May 2019 - The Everything Store: Jeff Bezos and the Age of Amazon by Brad Stone

This book is a great deep dive on the history of Amazon and how it became the global powerhouse that it is today.

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The Birth of AWS. We’ve looked at the software transition from on premise, license maintenance software to SaaS hosted in the cloud, but let’s dive deep into how the cloud came to be. The first ideas of AWS go back to 2002 when Bezos met with O’Reilly Media, a book publisher who in order to compete with Amazon, had created a way to scrape the latest book rankings off Amazon’s website. O’Reilly suggested creating a set of tools to let developers access Amazon’s rankings, and in 2003 Amazon launched Amazon Web Services (AWS) to create commerce API’s for third parties. Around this time, Amazon had centralized its IT computing resources in a separate building with hardware professionals operating and maintaining the infrastructure for the entire company. While parts of the infrastructure had improved, Amazon was struggling internally to provision and scale its computing resources. In 2004, Chris Pinkham, head of the infrastructure division, relocated to South Africa to open up Amazon’s first office in Cape Town. His first order of business was to figure out the best way to provision resources internally to allow developers to work on all types of applications on Amazon’s servers. Chris elected to use Xen, a computer that sits on top of infrastructure and acts as a controller to allow multiple projects access the same hardware. This led to the development of Elastic Compute Cloud (EC2). During this time, another group within Amazon was working on solving the problem of storing the millions of gigabytes of data Amazon had created. This team was led by Alan Atlas, who could not escape Bezos’ laser focus: “It would always start out fun and happy, with Jeff’s laugh rebounding against the walls. Then something would happen and the meeting would go south and you would fear for your life. I literally thought I’d get fired after everyone one of those meetings.” In March 2006, Amazon launched the Simple Storage Service (S3), and then a few months later launched EC2. Solving internal problems can lead to incredibly successful companies; Slack, for example, originally started as a game development company but couldn’t get the product off the ground and eventually pivoted into the messaging giant that it is today: “Tiny Speck, the company behind Glitch, will continue. We have developed some unique messaging technology with applications outside of the gaming world and a smaller core team will be working to develop new products.”
A9. In the early 2000s, Google arrived on the scene and began to sit in between Amazon and potential sales. Around this time, Amazon’s core business was struggling and a New York Times article even called for Bezos to resign. Google was siphoning off Amazon’s engineers and Bezos knew he had to take big strategic bets in order to ward off Google’s advances. To do that, he hired Udi Manber, a former Yahoo executive with a PhD in computer science who had written the authoritative textbook on Algorithms. In 2003, Udi set up shop in Palo Alto in a new Amazon subsidiary called A9 (shorthand for Algorithms). The new subsidiary’s sole goal was to create a web search engine that could rival Google’s. While A9.com never completely took off, the new development center did improve Amazon’s website search and created Clickriver, the beginning of Amazon’s advertising business, which minted $10B in revenue last year. Udi eventually became VP of Engineering for all of Google’s search products and then its Youtube Division. A9 still exists to tackle Amazon’s biggest supply chain math problems.
Innovation, Lab126 and the Kindle. In 2004, Bezos called Steve Kessel into his office and moved him from his current role as head of Amazon’s successful online books business, to run Amazon Digital, a small and not yet successful part of Amazon. This would become a repeating pattern in Kessel’s career who now finds himself head of all of Amazon’s physical locations, including its Whole Foods subsidiary. Bezos gave Kessel an incredibly abstract goal, “Your job is to kill your own business. I want you to proceed as if your goal is to put everyone selling physical books out of a job.” Bezos wanted Kessel to create a digital reading device. Kessel spent the next few months meeting with executives at Apple and Palm (make of then famous Palm Pilots) to understand the current challenges in creating such a device. Kessel eventually settled into an empty room at A9 and launched Lab126 (1 stands for a, 26 for z – an ode to Bezos’s goal to sell every book A-Z), a new subsidiary of Amazon. After a long development process and several supply chain issues, the Company launched the Kindle in 2007.
Business Themes
Something to prove: Jeff Bezos’s Childhood. What do Jeff Bezos, Steve Jobs, Elon Musk and Larry Ellison (founder of Oracle) all have in common? They all had somewhat troubled upbringings. Jobs and Ellison were famously put up for adoption at young ages. Musk’s parents divorced and Elon endured several years of an embattled relationship with his father. Jeff Bezos was born Jeffrey Preston Jorgenson, on January 12, 1964. Ted Jorgenson, Bezos’s biological father, married his mother, Jackie Gise after Gise became pregnant at age sixteen. The couple had a troubled relationship and Ted was immature and an inattentive father. The couple divorced in 1965. Jacklyn eventually met Miguel Bezos, a Cuban immigrant college student, while she was working the late shift at the Bank of New Mexico’s accounting department. Miguel and Jacklyn were married in 1968 and Jeffrey Jorgenson became Jeffrey Bezos. Several books have theorized the maniacal drive of these entrepreneurs relates back to ultimately prove self-worth after being rejected by loved ones at a young age.
Anti-Competitive Amazon & the Story of Quidsi. Amazon has an internal group dubbed Competitive Intelligence, that’s sole job is to research the products and services of competitors and present results to Jeff Bezos so he can strategically address any places where they may be losing to the competition. In the late 2000s, Competitive Intelligence began tracking a company known as Quidsi, famous for its site Diapers.com, which provided discount baby products that could be purchased on a recurring subscription basis. Quidsi had grown quickly because it had customized its distribution system for baby products. In 2009, competitive intelligence reached out to Quidsi founder, Marc Lore (founder of Jet.com and currently the head of Walmart e-commerce) saying it was looking to invest in the category. After rebuffing the offer, Quidsi soon noticed that Amazon was pricing its baby products 30% cheaper in every category; the company even tried dropping prices lower only to see Amazon pages reset to even lower prices. After a few months, Quidsi knew they couldn’t remain in a price battle for long and launched a sale of the company. Walmart agreed in principle to acquire the business for $900M but upon further diligence reduced its bid, which prompted Lore to call Amazon. Lore and his executive team went to meet with Amazon, and during the meeting, Amazon launched Amazon Mom, which gave 30% discounts on all baby products and allowed participants to purchase products on a recurring basis. At one point, Amazon’s prices dipped so low it was on track to lose $100M in three months in the diapers category alone. Amazon submitted a $540M bid for Quidsi and subsequently entered into an exclusivity period with the Company. As the end to exclusivity grew nearer, Walmart submitted a new bid at $600M, but the Amazon team threatened full on price war if Quidsi went with Walmart, so on November 8, 2010, Quidsi was acquired by Amazon for $540M. One month after the acquisition, Amazon stopped the Amazon Mom program and raised all of its prices back to normal levels. The Federal Trade Commission reviewed the deal for four months (longer than usual), but ultimately allowed the acquisition because it did not create a monopoly in the sale of baby products. Quidsi was ultimately shut down by Amazon in 2017, because it was unable to operate it profitably.
The demanding Jeff Bezos and six page memos. At Amazon, nobody uses powerpoint presentations. Instead, employees write out six page narratives in prose. Bezos believes this helps create clear and concise thinking that gets lost in flashy powerpoint slides. Whenever someone wants to launch new initiative or project, they have to submit a six page memo framed as if a customer might be hearing it for the first time. Each meeting begins with the group reading the document and the discussion begins from there. At times, especially around the release of AWS, these documents grew increasingly complex in length and size given the products being described did not already exist. Bezos often responds intensely to these memos, with bad responses including: “Are you just lazy or incompetent?” and “If I hear that idea again, I’m gonna have to kill myself” and “This document was clearly written by the B team. Can someone get me the A team document? I don’t want to waste my time with the B team document.” Its no wonder Amazon is such a terrible place to work.

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February 2019 - Cloud: Seven Clear Business Models by Timothy Chou

While this book is relatively old for internet standards, it illuminates the early transition to SaaS (Software as a Service) from traditional software license and maintenance models. Timothy Chou, current Head of IoT at the Alchemist Accelerator, former Head of On Demand Applications at Oracle, and a lecturer at Stanford, details seven different business models for selling software and the pros/cons of each.

Tech Themes

The rise of SaaS. Software-as-a-Service (SaaS) is an application that can be accessed through a web browser and is managed and hosted by a third-party (likely a public cloud - Google, Microsoft, or AWS). Let’s flash back to the 90’s, a time when software was sold in shrink-wrapped boxes as perpetual licenses. What this meant was you owned whatever version of the software you purchased, in perpetuity. Most of the time you would pay a maintenance cost (normally 20% of the overall license value) to receive basic upkeep services to the software and get minor bugs fixed. However, when the new version 2.0 came out, you would have to pay another big license fee, re-install the software and go through the hassle of upgrading all existing systems. On the backs of increased internet adoption, SaaS allowed companies to deliver a standard product, over the internet, typically at lower price point to end users. This meant smaller companies like salesforce (at the time) could compete with giants like Siebel Systems (acquired by Oracle for $5.85Bn in 2005) because companies could now purchase the software in an on-demand, by-user fashion without going to the store, at a much lower price point.
How cloud empowers SaaS. As an extension, standardization of product means you can aptly define the necessary computing resources - thereby also standardizing your costs. At the same time that SaaS was gaining momentum, the three mega public cloud players emerged, starting with Amazon (in 2006), then Google and eventually Microsoft. This allowed companies to host software in the cloud and not on their own servers (infrastructure that was hard to manage internally). So instead of racking (pun intended) up costs with an internal infrastructure team managing complex hardware - you could offload your workloads to the cloud. Infrastructure as a service (IaaS) was born. Because SaaS is delivered over the internet at lower prices, the cloud became an integral part of scaling SaaS businesses. As the number of users grew on your SaaS platform, you simply purchased more computing space on the cloud to handle those additional users. Instead of spending big amounts of money on complex infrastructural costs/decisions, a company could now focus entirely on its product and go-to-market strategy, enabling it to reach scale much more quickly.
The titans of enterprise software. Software has absolutely changed in the last 20 years and will likely continue to evolve as more specialized products and services become available. That being said, the perennial software acquirers will continue to be perennial software acquirers. At the beginning of his book, Chou highlights fifteen companies that had gone public since 1999: Concur (IPO: 1999, acquired by SAP for $8.3B in 2014), Webex (IPO: 2002, acquired by Cisco in for $3.2B in 2007), Kintera (IPO: 2003, acquired by Blackbaud for $46M in 2008), Salesforce.com (IPO: 2004), RightNow Technologies (IPO: 2004, acquired by Oracle for $1.5B in 2011), Websidestory (IPO: 2004, acquired by Omniture in 2008 for $394M), Kenexa (IPO: 2005, acquired by IBM for $1.3B in 2012), Taleo (IPO: 2005, acquired for $1.9B by Oracle in 2012), DealerTrack (IPO 2005, acquired by Cox Automotive in 2015 for $4.0B), Vocus (IPO: 2005, acquired by GTCR in 2014 for $446M), Omniture (IPO: 2006, acquired by Adobe for $1.8B in 2009), Constant Contact (IPO: 2007, acquired by Endurance International for $1B in 2015), SuccessFactors (IPO: 2007, acquired by SAP for $3.4B in 2011), NetSuite (IPO 2007: acquired by Oracle for $9.3B in 2016) and Opentable (IPO: 2009, acquired by Priceline for $2.6B in 2015). Oracle, IBM, Cisco and SAP have been some of the most active serial acquirers in tech history and this trend is only continuing. Interestingly enough, Salesforce.com is now in a similar position. What it shows is that if you can come to dominate a horizontal application - CRM (salesforce), ERP (SAP/Oracle), or Infrastructure (Google/Amazon/Microsoft) you can build a massive moat that allows you to become the serial acquirer in that space. You then have first and highest dibs at every target in your industry because you can underwrite an acquisition to the highest strategic multiple. Look for these acquirers to continue to make big deals when it can further lock in their market dominant position especially when you see their core business slow.
Business Themes

Here we see the “Cash Gap” in the subscription model - customer acquisition expenses are incurred upfront but are recouped over time.

The misaligned incentives of traditional license/maintenance model. Software was traditionally sold as perpetual licenses, where a user could access that version of the software forever. Because users were paying to use something forever, the typical price point was very high for any given enterprise software license. This meant that large software upgrades were made at the the most senior levels of management and were large investments from a dollars and time perspective. On top of that initial license came the 20% support costs paid annually to receive patch updates. At the software vendor, this structure created interesting incentives. First, product updates were usually focused on break-fix and not new, “game-changing” upgrades because supporting multiple, separate versions of the software (especially, pre-IaaS) was incredibly costly. This slowed the pace of innovation at those large software providers (turning them into serial acquirers). Second, the sales team became focused on selling customers on new releases directly after they signed the initial deal. This happened because once you made that initial purchase, you owned that version forever; what better way to get more money off of you than introduce a new feature and re-sell you the whole system again. Salespeople were also incredibly focused on closing deals in a certain quarter because any single deal could make or break not only their quarterly sales quota, but also the Company’s revenue targets. If one big deal slipped from Q4 to Q1 the following year, a Company may have to report lower growth numbers to the stock market driving the stock price down. Third, once you made the initial purchase, the software vendor would direct all problems and product inquiries to customer support who were typically overburdened by requests. Additionally, the maintenance/support costs were built into the initial contract so you may end up contractually obligated to pay for support for a product that you don’t like and cannot change. The Company viewed it as: “You’ve already purchased the software, so why should I waste time ensuring you have a great experience with it - unless you are looking to buy the next version, I’m going to spend my time selling to new leads.” These incentives limited product changes/upgrades, focused salespeople completely on new leads, and hurt customer experience, all at the benefit of the Company over the user.
What are CAC and LTV? CAC or customer acquisition costs are key to understand for any type of software business. As HubSpot and distinguished SaaS investor, David Skok notes, its typically measured as, “the entire cost of sales and marketing over a given period, including salaries and other headcount related expenses, and divide it by the number of customers that you acquired in that period.” Once the software sales model shifted from license/maintenance to SaaS, instead of hard-to-predict, big new license sales, companies started to receive monthly recurring payments. Enterprise software contracts are typically year-long, which means that once a customer signs the Company will know exactly how much revenue it should plan to receive over the coming year. Furthermore, with recurring subscriptions, as long as the customer was happy, the Company could be reasonably assured that customer would renew. This idea led to the concept of Lifetime Value of a customer or LTV. LTV is the total amount of revenue a customer will pay the Company until it churns or cancels the subscription. The logic followed that if you could acquire a customer (CAC) for less than the lifetime value of the customer (LTV), over time you would make money on that individual customer. Typically, investors view a 3:1 LTV to CAC ratio as viable for a healthy SaaS company.

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