Amazon.com - Research Report - Part 1

Amazon.com Company Deep Dive: A culture of customer obsession

“To be Earth's most customer-centric company, where customers can find and discover anything they might want to buy online.”

This research report is divided into three sections. This is Part 2 of 3. In this segment, we will explore:

Introduction of the company

• Amazon’s culture

• Amazon’s culture in practice

The business model

• Online stores

• Amazon Web Services (AWS)

• Amazon Advertising Services (ADS)

• Subscription Services

• Physical Stores

• Other

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Typically, a brief introduction and a breakdown of the business model come first in our research reports. For many companies, the business model is the foundation of the business. It is obvious that a wide moat protects Amazon's business model. Hence, this analysis pays extra attention to the foundation of this moat: Amazon's culture. From this culture, many Amazon products and services have emerged. The art is to understand what makes Amazon successful, how successful this approach will be in the future, and to play the right game as an Amazon investor.

1) Introduction & Culture

Let’s start with the company's culture and how it has contributed to its success.

Amazon's culture is the basis of its success. When founded in 1994, Amazon seemed to be the umpteenth company selling products online that were previously sold offline. Yet, Amazon managed to survive the dark days of the Dot-Com Bubble and, as of 2024, is the third-largest company in the world based on revenue. The book "Working Backwards" by Colin Bryar and Bill Carr offers a unique insight into the culture underlying this tremendous success.

The simplest and best description of why Amazon is so successful comes from Jeff Bezos himself: "We have an unshakable conviction that the long-term interests of shareholders are perfectly aligned with the interests of customers". In other words, the customer is king, and financial results will naturally follow.

1.1 Amazon’s culture: the bedrock of success

Amazon's culture is pivotal to its triumph. Founded in 1994, Amazon has evolved from an online retailer into the world's third-largest company by 2024, as detailed in Working Backwards by Colin Bryar and Bill Carr. Jeff Bezos credits Amazon's success to a steadfast belief in aligning shareholder interests with customer satisfaction. At the 2018 Air, Space, and Cyber Conference, Bezos outlined four critical elements of Amazon's culture, underscoring the importance of prioritizing customer needs:

1. Customer Obsession: Prioritizing customer needs over competition obsession.

2. Long-Term Thinking: Possessing a longer investment horizon than most industry peers.

3. Inventiveness: Accompanied inevitably by failure.

4. Operational Excellence: Taking professional pride in this area.

Bezos highlighted these cultural elements in his first letter to shareholders in 1997. These elements form the basis for how Amazon shareholders should view the company. Expecting Amazon to focus solely on beating competitors, to invest with a 5-year horizon for results, or to never make mistakes will lead to disappointment. Investment should be based on confidence in the management. Amazon is not like Coca-Cola, which could be led by an 'idiot.'

1.2 Amazon's Culture in Practice

Within Amazon, 16 Leadership Principles lay the foundation for the company's management behavior. These principles include:

1. Customer Obsession

2. Ownership

3. Invent and Simplify

4. Leaders Are Right, A Lot

5. Learn and Be Curious

6. Hire and Develop the Best

7. Insist on the Highest Standards

8. Think Big

9. Bias for Action

10. Frugality

11. Earn Trust

12. Dive Deep

13. Have Backbone; Disagree and Commit

14. Deliver Results

15. Strive to be Earth’s Best Employer

16. Success and Scale Bring Broad Responsibility

Working Backwards highlights these principles as the building blocks of Amazon's culture. Additionally, Amazon distinguishes itself with five essential processes, particularly in the late '90s and early '00s. In 1999, Amazon introduced the Bar Raiser Program to ensure the hiring of suitable candidates over-hasty decisions. A Bar Raiser is an interviewer in the hiring process, acting as an objective third party to make the best long-term decisions. This systematic approach was crucial as Amazon's workforce multiplied tenfold between 1997 and 2000.

During periods of rapid growth, it became evident that this expansion slowed innovation. Coordination took precedence over working on innovations. Amazon's solution was Single-Threaded Leadership, an organizational design that minimizes team dependencies, with each team led by a single leader focused solely on a specific initiative. This structure enables Amazon to pursue a large number of initiatives concurrently.

Amazon's unique approach extends to its internal communication. The top management (the S-Team) has two recurring meetings weekly: an S-Team meeting and a Weekly Business Review. The time spent in these meetings is highly valuable, emphasizing the alignment of customer and shareholder interests. In 2004, Jeff Bezos banned the use of PowerPoints in S-Team meetings, adopting the Six-Pager method instead. This method involves written documents that lay out ideas in narrative form, distributed at the start of meetings for focused reading and note-taking. The Six-Pager Method enhances clarity, critical thinking, efficiency, presenter preparation, participant engagement, and interdepartmental communication. It's a technique applicable in almost all companies, inspired by Jeff Bezos' innovative approach.

The Six-Pager Method offers significant advantages:

1. Ideas are explained more clearly and understood better.

2. Critical thinking is enhanced during meetings.

3. Meetings become more efficient.

4. Presenters think more thoroughly in advance.

5. Participants are more engaged.

6. Better communication across different fields.

This method is applicable in nearly all companies and is worth considering.

In addition to the S-Team meeting, Amazon also makes optimal use of the Weekly Business Review (WBR). During the WBR, key performance indicators (KPIs) are scrutinized. Selecting the right KPIs is crucial for Amazon. The company focuses on "controllable input metrics," which are KPIs over which Amazon has the most control. These metrics ultimately determine output metrics, such as stock price. Employees from other tech companies often remark to Amazon employees, "You can do that because you don't care about profit." According to Working Backwards authors Colin Bryar and Bill Carr, this is not the case. Profit is just as important to Amazon as it is to any other company, along with revenue, total customer count, Prime memberships, and (over the long term) stock price. However, Amazon differentiates itself by focusing on internal KPIs to drive growth.

Growth is essential for Amazon. It propels the Amazon flywheel, also known in the investment world as Scale Economies Shared. Once this flywheel is set in motion, it's nearly unstoppable. I might even call this the secret to Amazon's success. Here's how it works:

At this point, further details on the Amazon flywheel effect and its implications for growth and market dominance could be discussed, highlighting the interplay between customer satisfaction, inventory management, and technological innovation that drives Amazon's continuous expansion and profitability.

Figure 1 | Amazon’s Network Effect

Because it forms a circle, it doesn't matter where you start. For instance, an improved customer experience leads to increased traffic, which in turn attracts more sellers. More sellers contribute to a wider selection of offerings, and this enhanced selection improves the customer experience further. This cycle fosters growth, enabling a lower cost structure that allows Amazon to reduce prices, thereby enhancing the customer experience once again. Additionally, investments in infrastructure ensure quick and reliable delivery, making Amazon seem unstoppable. When you identify this flywheel in a company, pay close attention—it might be very promising. Just ask Nick Sleep, who achieved a 921% return with his Nomad Portfolio between 2001 and 2014 by investing in companies like Amazon, Costco, and Berkshire.

Finally, the way of thinking and communicating within Amazon's autonomous product teams is emblematic of the company. These teams employ the Working Backwards process, starting with identifying what the customer wants, then innovating by writing a Press Release including FAQs before implementation. This process aims to keep customer desires and needs at the forefront. The advantage of this approach is that it keeps teams focused on the customer experience, working towards a shared goal, and allows Amazon to make early adjustments or discontinue projects as needed.

Figure 2 | Working Backwards Process | Source: Working Backwards (book)

Of course, these processes do not make Amazon immune to mistakes. As Jeff Bezos mentioned in the third cultural element, "The urge to invent, which naturally comes with failure." Despite the thoughtful processes, failures like the Fire Phone, Amazon Unbox, and Amazon Local have occurred. However, these failures have paved the way for significant successes such as Amazon Prime, Kindle, and AWS.

2) The business model

In its annual report, Amazon reports on three segments: North America, International, and AWS. This is speculative, but it somewhat obscures the fact that they are active in many different markets. It seems like Amazon wants to stay out of the spotlight of regulators. As an investor, you want to look at and understand the different product groups of Amazon. Each product group has its own characteristics and a unique moat that determines the success of the product group and, thereby, Amazon's success. Of course, there is a strong correlation between the product groups. For example, more Amazon.com visitors lead to more sales, advertising revenue, and Amazon Prime members. To better understand Amazon, I prefer to look at the product groups. When the product groups make customers happy, geographical expansion is just a matter of time. It is notable that almost every product group with which Amazon earns money rides on a multi-year megatrend.

Table 1 shows the revenue of the different product groups. Amazon does not report on the profitability of the individual product groups. Amazon only reports on the profitability of the three segments: North America, International, and AWS.

Table 1 | Amazon Product Groups in Billions $

Amazon Revenue Distribution 2023. The image below shows how Amazon's revenue is distributed across the different product groups in 2023.

Figure 3 | Amazon Revenue Distribution 2023 | Source: Finchat.io

2.1 Online stores

Megatrend: Transition from physical stores to e-commerce Part of the world making online purchases:

• 2024: 53.9%

• 2028: 63.2%

Online stores account for 40.3% of revenue in 2023. This revenue mainly comes from the various products, both physical and digital, sold by Amazon in its webshops worldwide. Amazon does not report the profitability of just the online stores. Amazon only reports the profitability of the segments North America, International, and AWS. The profits and losses of the below product groups are all clustered by Amazon into these three segments.

Figure 4 | Retail e-commerce sales worldwide, 2014 - 2027 | Source: Statista

Third-party seller services account for 24.4% of the revenue in 2023. The online store segment includes all sales of products sold by Amazon itself. The third-party seller services segment includes all revenue earned from resellers selling on Amazon. Third-party sellers are responsible for selling 61% of the products on Amazon. Amazon receives commissions on these sales. Additionally, Amazon earns from related fulfillment and shipping fees and other services they offer to third-party sellers. In 2015, the revenue from third-party seller services was only $15.95 billion, less than ten years later, the revenue was $140 billion. In comparison, AWS made $7.9 billion in 2015 and is now $90 billion. The shift towards third-party seller services and advertisements is making Amazon's e-commerce segment increasingly profitable.

According to a Marketplace Pulse report, Amazon nowadays pockets 50% of third-party sellers' revenue. Five years ago, this was 40%. This is due to increased fulfillment costs and the inevitability of Amazon sellers to spend money on advertisements, hence the rapid growth of Amazon Advertisement Services. The transaction fees of 15% that Amazon charges have been the same for over ten years. The transaction fees vary by category. Additionally, Amazon sellers are spending more on the services they use. Sellers have not started using more services, but current services are becoming more expensive. Amazon sellers cannot easily switch to another platform. After all, Amazon has the most visitors. New sellers, for example, pay much lower transaction fees on Walmart.com. But Walmart is also smaller, so it yields fewer sales for sellers. Another option is to choose a direct-to-consumer platform like Shopify or Bigcommerce. Here, sellers face the same problem; a lack of visitors. Hence, there is a two-sided network effect. More customers make the platform more attractive for sellers, and more sellers make the platform more attractive for customers.

Figure 5 | Amazon Seller Fees | Source: MarketPlacePulse

2.2 Amazon Web Services (AWS)

Megatrend: Transition from physical IT infrastructure to the cloud.

The hidden gem within Amazon is no longer hidden. Everyone knows AWS exists and generates $90 billion in revenue, but does everyone also understand the potential and power of AWS?

Amazon Web Services (AWS) was founded in 2006. AWS is a cloud platform that provides every organization access to a fast, flexible IT environment at relatively low costs. This includes servers, storage, networking, databases, remote computing, email, mobile development, and security. In other words, AWS, Microsoft Azure, and Google Cloud provide the entire digital infrastructure for companies. The cloud players not only make it possible, but they also earn money from it. Estimates vary, but most studies show that the cloud market is currently about $600–$700 billion. The diverse expectations are that the cloud market will be $1400 to $1600 billion by 2030. If the expectations come true, the cloud has a double in store for the next six years. The cloud market is currently divided between AWS, Microsoft Azure, and Google Cloud. AWS has a market share of 31%, Azure has a market share of 24%, and Google Cloud follows with 11%. The rest of the market is divided between Salesforce, Alibaba, Oracle, IBM, and other small players.

Figure 6 | AWS Market Share | Source: Synergy Research Group

Myth about AWS. Before we delve deeper into AWS, let's first dispel a myth about the origins of AWS. AWS did not arise because Amazon had excess IT capacity available and sold it to other companies. Amazon requires extremely high IT capacity prior to the holiday season. Although it is logically reasoned that Amazon sold or rented this capacity for the rest of the year, this is impossible.

AWS Products. Many people know AWS, but few people know what AWS offers. To better understand this, some popular AWS services are highlighted below.

1. Amazon EC2

   Amazon Elastic Compute Cloud (Amazon EC2) offers on-demand, scalable computing power in the AWS Cloud. By using Amazon EC2, hardware costs are lower, allowing companies to develop and deploy applications faster. Companies can use Amazon EC2 to start as many or as few virtual servers as they need, configure security and networking, and manage storage.

2. Amazon Lambda

   Lambda is a serverless computing service that allows code to be executed without managing hardware. For example, it can be used for long-running tasks such as processing video streams.

3. Amazon S3 Cloud Object Storage

   This service is the easiest to understand. This is the service in which files such as PDFs, videos, and images are stored.

4. Amazon RDS

   Amazon RDS is one of AWS's database services. Amazon RDS is a relational database service. With this service, Amazon directly competes with Oracle. Example: Samsung moves 1.1 billion users across three continents from Oracle to AWS. This migration takes 18 months and reduces monthly database costs by 44%. One of the reasons this migration takes so long is that internet speed does not grow as fast as the amount of data produced. To transfer massive amounts of data, AWS sends companies a so-called snowball. The snowball can move 100 terabytes of data. This seems like a lot, but it's manageable. So nowadays, AWS sends a snowmobile. This is not a snow scooter, but a truck full of snowballs that transfer all data to AWS. Even with this truck, it can take up to six months (!) before all data is transferred. Those are some serious switching costs! Moreover, Amazon has always used Oracle databases themselves. Amazon has only been off Oracle databases since 2019 and now uses AWS, of course. This is also the reason Oracle still exists and is highly profitable. Despite AWS's scale, AWS still has a long way to go. The total market for database storage is about $100 billion and is growing at 10% per year. With increasing digitization, growth seems unlikely to decrease in the coming years.

Figure 7 | AWS Snowball | Source: AWS

6 Reasons to Switch to AWS. In 2012, when AWS had to convince large companies with traditional IT infrastructure to choose AWS, Andy Jassy gave 6 reasons to switch to AWS:

1. Capital expenditures are swapped for operational expenses.

2. Lower operational expenses than when companies set it up themselves due to scale advantages.

3. Companies do not need to estimate in advance how much IT capacity they need. AWS is elastic. When companies need more, they upgrade. When companies need less, they downgrade.

4. Companies have the option to downscale.

5. Software engineers have more time to code instead of being busy with infrastructure.

6. Companies can move more easily because they no longer have physical servers.

Cloud Revolution. Before Amazon introduced AWS, companies had to take huge service packages from companies like IBM and Oracle to store their data. These service packages are mega profitable and have gross profit margins of around 80%. Logical that IBM and Oracle are not willing to give up their business and missed the boat regarding the move to the cloud. Meanwhile, Amazon was willing to run gross profit margins between 20 and 40% on AWS. For Amazon, this is a tenfold increase in the margins Amazon makes with e-commerce. Amazon sees these 'low' margins as pure profit, while it is unattractive for IBM and Oracle. Add to this that IBM and Oracle customers have to perform costly updates every so often, while AWS is always up-to-date. In other words, AWS has completely revolutionized this business by introducing a pay-as-you-go model. Thus, it can easily be scaled up and down. This is a major advantage for customers, resulting in a shift from physical data storage to the cloud. However, this flexibility means that the cloud business is somewhat cyclical. This became clear in 2022 when profitability declined.

Estimates vary, but about 50% of all storage is only in the cloud now. Cloud computing and AWS thus seem to have a long runway with growth opportunities. Something many people don't seem to realize: AWS's revenue is guaranteed to double. AWS reports a backlog of $100 billion in contractual revenue that AWS receives over the coming quarters and years. AWS can thus stop all marketing and sales activities and still bring in $100 billion in revenue.

Amazon Web Services (AWS) accounts for 15.8% of the revenue in 2023. Unlike the Online Stores, AWS is profitable. In 2023, AWS's operating profit was $24.6 billion. The table below shows the revenue, profit, and profit margin of AWS.

Table 3 - AWS revenue and operating profit in billions of $

2.3 Amazon Advertising Services

Megatrend: Transition from traditional media advertising to digital media.

Total digital advertising expenditures:

• 2023: $601 billion

• 2027: $870 billion

Table 4 | Revenue of digital advertising giants in FY2023

Once again, Amazon benefits from a megatrend that is happening around the world. In 2023, 86% of the dollars spent on digital advertising went into the hands of the three big tech giants: Alphabet, Amazon, and Meta. Amazon has recognized that digital advertising is a massive end market and has wedged itself between Alphabet and Meta. A clever strategic move by management.

The advertising product group has become rapidly large within Amazon. In 2019, there was not even a report on the product group, and now it accounts for 8.2% of Amazon's revenue. Meta and Google have shown how lucrative advertising can be. Meta's gross profit margin is 80%, and Alphabet's gross profit margin on search advertising is also around 80%. Although Amazon does not report this, it is plausible that Amazon Advertising Services is also around 80%.

The rapid growth is mainly possible because Amazon shows more and more advertisements on the platform. Sellers have thus become increasingly dependent on advertisements to be successful on Amazon. The more dependent the sellers are on advertisements, the more money is spent on advertisements. In addition, Amazon has started showing advertisements to Amazon Prime Video customers. Amazon mainly uses sponsored products in the search results, a brand campaign (promoting your brand in combination with recommended products), display advertisements, and video advertisements.

Although very profitable, it is somewhat peculiar that a company built on putting the customer at the center shows advertisements on its platform. On the other hand, companies, given the growth of the product group, are happy with the opportunity to advertise on Amazon. Amazon is, in that regard, the perfect place to advertise, with the target audience already poised to buy something on Amazon. Amazon must be careful that the advertisements do not detract too much from the customer experience.

2.4 Subscription services

Subscription services account for 7% of Amazon's revenue. The product group consists mainly of Amazon Prime, Kindle subscriptions, and Audible subscriptions. Amazon Prime has proven to be a masterstroke by Jeff Bezos. With Amazon Prime, customers have access to faster and free delivery of packages and a video and gaming service. Customers are extremely satisfied with Amazon Prime. 95 to 99% of Prime customers renew their subscriptions. This retention rate is extremely high for a business-to-consumer subscription. For example, Netflix has a retention rate of 72% per 6 months.

The advantage of this revenue is that customers pay first, and the costs come later. Another advantage is that customers experience the feeling of sunk costs. Customers have already spent money on Prime and now want to use it. This is evident: the average Prime member spends $1,400 per year on Amazon.

Amazon spent $18.9 billion on video and music in 2023. These costs are all incurred to improve the Prime offering. Of course, the costs of infrastructure are also partly to improve the Prime offering.

Amazon Prime has a similar type of network effect as Netflix. All costs regarding Amazon Prime services can be distributed among Prime members. The more Prime members, the higher the budget for new services, and the better the offer. An improved offer again leads to more Prime members, and so the circle repeats.

Amazon does not report a specific number of Prime customers. According to various sources, there are more than 200 million. At least 75% of these are from the US. So, there is still room for growth outside the US. Two-thirds of internet users in the US have a Prime membership. If the number of Amazon Prime members were a country, it would be the eighth largest country in the world. Amazon Prime is a service that distinguishes Amazon from competitors and is difficult to copy. Competitors can't compete on low shipping costs and make a profit.

2.5 Physical stores

Physical stores account for 3.5% of the revenue in 2023. The product group consists mainly of Whole Foods (517 stores), AmazonGo (28 stores), and AmazonFresh (44 stores). Whole Foods was acquired in 2017. Hence, revenue increased by 197% in 2018. Many earlier experiments have failed. Such as AmazonStyle, AmazonBooks, and the Amazon 4-star store, where only products that received four stars in the webshop were sold. Amazon is still searching. In February 2023, Amazon announced it was pausing the rollout of the AmazonFresh store. Although Andy Jassy told the Financial Times he was hopeful, Amazon has not yet opened any new stores.

Before Amazon acquired Whole Foods, Whole Foods had an operating profit margin of about 6%. Assuming this has not changed and AmazonGo and AmazonFresh are breaking even, this means that approximately $1.2 billion profit is made within this product group.

2.6 Other income

Well, what to do with it… Many projects in this product group are loss-making, fail, and are difficult to model. Therefore, it is easy for many investors to dismiss this product group as irrelevant. This is far from it. "Invention is often messy," as Andy Jassy says in his annual letter in 2022. The product group 'other income' is the product group where the next big product group of Amazon should come from. Five years ago, advertising was still in the 'other income' product group; in 2023, advertising delivered Amazon $46 billion in very profitable revenue. So, as an Amazon investor, you want to keep a close eye on what's happening in this product group.

It is noticeable that the 'other income' product group, even after a 95% revenue growth in 2022, managed to grow by another 16.7% in 2023. It is difficult to make predictions here, but it is a sign that Amazon is taking steps to set up a new product group.