The Wisdom of Jeff Bezos, Part 3

Two words: low margins. That’s the secret to Amazon’s success. Seems crazy when you put it that way. But Jeff Bezos views it as a competitive advantage. Amazon has spent a decade and a half making low margins profitable. And, as Bezos sees it, when you aren’t addicted to high margins, there is a certain discipline inherent in how you operate. He doesn’t quite come out and say that high margins are for the lazy. But you can tell it is a point of pride. Anyone can survive on high margins. It takes a real man to thrive on low margins. Jeff Bezos is that man.

Bezos is quite clear about the high margin/low margin dichotomy. In his Wired interview he says “There are two ways to build a successful company. One is to work very, very hard to convince customers to pay high margins. The other is to work very, very hard to be able to afford to offer customers low margins.” He has chosen low margins. Why? Because he believes that offering the lowest possible price will allow you to attract the largest possible customer base. Putting on my consultant hat (OK, I never actually wore a consultant hat — but I have met enough of them that I can channel consultant), here’s the two by two matrix of margins:

      Low Margins               High Margins

      High Volume               High Volume

      Low Margins               High Margins

      Low Volume                Low Volume

Jeff has chosen to sit in the upper left corner of the matrix — low margin, high volume. He has proven that there is a big business to be built there. It is certainly better than low margins, low volume; that’s a recipe for extinction. He suggests that the tech world is focused on high margin, low volume businesses in which companies fight it out to win over customers and sell high margin software or hardware to a relatively smaller numbers of customers. His ability to show profitability with low margins allows him the opportunity to deliver rock bottom pricing and amass the greatest possible consumer base. [1] That capacity to execute on low margins has allowed Bezos the ability to broadly extend his product mix, attracting an ever larger customer base.

So what does it take to deliver low margins? Incredible efficiency. Bezos has been obsessed with efficiency from day one. And that efficiency extends throughout his entire enterprise. Bezos has built the state of the art distribution system that allows Amazon to deliver practically anything to practically anywhere (at least anywhere in the United States) in the shortest possible time for the smallest amount of money. That efficiency has made it possible for Amazon to offer Amazon Prime, providing free two day delivery while still making money (ok, Prime isn’t completely free, but it’s darn close when amortized over a customer’s ever-increasing order volume). Amazon also maniacally focuses on driving down the cost of customer support. According to Jeff, “[e]very time a customer contacts us, we see it as a defect.” That doesn’t mean Amazon ignores the needs of customers. They simply work hard to satisfy customers with the smallest amount of human intervention possible. The system appears to be working — Amazon has one of the highest net promoter scores on the planet.

Bezos’ obsession with efficiency is perhaps best seen in Amazon Web Services (AWS). AWS is an extension of Amazon’s own technical infrastructure (its development has dramatically driven down the cost of maintaining Amazon’s own web presence). Bezos has always been determined to deliver AWS the same way that he has delivered books — high volume, low margin. Moreover, Bezos was not willing to use “inferior products” to deliver the lowest possible price point. That dramatic pricing with quality components has made AWS the backbone of a stunningly large percentage of the Web today (from FourSquare to the New York Times). Jeff asserts that, “the most expensive thing you can do is make a mistake” and as a result, “[Amazon] can afford to focus on smaller and smaller defects and eliminate them at their root. That reduces cost, because things just work.” It does seem to be working. AWS has become a big business, while simultaneously increasing the efficiency of Amazon’s own infrastructure — that’s a win, win.

Low margins may not be for everyone. It is a tough business, and an unforgiving one at that. But Jeff Bezos deserves huge credit for knowing his business model from day one and executing perfectly on his strategy. By driving down costs and driving up quality through an obsession over efficiency, Amazon is able to deliver the best possible service at the lowest possible price. That makes it awfully hard for others to compete. And that is just how Jeff likes it.

[1] Of course if I am going to properly channel my inner consultant, I have to be honest and point out that the upper left quadrant is always the desired outcome. This matrix is no exception. The ability to deliver high margin and high volume is manna from heaven. There’s a reason Apple is the most valuable company in the world and has $97 Billion dollars in the bank. They’ve cracked the code on high volume, high margin. As have Google ($44 Billion in the bank) and Microsoft ($50 Billion in the bank). But when it comes to high volume, low margin, Amazon is as good as it gets.

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