Money earned is a reasonable approximation of the value you’re creating

Tuesday, May 30th, 2017

Amazon is the most defensible company on earth — for not-so-obvious reasons:

It’s the fact that each piece of Amazon is being built with a service-oriented architecture, and Amazon is using that architecture to successively turn every single piece of the company into a separate platform — and thus opening each piece to outside competition.

I remember reading about the common pitfalls of vertically integrated companies when I was in school. While there are usually some compelling cost savings to be had from vertical integration (either through insourcing services or acquiring suppliers/customers), the increased margins typically evaporate over time as the “supplier” gets complacent with a captive, internal “customer.”

There are great examples of this in the automotive industry, where automakers have gone through alternating periods of supplier acquisitions and subsequent divestitures as component costs skyrocketed. Divisions get fat and inefficient without external competition. Attempts to mitigate this through competitive/external bid comparison, detailed cost accountings and quotas usually just lead to increased bureaucracy with little effect on actual cost structure.

The most obvious example of Amazon’s SOA structure is Amazon Web Services (Steve Yegge wrote a great rant about the beginnings of this back in 2011). Because of the timing of Amazon’s unparalleled scaling — hypergrowth in the early 2000s, before enterprise-class SaaS was widely available — Amazon had to build their own technology infrastructure. The financial genius of turning this infrastructure into an external product (AWS) has been well-covered — the windfalls have been enormous, to the tune of a $14 billion annual run rate. But the revenue bonanza is a footnote compared to the overlooked organizational insight that Amazon discovered: By carving out an operational piece of the company as a platform, they could future-proof the company against inefficiency and technological stagnation.

In the 10+ years since AWS’s debut, Amazon has been systematically rebuilding each of its internal tools as an externally consumable service. A recent example is AWS’s Amazon Connect — a self-service, cloud-based contact center platform that is based on the same technology used in Amazon’s own call centers. Again, the “extra revenue” here is great — but the real value is in honing Amazon’s internal tools.

If Amazon Connect is a complete commercial failure, Amazon’s management will have a quantifiable indicator (revenue, or lack thereof) that suggests their internal tools are significantly lagging behind the competition. Amazon has replaced useless, time-intensive bureaucracy like internal surveys and audits with a feedback loop that generates cash when it works — and quickly identifies problems when it doesn’t. They say that money earned is a reasonable approximation of the value you’re creating for the world, and Amazon has figured out a way to measure its own value in dozens of previously invisible areas.

But this much is obvious — we all know about AWS. The incredible thing here is that this strategy — in one of the most herculean displays of effort in the history of the modern corporation — has permeated Amazon at every level. Amazon has quietly rolled out external access in nooks and crannies across their entire ecosystem, and it is this long tail of external service availability that I think will be nearly impossible to replicate.

Comments

  1. David Foster says:

    Years ago, Drucker compared two foundries, both of which were components of large manufacturing companies. In company A, the foundry was a purely internal operation — it made castings only for use in the company’s own manufacturing operations. In company B, the foundry made castings for internal use, but was also allowed to sell its services on the open market.

    Over the years, Drucker observed, the company “A” foundry did a workmanlike job, but nothing spectacular. The same guy ran the place for well over a decade. The company “B” foundry, on the other hand, was continually at the forefront of innovation — and several of the foundry managers had been promoted to other parts of the business.

  2. Dan Kurt says:

    The real questions are:

    Does Amazon make any money?

    Is Amazon a Bubble that will pop?

  3. Slovenian Guest says:

    Again from the Market Ticker:

    Amazon is the worst of all. For 10 years Amazon has sold at P/Es that are ridiculous — currently at 177x earnings but it has traded as high as 1,000x or more. Yes, it has revenue growth but just the other day Bezos announced yet another price cut on AWS — their high-margin cloud server business. The rest of Amazon actually operates at breakeven or even a loss, especially when shipping is considered. So when you take 5 or 10 points off AWS margins what you’re really doing is to destroy the entire profitability of the company! Oh, and AWS is not the low-cost provider of these services either; I recently tried to compare their service against Digital Ocean’s (where The Market Ticker currently resides after I moved it off my own infrastructure) and was unable, with ~30 minutes of study, to determine exactly what I had to buy to be equal to what I could easily understand at Digital Ocean and how much it would cost. Amazon lost as a result and for many workloads this will continue since I can’t be the only geek who throws up his hands when I can’t figure out how to compare apples to apples easily. In short AWS pricing looks a lot like trying to figure out how much your doctor is going to gang***** you for in the hospital! The problem for Amazon is that unlike the medical system there’s no protection from competition for them.

    The last two, Tesla and Netflix, are even worse.

    Netflix has been running perennial negative free cash flow. The only reason they’re in business at all is that the bond market continues to allow them to borrow money! That’s right, without that they’re out of business immediately because they have forward commitments to spend on content but don’t generate enough cash to pay for that commitment. The market “believes” that some day all that programming will continue to generate cash flow without having to continue to spend on it. Really folks? Ever look at the residual fees for a TV show? They’re worth almost nothing! So Netflix must continue to spend more and more and what’s worse is that their US market is saturated and all their growth, in percentage terms, is coming from overseas. That would great except that most of those people don’t speak English and have different cultures so now you need differentiated programming for them at even more cost! This is a company that on an operating basis has, in my opinion, negative current value as a going concern but it sells for about $155 a share. Yeah.

    Then there’s Tesla. Tesla loses money on every car they sell even with government subsidies! In other words it’s a tax farm and yet it loses money even after stealing funds for every car from the taxpayer! Those subsidies, by the way, will eventually expire and when they do the company will lose even more money per vehicle sold. The only reason Tesla is still in business is that it, like Netflix keeps going back to the bond market and convincing them to pour more cash on a bonfire and, by the way, their total debt load is now greater than their annual revenue! This is a company that, on a current operating basis is an outrageous zero and exists only because it manages to convince the bond market and steal from the taxpayer.

    I’ve seen this movie before, and by the way, most of the recent gains in the market and a huge percentage of the gains since the 2008 recession have come from these companies.

  4. Gaikokumaniakku says:

    “Money earned is a reasonable approximation of the value you’re creating…”

    Alphose Capone and Pablo Escobar must have created a lot of value, then…

  5. Gaikokumaniakku, I’d say “provided” rather than “created,” but yes, yes they did; Capone and Escobar each served a demand whose supply had been suppressed — but not ended — by government.

    It was that very government suppression that increased — not inflated — the value of the services Capone and Escobar provided, and thus they profited handsomely.

  6. Gaikokumaniakku says:

    David White Wolf:

    Touche. Capone and Escobar sold the people what they wanted. I suppose it was unjust of me to compare such free-trade capitalists to a trade-impeding would-be monopolist like Amazon.

    I was riffing on the opening line: “Amazon is the most defensible company on earth” because Capone and Escobar were good at defending themselves until they got taken down.

    Am I the only one who gets reminded of Standard Oil when I look at Amazon? They seem to think that “competition is sin” when it’s external competition that threatens Amazon.

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