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Cheap Capital → 100x Risks
Shrewdly and publicly, Mr. Bezos bifurcates Amazon’s risk taking into two
types: 1) Those you can’t walk back from (“This is the future of the
company”), and 2) Those you can (“This isn’t working, we’re out of here”).
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Bezos’s view is that it’s key to Amazon’s investment strategy to take on
many Type 2 experiments—including a flying warehouse or systems that
protect drones from bow and arrow. They’ve filed patents for both. Type 2
investments are cheap, because they likely will be killed before they waste
too much money, and they pay big dividends in image building as a leading-
edge company. Shareholders love these stories; it makes them feel like
they’re part of an exciting adventure. Plus, every once in a while, they
actually pan out—and when they do, Amazon has the fuel (capital) to pour on
the spark and start a firestorm that sears the competition. The overlooked
lesson here, other than having a shit-ton of capital, is the willingness to
perform infanticide on initiatives or products that aren’t working, thus freeing
up capital (in Amazon’s case, human capital) to start new crazy initiatives.
My experience in traditional firms is that anything new is seen as
innovative, and the people assigned to it, like any parent, become irrationally
passionate about the project and refuse to acknowledge just how stupid and
ugly your little project has become. As a result, traditional companies not
only have less capital to invest but fewer swings at the plate. Amazon
demonstrates real discipline around not ramping investment until they know
something is working. For all the hype over the last three years about
Amazon’s entry into brick-and-mortar retail, the sum of their efforts is around
two dozen stores. They haven’t found a format they feel they can scale.
Bezos, like any great leader, has the ability to explain a crazy idea in a way
that makes it seem less crazy but practical. Wait, that’s obvious—how did we
not think of that? The really crazy shit isn’t stupid, it’s “bold.” Yeah, a
floating warehouse sounds crazy the first time you hear of it. Now, ponder
the cost of leasing and running a traditional terrestrial warehouse. What are
its biggest expenses? Proximity and rent, respectively. Now, think again
about a floating warehouse. Not so crazy, right?
Bezos’s perpetual message is that it’s Amazon’s nature to swing for the
fences on a regular basis. But the analogy is wrong: in baseball, a grand slam
only scores four runs. By comparison, the home runs of Amazon Prime and
AWS produced several thousand runs when the Seattle firm connected with
the ball. As Bezos wrote in Amazon’s first annual letter, in 1997, “Given a 10
percent chance of a hundred times payout, you should take that bet every
time.”
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Needless to say, most CEOs don’t think this way. Most won’t even take
risks that have less than a 50 percent chance of success—no matter how big
the potential payoff. This is a big reason why old-economy firms are leaking
value to new-economy firms. Today’s successful companies may have the
assets, cash flow, and brand equity, but they approach risk differently than
many tech firms that have seen their death. They live for today and
acknowledge that great success only comes with significant, even existential,
risk.
There is a survivor bias that plagues old-economy CEOs and their
shareholders. My nightmare job is the “invisible until you fuck up” position.
These jobs are everywhere: IT, corporate treasurer, auditor, air traffic
controller, nuclear power plant operator, county elevator inspector, TSA
officer. You’ll never be famous, but you have a small, and terrifying, chance
of being infamous. CEOs of successful old-economy firms have a similar
bias—they are “rich until they fuck up.”
CEO pay has become so crazy that on a risk-adjusted basis, you’re better
off staying out of traffic, logging your six to eight years, and retiring rich.
However, if you google “biggest mistakes in business history,” the majority
of results are risks that firms failed to take, such as Excite and Blockbuster
passing on acquiring Google and Netflix, respectively.
History favors the bold. Compensation favors the meek. As a Fortune 500
company CEO, you’re better off taking the path often traveled and staying
the course. Big companies may have more assets to innovate with, but they
rarely take big risks or innovate at the cost of cannibalizing a current
business. Neither would they chance alienating suppliers or investors. They
play not to lose, and shareholders reward them for it—until those
shareholders walk and buy Amazon stock.
Most boards ask management: “How can we build the greatest advantage
for the least amount of capital/investment?” Amazon reverses the question:
“What can we do that gives us an advantage that’s hugely expensive, and that
no one else can afford?”
Why? Because Amazon has access to capital with lower return
expectations than peers. Reducing shipping times from two days to one day?
That will require billions. Amazon will have to build smart warehouses near
cities, where real estate and labor are expensive. By any conventional
measure, it would be a huge investment for a marginal return.
But for Amazon, it’s all kinds of perfect. Why? Because Macy’s, Sears,
and Walmart can’t afford to spend billions getting the delivery times of their
relatively small online businesses down from two days to one. Consumers
love it, and competitors stand flaccid on the sidelines.
In 2015, Amazon spent $7 billion on shipping fees, a net shipping loss of
$5 billion, and overall profits of $2.4 billion.
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Crazy, no? No. Amazon is
going underwater with the world’s largest oxygen tank, forcing other retailers
to follow it, match its prices, and deal with changed customer delivery
expectations. The difference is other retailers have just the air in their lungs
and are drowning. Amazon will surface and have the ocean of retail largely to
itself.
Making Type 2 investments also desensitizes Amazon’s shareholders to
failure. All of the Four share this—look at Apple and Google with their not-
so-secret autonomous vehicle projects, and Facebook with its regular
introduction of new features to further monetize its users, which it then pulls
back when the experiments don’t pan out. Remember Lighthouse? As Bezos
also wrote in that first annual letter: “Failure and invention are inseparable
twins. To invent you have to experiment, and if you know in advance that it’s
going to work, it’s not an experiment.”
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