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JEFF BEZOS – ARBITRAGING OTHER PEOPLES CAPEX

By Investment Master Class. Originally published at ValueWalk.

By Investment Master Class

“I’ve never seen any person develop two really important industries at the same time. Jeff Bezos is the most remarkable businessperson of our age” Warren Buffett

I remember listening to Warren Buffett complementing Jeff Bezos at Berkshire Hathaway’s first live-streamed annual meeting in April 2016. In a more recent interview, Buffett referred to Jeff Bezos and recommended viewers watch the Charlie Rose interview with him [see here].  Below I’ve summarised some of the aspects of the interview I found most interesting …

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THINK BACKWARDS

“.. the thing that connects everything that Amazon does is the number one – our number one conviction and idea and philosophy and principle which is customer obsession, as opposed to competitor obsession. And so we are always focused on the customer, working backwards from the customer’s needs, developing new skills internally so that we can satisfy what we perceive to be future customer needs. We have a whole working backward process that starts with the customer needs and works backwards. So that is really, if you look at, seems like we are in a bunch of different businesses” Jeff Bezos

‘Thinking backwards’ or ‘inverting’ is a commonly undertaken method of analysis by the Investment Masters.  In a recent Wealthtrack interview, Investment Master Thomas Russo stated… “Amazon is nothing to do with technology, Bezos is all about customer service. All about the consumer experience. Bezos’s job is to reason back from what steps it will take to improve consumer experience and that directs his investment. That is purely the ‘Charlie Munger’ story. Charlie has said at annual meeting for decades, the way to live your life is through the power of ‘inversion’. Think of what it is you want to create, and reason backwards to come up with most efficient way to get there.  That’s Charlie Munger in spades and that’s exactly what Bezos is talking about.”

INVENTIVE CULTURE

“We have a very inventive culture, so we like to pioneer invent” Jeff Bezos

The Investment Masters recognise that a common trait amongst successful companies is a culture of innovation. In a study of US firms, James Heskett, a Professor Emeritus at Harvard University’s Business School and renowned business culture expert, found “organizations with the best performance were those with values and leadership that encouraged behaviours such as innovation, continuous quality improvement, bench-marking against the world’s best, and efforts to import good ideas from anywhere outside the organisation as well as to generate them within”. Mr Heskett noted “we deemed these values and behaviours typical of an adaptive culture, one that supports an organisation’s ability to adapt to change in the competitive, social and regulatory environment”.

THINK LONG TERM

“Willingness to think long-term. I think that is another common thread that runs through every single thing we do” Jeff Bezos

“It’s the combination of the risk-taking and the long-term outlook that make Amazon, not unique, but special in a smaller crowd. And then finally, taking real pride in operational excellence, so just doing things well, finding defects, and working backwards.” Jeff Bezos

The Investment Masters understand the benefits of taking a long term view.  They look out three to five years or more with a view to figuring out the company’s  likely successful competitive position, what it might be earning, and thus likely to be worth, at that time.  Warren Buffett has informed Berkshire’s shareholders that he will measure the success of his investments ‘by the long term-progress of the companies rather than by the month-to-month movements of their stocks‘.

Occasionally, companies may forego near term earnings by investing in longer term initiatives. Thomas Russo makes the point with respect to Berkshire’s investment in GEICO .. “when is it sensible to accept lower earnings? When you have the capacity to suffer. Buffett decided to forgo profits at GEICO to take market share from 2% to 11% by spending more on marketing.”

Conversely, companies that are subject to short term imperatives, and are unable to adopt a longer term view are likely to suffer over the longer term. The highly successful corporate investor, Henry Kravis of KKR notes .. “The trouble, in my opinion, with corporate America today, is that everything is thought of in quarters. Analysts push them. “What are you going to earn this quarter?” We say to the management of companies, “You are here today. Where do you want to be five years from now, and how are you going to get there?” It may very well mean taking a step backwards. But believe me, in five years, we are going to have a company that is much more productive, efficient, and competitive.

ROOM FOR IMPROVEMENT

“I am never disappointed when we’re not good at something because I think, well think how good it’s going to work when we are good at it…  There is so much opportunity. Nobody really knows how to do a great job of offering — apparel online yet.  And we have tons of invention and ideas and working our way through that experimental list.” Jeff Bezos

COMPETITION

“One of the most unusual things that happened with Amazon Web Services is the amount of runway that we got, which is a gift, before we faced like-minded competition, we had – it appears to me just empirically that if you invent a new way of doing something, typically if you are lucky, you get about two years of runway before competitors copy your idea. And two years is actually a pretty long time in a fast-moving industry so that’s a big head start.”

“Amazon Web Services got seven years of runway before we faced like-minded competition.

Competition is what destroys corporate returns. As Investment Master, Sam Zell has noted “There’s no substitute for limited competition. You can be a genius, but if there’s lots of competition, it won’t matter. I’ve spent my career trying to avoid it’s destructive consequences”. Having a runway without competition allowed Bezos to establish a first mover advantage by building scale which allowed pricing at a level which is uneconomical for potential competitors without such scale.

INNOVATE

“every year, 500, 600, 700, 800 new features and services [are added to Amazon Web Services]“

Companies must continue to innovate. The Investment Master, Phil Fisher stated .. “The company that doesn’t pioneer, doesn’t take chances, and merely goes along with the crowd is liable to prove a rather mediocre investment in this highly competitive age”. Famous Nobel Prize physicist and renowned thinker Richard Feynman said “I think that to keep trying new solutions is the way to do everything”.

THE POTENTIAL OF AMAZON WEB SERVICES [AWS]

“Amazon.com, the retailer needs these things. But pretty soon everybody is going to need these things. And so with a little extra work, we can turn what we were going to build just for ourselves into a service for the world. And that’s what we did.” Jeff Bezos

Amazon realised the benefits of turning a cost centre into a

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