer resources to invest in having the widest selection possible or the most convenient shopping locations. Since capital and other resources are limited, each retailer must decide which lever to push the hardest making it a game of priorities and compromise. There are always trade-offs. 

See the red X's in the diagram below showing (in simplistic form) how retailers might choose to push their levers. At the far left, price gets the biggest investment, but selection is narrow and convenience is low. In this scenario (think discount grocer Aldi), the retailer is betting the very low price gets customers in the door even if they have to drive further to the store or have fewer items on the shelves to select from. 

In the middle, the retailer only pushes any of the levers so far, aiming for balance instead of a big bet on any individual lever. This might be the case for a grocery store like Kroger. It wants to find the real estate that makes its store locations more convenient to customers so they won't drive another five miles to Safeway or ten miles to a Walmart Supercenter. It will keep a wide selection to meet your full week of grocery needs without making trips to other stores. And it will charge the highest price it can without forcing customers to seek cheaper (but less convenient) alternatives. 

And on the right we have the retailer that forfeits price investments in favor of a very wide selection and a high degree of convenience for its customers. This might be the Whole Foods approach.

Retailers Must Decide Which Levers Get Their Investment Resources
Why do we call them the growth levers? I'll get to that next.

Monday, July 16, 2012

Amazon Sellers Competing With Amazon...On Amazon

A couple weeks ago Greg Bensinger wrote a worthwhile read in the Wall Street JournalCompeting With Amazon on Amazon. The gist is this: Amazon has a nasty habit of poaching the highest volume products from its third party sellers, opting to compete with them by selling the same thing in its marketplace rather than just sitting back and collecting the fees it gets from letting the partner make the sell. 

It's a solid story from Greg. What it misses, but something I'm certain Greg is thinking about, is why would Amazon be simultaneously pushing its third party seller program while poaching best selling products from those partners? That's befuddling. 

First, let me take a stab at the simple answer: Follow the money. 

In the fourth quarter of 2011, Amazon did $10 billion in sales from third-party merchants. Against this it charged somewhere in the ballpark of 13 percent fees. (That's an average of all fees charged, though it ranges pretty dramatically from category to category and can go up or down depending on which of Amazon's services sellers take advantage of.) It gets 80 percent gross margin for that business, so the whole thing netted Amazon about $1 billion in gross profits. That's cold hard cash it extracts from sellers in exchange for using the Amazon platform to get access to their customers. 

But what could Amazon make in gross profit dollars if it sold that same $10 billion of its own inventory instead of taking the third party merchant commissions?  Its gross margins tend to be a little better than 20 percent, so we'll go with that number. $10 billion times 20 percent is $2 billion in gross profit. 

Twice as much. Amazon would have made a lot more selling that $10 billion itself.

But conventional wisdom seems to be that Amazon is more about its marketplace than it is about being a retailer that buys and sells its own inventory. In Greg's article, he quotes Piper Jaffray analyst Gene Munster who forecasts that these third party sales could grow from 36 percent of Amazon's business to as much as 55 percent within five years. Amazon wants third parties to be a bigger piece of its business, he suggests.

A marketplace can be a great business. That 13 percent gross profit is particularly nice when you don't have to invest money in inventory to get it. It reduces overall capital needs, freeing up cash to be used in other parts of the business or to pay out to investors. Once you have the marketplace infrastructure in place (e-commerce technology, customer service, distribution capabilities, and a large base of returning customers), the profit is almost frictionless. You can earn more and more by just signing up additional sellers for the marketplace and making sure customers stay happy.

(Related: Read this post about Overstock.com's use of the marketplace concept to generate high returns on invested capital.)

What seems to fly in the face of that conventional wisdom is that Amazon continues to build its internal merchant infrastructure at a torrid pace. If it were truly satisfied with the third-party marketplace model, it doesn't make sense to me that it would keep hiring buyers to build new web stores (with Amazon-owned inventory) in an ever-growing list of product categories.

What seems more realistic is that Amazon is using third parties to accelerate its goal to offer the widest selection possible (a proven way to attract all those customers). But, as Greg's interviews suggest, that it watches the sales data closely to see which products are most popular and can be folded into its existing merchant operations. When you're selling toys, have lots of existing relationship with toy manufacturers, and have lots of toy buyers, it's not that hard to - going with one of Greg's examples - run to the original manufacturer of NFL pillow pets and get your own supply. And most certainly at a cheaper price than your third-party seller got. Amazon seems to have done just that upon noting that Collectible Supplies of California was selling 100 or more of these items every day. From the article:

Sales of Collectible Supplies' Pillow Pets soon fell to 20 a day "because Amazon was offering it," Mr. Peterson said. "I tried lowering the prices, but Amazon would always match my price or go lower until I eventually gave up" and set it at the manufacturer's suggested price, he added. Prices fluctuate, but Amazon was recently selling a Baltimore Ravens Pillow Pet for $12 with free shipping, while Mr. Peterson is again offering the product for $29.99.
My own two cents are these: Amazon is not wed to the marketplace idea where it serves as neutral arbiter of commerce. Despite the high returns on invested capital from running an inventory-free retail operation, Amazon is nothing if not confident about its ability to generate a lot of volume through its infrastructure. Meaning, Amazon believes it can score a nice flow of cash from buying, storing, and selling its own inventory at 20 percent gross profit. And it would prefer 20 percent to 13 percent.

But having wide product selection is the rub. Amazon wants all web shoppers to come to its site for anything they want or need. It wants shoppers to think first of Amazon for whatever they want to buy, and it wants shoppers to trust that Amazon will have the best price. They would then stop shopping around for best price. They would just go to Amazon and be done with it. And once those shopping habits are set, it's hard for a new competitor to break them.

So Amazon is glad to use third party sellers to help it build out selection. And while they help, Amazon is taking that 13 percent fee and using it to pay for its growing network of fulfillment centers, subsidizing shipping costs to enhance the customer experience further, and expanding the products it buys and puts in inventory. 

The third party sellers are fueling Amazon's growth and, for many of them at least, putting themselves out of business one fast-moving product at a time.

Thursday, July 12, 2012

Why Has Amazon Blacked Out Its 2012 Shareholder Meeting Presentation?

Granted, Amazon is not renowned for transparency. Quite the opposite. In some regards, I'm okay with that.  I respect that a business with grand growth ambitions might want to hold its strategy cards close to the vest. Jeff Bezos and crew have an outstanding track record of keeping new initiatives under wraps until they're ready to launch. And they notch up more victories than losses with these schemes. I imagine the practice helps keep the teams focused while giving Amazon the upper hand - keeping competitors in the dark - when they bring new stuff into the market. 

But the stinginess with information can be frustrating, too, for those eager to understand Amazon.

In those rare moments when Bezos decides to make public pronouncements, he can be surprisingly forthcoming. I relish the opportunity to learn from each sit-down he has with Charlie Rose; each Q&A with Steven Levy

But the best resource has been the presentation and webcast of each annual meeting of shareholders. Each year Bezos waxes philosophic on the business of Amazon, providing nuggets of insight into what he considers the most important traits, the biggest challenges, the guiding initiatives. In the 2011 question and answer session, he provided a brilliant response to a question from shareholder Evan Jacobs (transcribed by GeekWire and posted here), speaking eloquently on what it means to be misunderstood.

Those presentations have been made available each year on Amazon's investor relations website. But not so this year, even six weeks after the meeting and despite direct requests of Amazon's IR staff to make them available. We've been blacked out!

This is troubling even to someone (like me) who has a high degree of tolerance for Amazon's silence. I suppose (though am not positive) that providing meeting transcripts of shareholder meetings is left to the company's discretion and whim, not an SEC requirement. Still, as a public company, we have reasonable expectations that important information about the business that is made available to a few shareholders (those able to attend the meeting) be available to all shareholders. 

What information I've been able to gather has come from bloggers and reporters attending the meeting or monitoring it from outside (see this GeekWire coverage, this from the Seattle Times, and this from Xconomy). It seems like a tumultuous meeting at which protesters were eager for attention and willing to disrupt the proceedings. Police were there to escort disruptive and unruly activists out of the meeting. Curt Woodward of Xconomy described the CEO thusly: 
From his place at center stage, founder and CEO Jeff Bezos seemed to watch the antics as if an alien species had landed in the room.
He stood onstage, head cocked to the side, as the made-for-news-media spectacle unfolded. Once the noise died down, Bezos made sure he got the last word: “l’d like to thank all of you for coming, and we’ll see you next year.”
I suppose there were embarrassing moments. I imagine the Q&A is far less interesting when you have rabble rousers seeking attention for their agendas rather than shareholders picking the great brain of Bezos. Be assured, as Amazon becomes more dominant in its respective markets, this attention will only grow. You can't shy away from basic communication just because others are leaching off your megaphone. 

The presentation was intended for the consumption of shareholders. Amazon has made a habit of sharing it in the past. And they should make it available this year, too.

Re: Google vs. Your Boys (but really about amazon)

We had a very pleasant lunch, as we always do. He is an old and good friend. He was amused by my unhealthy fixation with Amazon. And so he sends me this gentle barb a few days later:  Google is coming! [Links to WSJ article.] 

Uh-oh, a threat to Amazon's AWS cloud computing service. I get these challenges with some frequency from people that have learned of my obsession. I love them. Not so much because it offers a chance for debate and I consider myself the superior debater. I'm not. It's more because the challenges keeps me honest. 

It reminds me of the verse from Rudyard Kipling's "If": 

...If you can trust yourself when all men doubt you,
But make allowance for their doubting, too...

It's the only way to keep a kernel of intellectual integrity in his game of investing...look for challenges to your theses. Not to fight back and counterpoint the opposing argument, but for the strength and the wisdom the challenge could bring, giving you the opportunity to improve your models, test your reasoning. It's possible to find something nearing sublime in approaching the debate with philosophical detachment, shunning dogma as best as our bloated egos allow.

Unfortunately, our tendency is to seek out those of like-minded opinions, forming echo chambers for our views and doubling down on the risk of our wrongness being compounded in a confirmation marketplace.

Below is my reply to my good lunch friend:

Thanks for passing this on, T. I'm fascinated by this impending convergence of the major tech giants. They're all sitting on these enormous and valuable assets, mainly large customer bases and some combination of tech gear, tech infrastructure, and customer captivity. As a sort of manifest destiny, they are all compelled to extend and expand the use of their infrastructure...those assets. It's inevitable, as if the combination of management ego and economic drive for higher profits, creates a siren's song for the businesses to expand. I've started calling it the growth imperative, a set of behaviors I've noted in other industries, too.

So it becomes interesting with Amazon, Apple, Facebook, and Google. [See The Great Tech War of 2012 by Farhad Manjoo in Fast Company back in October 2012.] Their markets, as they expand, are overlapping more and more. They must compete, not only to grow, but also to make sure one of the competitors doesn't gain some advantage that allows them to attack their core markets....sort of like offense is the best defense.

A theory I've considering works something like this: cloud computing is a huge market that Amazon entered early and has pretty much controlled. Amazon is taking great pains to commoditize the industry - making the services non-branded - so it will be defined by who can offer computing at the cheapest price to customers. Amazon has demonstrated its willingness to make AWS (its cloud computing) cheaper and cheaper, having lowered prices 20 times since launching. Jeff Bezos has thrown down a gauntlet and dared others - IBM, Microsoft, a slew of tiny players, and now Google - to follow. Amazon has said it will make it all about price.

That creates a fascinating dynamic, and this is where the theory part kicks in. What company can afford to offer cloud computing the cheapest? Both Amazon and Google have deep cash reserves, so they can duke it out on low price there while subsidizing any losses with their own cash. That could be a painful war, and we must ask who would win.

My bet would be with Amazon, and for a simple reason...Amazon has demonstrated both an indifference to how the stock market perceives it as it pursues long-term dominance of an industry, and it has demonstrated a capacity to suffer while its stock price is getting killed because it is losing money in pursuit of dominance. Jeff Bezos frequently says he's comfortable being misunderstood for long periods of time.

So let's consider this like a game theory scenario...you have two giants pressing on the gas, hurling their dragsters at each other in a business that one of them (amazon) is willing to define by price. They will both take losses. The more they fight, the deeper those losses will be, and the more likely their stocks will tank as long as the war persists.

Jeff Bezos is fond of saying something to the effect of ..we want to sell the same thing as everyone else, but because we run more efficiently than they do, we can sell it cheaper. So if they want to have a price war, they'll go broke 5 percent before we do.

He's signaled to the world his intentions and his willingness to be a fanatic in pursuit of them. Now, how crazy is google willing to be as it enters the cloud computing market? How deep is its capacity to suffer? And remember, there's a lot of catching up to do since Amazon has been in the market since 2006.

In this game theory game of chicken, my vote is with crazy Jeff Bezos. That dude's a fanatic!

Friday, July 6, 2012

Amazon Entering Smartphone Game...Why?

Bloomberg reported this morning that Amazon has its own smartphone in development, that the company is working with Foxconn in China for production, and that it has actively been acquiring wireless technology-related patents in advance of the launch. See the story here

Even more so than its decision to challenge Apple's dominance of the tablet market by introducing the Kindle Fire, this move into smartphones is likely to leave a lot of consumers and investors scratching their heads. What business does Amazon - a web retailer - have getting into the phone market? 

Let me take a stab at that...

Convergence of the Tech Giants

Though Jeff Bezos will deny it until he's blue in the face, this is a classic move of defense by playing offense.  

There's a convergence going on in technology.  Apple, Google, Facebook, and Amazon are quickly converging on the same base of customers. To be sure, there is a growth imperative at play, too. Each of these companies has become accustomed to growing at a rapid clip, and each has the ambition (and gall) to believe it should continue growing. And as each runs out of room to expand in its core markets, it will seek new growth by introducing services that poach customers from the other tech giants. The spheres in which they operate, once so placidly independent of each other, are beginning to overlap. If you put a Venn diagram of their markets on time-lapse video, the shaded areas of market overlap would grow darker and darker with each passing year. Convergence is happening.

And in a converging marketplace, if you don't play offense by actively growing into your competitors' markets, you run the risk that they will grow into yours in the near future. Offense becomes the best form of defense. It compels you to grow, thus the growth "imperative."

(To put this in the appropriate context, you should take a look at Farhad Manjoo's The Great Tech War of 2012, published in Fast Company back in October 2012.)

An Aside on Google

Google has been the most interesting case study for both the growth imperative and how a company reacts to convergence. For the time being, Google is spinning like a dervish. It seems to believe it must compete with each of these giants...and NOW. Its rivalry with Facebook has been well-documented with Google+. (See James Whittaker's Why I Left Google blog entry.) That's a competition for the future of advertising dominance, and I think it makes sense.

What makes far less sense to me is Google's foray into retail with its "Prime" one-day delivery deal with bricks-and-mortar shops (see this WSJ blog description and the best overview from amazonstrategies.com here). Google benefits from competition among lots of retailers selling the same products and bidding up adword search prices to get premier listing on the search engine. But with Amazon becoming the ubiquitous web retailer, more consumers are skipping Google altogether and just going straight to Amazon for searches. This is costly for the search engine. And so it goes on the offensive, putting its considerable clout (and resources) behind an attempt at a competitive retail offering.

According to a Walter Isaacson (the Steve Jobs biographer) HBR.org essay back in April, Larry Page visited Jobs in his dying days looking for advice. Jobs asked him..."What are the five products you want to focus on? Get rid of the rest, because they’re dragging you down. They’re turning you into Microsoft. They’re causing you to turn out products that are adequate but not great.”...FOCUS! Isaacson credits Page with taking the advice to heart. I think there's plenty of evidence to the contrary.

Amazon Devices to Prevent Apple iTunes Dominance

But back to Amazon and the smartphones. Amazon dips its toes in the water a lot. It's renown for its constant A/B testing and its devotion to running with winning concepts while ditching the losers. So once it decides on a strategy, Bezos brings the company all-in. 

In that regard, the smartphones can viewed as an extension of the reasons Amazon developed the Kindle Fire. A sizable chunk of its business is electronic media (songs, games, apps, movies, and books), and that media is being consumed more and more on mobile platforms. Apple gained an early lead in the market for those platforms with iPod, iPhone and iPad, creating a close-looped ecosystem of content to boot. Jobs and company might let others sell their content on iTunes, but they extracted a pound of flesh in return. This was problematic for Bezos and Amazon. To prevent total dominance by iOS, he had to present an alternative.

So we received the first iteration of Kindle Fire. But we know that electronic media is consumed on other devices as well, so it's only logical that Amazon continues its all-in philosophy to ensure it gets a piece of that action, too. I would expect more (and better) tablets in the future. I would expect better links into television sets (Amazon branded set-top boxes). I would expect music players. And I'm not surprised by the smartphones.

So What Should We Anticipate from the Amazon Move?

First, lots of hiccups. We saw this with the early Kindles and with the Kindle Fire. It's unavoidable when entering a sophisticated new market with complicated electronic technology. Amazon was not a device manufacturer a few years ago, but it is nothing if not a learning organization. Expect it to build on its experience, constantly improve, and ruthlessly eliminate defects. So, hiccups at first, but Amazon will only get better. 

Second, a low price. Amazon is committed to the low-margin/high-volume business model. It has the capacity to suffer, a willingness to take losses on the early batches of inventory while it grabs market share and improves its cost structure. 

Third, potential volatility in its stock price. Going all-in on phones - while juggling lots of other growth initiatives simultaneously - has the potential to move Amazon from profits to losses. And Bezos is not afraid of letting his company lose money for a while if he believes it will pay off in the long-term. The market, however, will not take kindly to this. It's reasonable to anticipate bad financial press and a hit to its stock price if the company sports losses over multiple quarterly earnings reports.  

Return of the Land Rush Metaphor

In 2001 Bezos told Charlie Rose (here) that Amazon understood the early days of web retailing (especially 1998 through 2000) through the heuristic of a land rush metaphor. That era was also dominated by a growth imperative. If Amazon didn't move at an almost reckless pace to establish scaled operations, expand its product selection, and improve its technology, it risked another retailer - fueled by a steady stream of venture capital cash - converging on its markets and earning the trust (and the habits) of customers. 

Bezos recognized the risk of being outflanked, so he engaged in the land rush. He bought into every niche retailer that sold a product that he thought Amazon might want to sell someday, better to bring your enemies close than let them flourish outside your control. He invested heavily in technology and distribution infrastructure. He priced his selection as aggressively as he could to attract customers. He bled cash, almost recklessly, because it kept Amazon in front of the pack and reduced the risk that another retailer could gain a toehold in its market. 

That land rush mentality came from Bezos' survey of the landscape at the time telling him that a convergence was afoot then, too. We see what he did to ensure he came out of the convergence as the dominant power.  Indeed, he came out of the dot-com bubble burst as the sole hegemonic power of web retailing. Despite the Amazon stock price falling from $106 to $6, despite losing countless hundreds of millions in equity investments in competing web retailers, and despite losing upwards of $500 million in personal fortune as the stock plummeted...the bursting of that bubble took all the outside cash out of the web retail industry. Everyone had to fend for themselves, and Amazon was the only one that could. Bezos did alright through it all.

If he's reading the current technology situation with a mind to his experience in the early days of web retailing, I think we can expect him to turn to a page from his old playbook. He will compete ferociously, bordering on recklessness. He will lean heavily into his investments. He will play to dominate the markets. 

This post was originally published here on Adjacent Progression.