What has driven the growth of Amazon?
In his annual letters to Amazon shareholders, Jeff Bezos outlines the principles behind the running of Amazon.
Based on those letters, here are four key factors that have driven Amazon’s growth:
1) Consumer focus
Amazon focussed on satisfying consumers. It introduced several innovations.
Most notable is the “one-click checkout“. But there was also the “look inside” feature for books, personalised recommendations and use of reviews.
In economics, we initially view profit maximisation as being separate from helping consumers.
But Bezos saw business success and consumer satisfaction as complementary.
Consumer satisfaction leads to brand loyalty. Therefore, consumers are more likely to return to make more purchases.
Word of mouth lowers “customer acquisition costs“. Simply, a given spend on advertising creates a greater increase in customers. This raises profits.
Amazon also sought to pass on cost reductions to consumers, in the form of lower prices.
To guarantee the best consumer experience, some firms may raise prices. So they can fund a better consumer experience.
But Amazon can making use of economies of scale (see below). Amazon could then both pass on cost reduction and software innovations to consumers. At the same time, Amazon could grow shareholder value.
2) Long term rather than short term profits
Amazon did not maximise short-term profits. Nor did it aim to increase the share price today.
In economics terms, we could say Amazon was trying to maximise sales or market share. The goal: long-term profit maximisation.
The decision to pass on cost reductions to consumers also has a long-term component.
Indeed the price elasticity of demand was inelastic for most products in the short term. But this may not be the case over five or ten years. So, cutting prices may make sense as a long-term move.
3) Economies of scale (“natural monopoly”)
The Amazon business model had high fixed costs and low marginal costs.
The high fixed costs included its product distribution centres and software.
This was a major change in comparison to other retail stores. Amazon did not have to invest in storefronts. This made it cheaper to operate than traditional retail.
Economies of scale meant that Amazon could spread its costs over a larger and larger output base. As the firm grows, its (long-run) cost per unit falls.
4) Making bets
Amazon made many successful bets.
Not only did Amazon bet on technological change and its distribution network. Amazon has expanded from books into toys and other goods.
There were also many new product offerings, like the Kindle, Amazon Web Services, as well as Amazon Prime.
There were also many failed bets.
This included $170 million lost on its Fire Smartphone.
Also Amazon invested $175 million into a failed deal site LivingSocial and $500 million in Drugstore.com.
But a focus on cash flow meant the company could survive any failed bets. Indeed Bezos argues that failure is part of innovating and that Amazon was the “best place to fail”.
As a result, Amazon now has a wide range of products and services.
Criticisms of Amazon
There are criticisms too of how Amazon runs its operations.
For instance:
- Market power. Amazon is a dominant buyer (and seller) of books. They can use this market power to push down prices. Cheaper prices can be good for consumers. But can reduce revenues for booksellers and authors. Monopsony power can also apply to workers.
- Concerns about working conditions in some centres, which have led to trade union activity. Moreover, there are reports of Amazon acting in opposition to trade unions. In particular, trying to prevent their formation.
- Competition authorities in the EU, UK and US have investigated online marketplaces like Amazon. Specifically whether their search rankings prefer their own products. Amazon has tried to address these concerns.
- Does Amazon pay enough tax? Direct taxation occurs on company profits but not sales. For instance in 2021, Amazon paid £492 million in direct taxes (2.4% of total UK sales) in the UK. While this may be perfectly legal, there is a broader question of how governments should tax global tech companies.
This is a sample of the criticisms levelled at Amazon. [This may merit a separate article in the future]
How to interpret Amazon’s financial success
How should we interpret Amazon’s success?
On one hand, Amazon has become a model for many other tech companies.
Other companies opt for rapid scaling (“blitzscaling“). This often involves making short-run losses or low profits. More recent examples are Spotify and Airbnb.
Amazon’s methods may not work in all businesses, however. Not all businesses will have such large economies of scale. Nor the ability to make large-scale bets.
Consider also the “survivorship bias“. Other companies may have tried Amazon’s approaches and failed. But such companies do not exist anymore.
In other words, we should not judge whether the attributes of Amazon made it successful, on the success of Amazon.
Instead we should also consider the companies that may have also had these attributes. Yet may have failed and no longer exist.
In a sense, timing and good fortune may also have played a role in Amazon’s success.
What can other companies learn from Amazon’s financial success?
Nevertheless, there is a lot that can be learnt from Amazon’s success. The focus on customers and on the long term are broadly applicable.
Moreover small-scale experiments (or what Bezos refers to as ” bets”) are now commonplace in tech companies.
The largest tech companies, including Google and Meta, are making larger bets. This often takes the form of company acquisitions.
Finally firms can realise economies of scale. In particular from software use and brand loyalty, while increasing sales volume.
The bottom line
In his annual letters to shareholders, Jeff Bezos puts Amazon’s success down to four key factors:
- Focus on customers.
- Long-term thinking.
- Economies of scale.
- Making bets.
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