[00:02:22] Clay Finck: But this is day one for the internet. And if we execute well for Amazon.com today, online commerce saves customers money and precious time tomorrow through personalization, online commerce will accelerate the very process of discovery. Amazon.com uses the internet to create real value for its customers, and by doing so, hopes to create an enduring franchise, even in established and large markets.

[00:02:49] Clay Finck: We have a window of opportunity as larger players marshal the resources to pursue the online opportunity. And as customers new to purchasing online are receptive to forming new relationships, the competitive landscape has continued to evolve at a fast pace. Many large players have moved online with credible offerings and have devoted substantial energy and resources to building awareness, traffic, and sales.

[00:03:14] Clay Finck: Our goal is to move quickly to solidify and extend our current position. While we begin to pursue the online commerce opportunities in other areas, we see substantial opportunity in the large markets we’re targeting. This strategy is not without risk. It requires serious investment and crisp execution against established franchise leaders.

[00:03:36] Clay Finck: And then the headline here, it’s all about the longterm. We believe a fundamental measure of our success will be the shareholder value we create over the longterm. This value will be a direct result of our ability to extend and solidify our current market leadership position. The stronger our market leadership, the more powerful our economic model market leadership can translate directly to higher revenue.

[00:03:59] Clay Finck: Higher profitability, greater capital velocity, and correspondingly stronger returns on capital. Our decisions have consistently reflected this focus. We first measure ourselves in terms of the metrics most indicative of our market leadership. Customer and revenue growth, the degree of which our customers continue to purchase from us on a repeat basis, and the strength of our brand.

[00:04:22] Clay Finck: We have invested and will continue to invest aggressively to expand and leverage our customer base, brand, and infrastructure as we move to establish an enduring franchise. Because of our emphasis on the long term, we may make decisions and weigh trade offs differently than some companies. Accordingly, we want to share with you our fundamental management and decision making approach so that you, our shareholders, may confirm that it is consistent with your investment philosophy.

[00:04:51] Clay Finck: We will continue to focus relentlessly on customers. Then he has a number of bullet points here that emphasize this focus on customers. First, we will continue to make investment decisions in light of long term market leadership considerations rather than short term profitability considerations or short term wall street reactions.

[00:05:10] Clay Finck: We will continue to measure our programs and the effectiveness of our investments analytically. To jettison those that do not provide acceptable returns and to step up our investment in those that work best. We will continue to learn from both our successes and our failures. We will make bold rather than timid investment decisions where we see sufficient probability of gaining market leadership advantages.

[00:05:33] Clay Finck: Some of these investments will pay off, others will not. And we will have learned another valuable lesson in either case, when forced to choose between optimizing the appearance of our gap accounting in maximizing the present value of our future free cash flows, we’ll take the cash flows. We will share our strategic thought processes with you when we make bold decisions to the extent competitive pressures allow so that you may evaluate for yourselves whether we are making rational long term leadership investments.

[00:06:03] Clay Finck: We will work hard to spend wisely and maintain our lean culture. We understand the importance of continually reinforcing a cost conscious culture, particularly in a business incurring net losses. We will balance our focus on growth with emphasis on long term profitability and capital management. At this stage, we choose to prioritize growth because we believe that scale is central to achieving the potential of our business model.

[00:06:29] Clay Finck: And then the last bullet point here, we will continue to focus on hiring and retaining versatile and talented employees. And continue to weight their compensation to stock options rather than cash. We know our success will largely be affected by our ability to attract and retain a motivated employee base, each of whom must think like and therefore must actually be an owner.

[00:06:52] Clay Finck: I love that point. So we are so bold as to claim that the above is the quote unquote right investment philosophy, but it’s ours. And we would be remiss if we weren’t clear in the approach we have taken and will continue to take with this foundation. We would like to turn a review to our business focus, our progress in 1997 and our outlook for the future.

[00:07:13] Clay Finck: And then the headlines here is obsess over customers. From the beginning, our focus has been on offering our customers compelling value. We’ve realized that the web was and still is the worldwide weight. Therefore, we set out to offer customers something they simply couldn’t get any other way. And began serving them with books.

[00:07:34] Clay Finck: We brought them much more selection than was possible in a physical store and presented it in a useful, easy to search and easy to browse format. And a store opens 365 days a year, 24 hours a day. We maintained a dogged focused on improving the shopping experience. And in 1997, substantially enhanced our store.

[00:07:55] Clay Finck: We now offer customer gift certificates. One click shopping and vastly more reviews, content, browsing options, and recommendation features. We dramatically lowered prices, further increasing customer value. Word of mouth remains the most powerful customer acquisition tool we have, and we are grateful for the trust our customers have placed in us.

[00:08:15] Clay Finck: Repeat purchases in word of mouth have combined to make Amazon.com the market leader in online book selling. By many measures, Amazon.com came a long way in 1997. So sales grew from 15. 7 million in 1996 to 147 million in 2010. In 1997, that’s an 838% increase. Cumulative customer accounts grew from a a 180,000 to 1.5 million 738% increase.

[00:08:42] Clay Finck: The percentage of orders that came from repeat customers grew from 46% in the fourth quarter to 58% in the same period for 1997. In terms of audience reach, their website’s rank went from 90th to within the top 20, and then they established relationships with some important partners. He lists America Online, Yahoo, Netscape, and a few others here.

[00:09:04] Clay Finck: And then he’s gotten section on infrastructure. During 1997, we worked hard to expand our business infrastructure to support these greatly increased traffic, sales, and service levels. Amazon.com’s employee base grew from 158 to 614, and we significantly strengthened our management team. Distribution center capacity grew from 50, 000 to 285, 000 square feet.

[00:09:28] Clay Finck: So inventories grew to over 200, 000 titles at year end, enabling us to improve availability for our customers. Our cash and investment balances at year end were 125 million. Thanks to our initial public offering in May, 1997, and our 75 million loan affording us substantial strategic flexibility. And then a section here on employees.

[00:09:52] Clay Finck: This past year’s success is the product of a talented, smart, hardworking group. And I take great pride in being a part of this team, setting the bar high and our approach to hiring has been, and will continue to be the single most important element of Amazon.com success. It’s not easy to work here. When I interview people, I tell them you can work long, hard, or smart, but at amazon. com, you can’t choose two out of the three, but we are working to build something important, something that matters to our customers, something that we can all tell our grandchildren about. Such things aren’t meant to be easy. We are incredibly fortunate to have this group of dedicated employees who sacrifices and passion build amazon. com. And then the last section here is on goals for 1998. We are still in the early stages of learning how to bring new value to our customers through internet commerce and merchandising. Our goal remains to continue to solidify and extend our brand and customer base. This requires sustained investment in systems and infrastructure to support outstanding customer convenience, selection and service.

[00:10:58] Clay Finck: While we grow, we are planning to add music to our product offering. And over time, we believe that other products may be prudent investments. We also believe that there are significant opportunities to better serve our customers overseas. Such as reducing delivery times and better tailoring the customer experience.

[00:11:15] Clay Finck: To be certain, a big part of the challenge for us will lie not in finding new ways to expand our business, but in prioritizing our investments. We now know vastly more about online commerce than when Amazon.com was founded, but we still have so much more to learn. Though we are optimistic, we must remain village and maintain a sense of urgency.

[00:11:37] Clay Finck: The challenges and hurdles we will face to make our long term vision for Amazon.com of reality are several aggressive, capable, well funded competition, considerable growth challenges, and execution risks. The risks of product and geographic expansion in the need for large continuing investments to meet an expanding market opportunity.

[00:11:57] Clay Finck: However, as we’ve long said, online book selling and online commerce in general should prove to be a very large market. And it’s likely that a number of companies will see significant benefit. We feel good about what we’ve done, and we’ve been more excited about what we want to do. 1997 was indeed an incredible year.

[00:12:17] Clay Finck: We at Amazon.com are grateful to our customers for their business and trust, to each other for our hard work, and to our shareholders for their support and encouragement. Jeffrey P. Bezos, founder and CEO of Amazon.com, Inc. So that was the end of the 1997 letter there, and there’s just so, so much to like.

[00:12:36] Clay Finck: The first thing I would say is just how easy it is to follow. So many shareholder letters nowadays are filled with just so much jargon. I think it goes over a lot of shareholders heads and it’s intended to be like that for many companies. I think Buffett had said that he would write his letters as if he was writing to his aunt Alice, who wasn’t a sophisticated investor.

[00:12:57] Clay Finck: It’s also amazing that Bezos recognized so early that they’ve really needed to think so long term and to have that urgency to build out that first mover advantage to try and capture that network effect. So he’s super, super candid about what metrics he believes matters most for the success of the company.

[00:13:15] Clay Finck: And then second, he’s completely straightforward in sharing those metrics with the shareholders. So in his case, he said that they were going to measure their progress based on customer and revenue growth, the degree of repeat customers, and then the strength of the brand, which is largely a subjective measure.

[00:13:30] Clay Finck: But there are some things you can do to sort of see whether the brand is heading in the right direction or not. The focus on the long term, it’s definitely worth mentioning. You see it time and time again, in his letters, he cares much more about long term value creation rather than the short term EPS targets or the short term targets that Wall Street would want him to hit.

[00:13:50] Clay Finck: So he’s definitely not trying to appeal to Wall Street to try and boost his share price. You know, and most of his letters, he’s hardly ever mentioning the share price at all. And of course, you see the jaw dropping growth. It’s just amazing. Sales increased from 15 million to 147 million in just one year.

[00:14:08] Clay Finck: And this tells you that this guy is just exceptionally efficient and hardworking and exceptionally good at, you know, And then he emphasizes the importance of adding value to customers. Amazon is an online business utilizing the internet, and this allowed him to add more value to customers through more selection, higher convenience.

[00:14:31] Clay Finck: And one thing that caught my attention is he only mentioned low prices, I think once during that first letter. But they do make that a big focus in some of the later letters. And then the focus really in the first letter again is they’re just selling books. And he mentions that he’s an e commerce company in general and he doesn’t call himself, you know, a bookseller.

[00:14:49] Clay Finck: And this implies that, you know, he’s not going to, he doesn’t plan to just limit himself to books. Did that seem pretty clear as well? So time and time again, throughout the letters, he mentions the alignment of the customer’s interest with the alignment of the shareholder’s interest. So essentially he had the thesis that by focusing on delivering the most value to customers, this would also deliver maximum value to the shareholders.

[00:15:13] Clay Finck: So for example, in his 2010 letter, he wrote, we have unshakable conviction that the longterm interests of shareholders are perfectly aligned with the interests of customers. And then the last thing I’ll mention here in reference to the 1997 letter is that if you go to Amazon’s website, and download any of their letters from 1997 through 2023.

[00:15:35] Clay Finck: At the end, they go back and just attach the 1997 letter. It’s just sort of a subtle reminder to shareholders that, Hey, we’ve been thinking longterm ever since the beginning, we didn’t just adopt this, you know, longterm framework in 2015 or 2010 or whatnot. They always attach that 1997 letter, which I thought was really cool.

[00:15:55] Clay Finck: And he also acknowledges that what they were doing doesn’t come without risk. For example, in the 1998 letter, he wrote, I quote, it is truly day one for the internet. And if we execute our business plan, well, it remains day one for Amazon. Given what’s happened, it may be difficult to conceive, but we think the opportunities and risks ahead of us are even greater than those that were behind us.

[00:16:21] Clay Finck: We will have to make many conscious and deliberate choices, some of which will be bold and unconventional. Hopefully, some will turn out to be winners. Certainly, some will turn out to be mistakes. And I think I heard in one of Bezos’s interviews that his parents had given him, I don’t know if it was a couple hundred thousand dollars or something to help him start Amazon.

[00:16:42] Clay Finck: And he just straight up told his parents he estimated a 70 percent chance of failure in starting the company. And this is him even knowing that 90 percent of businesses fail. So he felt he was giving himself even pretty good odds. So sales in 1998, they grew a modest 313 percent customer accounts grew by over 300%.

[00:17:02] Clay Finck: And despite Amazon needing to have these massive distribution centers to store their products, he writes, I quote, We’re fortunate to benefit from a business model that is cash favored and capital efficient as we do not need to build physical stores or stock these stores with inventory. Our centralized distribution model has allowed us to build our business to a billion dollars sales rate with just 30 million in inventory and 30 million in net plant and equipment.

[00:17:32] Clay Finck: In 1998, we generated 31 million in operating cash flow, which more than offset net fixed asset additions of 28 million end quote. Now, this is also just one part of the business that I wanted to better understand and reading these letters, because when you look at the financial statements in 1998, It looks like Amazon is just losing a ton of money.

[00:17:54] Clay Finck: And if Bezos were to write in his letters that the return on invested capital is well over 100%, then, you know, he would have attracted a lot of attention showcasing how profitable his business model is. So that’s another reason I started wanting to go through the letters is understand his thinking, understand the business a little bit better and see how I might be able to apply that to businesses I’m looking at today.

[00:18:17] Clay Finck: So the income statement for 1998, it shows sales of 609 million. Gross profit of 133 million and a net loss of 124 million. And then I look and I see a marketing and sales expense of 133 million. And this seems, you know, pretty big given that this is 20 percent of the revenue. And then in May of 1998, the company took on a senior note of 326 million at 10 percent interest in addition to issuing 1. 25 billion in convertible debt. And the company also had around 13 percent dilution in the shareholder base, which all points to a company that’s in hyper growth mode, just totally reinvesting for the future. Yeah, it doesn’t look like they’re all that profitable in 1998 at least, but this is just year four of the company.

[00:19:07] Clay Finck: So from an outsider’s view, I think a lot of people just saw a company that was just losing more and more money as it grew more and more. It just looked like they were losing more money and. They were also issuing shares, taking on more debt and whatnot. In 1998, he also wrote, we intend to build the world’s most customer centric company.

[00:19:26] Clay Finck: We hold as axiomatic that customers are perceptive and smart and that brand image follows reality and not the other way around. Our customers tell us that they choose Amazon.com and they tell their friends about us because of the selection, ease of use, low prices and services we deliver. So there you can already see the focus on low prices.

[00:19:47] Clay Finck: And then he also follows it up by writing, but there is no rest for the weary. I constantly remind our employees to be afraid to wake up every morning, terrified, not of our competition, but of our customers. Our customers have made our business what it is. They are the ones with whom we have a relationship.

[00:20:07] Clay Finck: And they are the ones to whom we owe a great obligation and we consider them to be loyal to us right up until the second that someone else offers them a better service. We must be committed to constant improvement, experimentation, and innovation in every initiative. End quote. He also shared a bit about his hiring approach since he’s proven to be pretty good at bringing on exceptional people.

[00:20:34] Clay Finck: During the company’s hiring meetings, the person that was doing the hiring, he would ask themselves three questions. So first, will you admire this person? So people you admire tend to be people you are able to learn from and then use as an example. Second, is will this person raise the average level of effectiveness of the group they’re entering?

[00:20:55] Clay Finck: To avoid becoming complacent and to fight entropy, Bezos always wanted to raise the bar for their organization. And then third is along what dimension might this person be a superstar for each person Amazon brought on board. They wanted us to know what that person was exceptional at. What also stood out to me in the 1998 letter is the increased number of shareholders.

[00:21:17] Clay Finck: So he said in the previous year that there were 13, 000 letters that were sent out to shareholders. And then the following year, it must’ve been the end of 1998, they printed 200, 000. And then, you know, you look at the stock price and I think you had a lot of short term shareholders that were chasing the rising price with no real interest in the underlying business.

[00:21:38] Clay Finck: So knowing that he had so many new shareholders coming in, he even wrote a section in 1999 titled, what do you own? And this is where we discuss how they set out to be the earth’s most customer centered company and how they were well positioned to achieve tremendous amounts of scale and profitability relative to other companies that were utilizing the internet.

[00:22:00] Clay Finck: And already in 1999, Bezos had his sights set not only on being the everything store, but being the everything store globally. So in the UK and Germany, for example, Amazon was the number one e commerce site in each country. He also touched on profitability in the 1999 letter. He wrote each of the previous goals I’ve outlined contribute to our long standing objective of building the best, most profitable.

[00:22:27] Clay Finck: Highest return on capital, long term franchise. So in a way, driving profitability is the foundation underlying all of these goals. In the coming year, we expect to deliver substantial margin improvement and cost leverage as we drive continuous improvement in our partnerships with suppliers, in our own productivity and efficiency, in our management of fixed and working capital, and our expertise in managing product mix and price.

[00:22:55] Clay Finck: Each successive product and service we launched this year should build on our platform. So our investment curve can be less steep in the time to profitability for each business should in general, continue to shorten and quo. So even with this intense focus on customers, he still wants to deliver high returns on capital to shareholders.

[00:23:15] Clay Finck: And he would always say that. It’s day one for the internet and that the online shopping experience today is the worst it will ever be as they see, you know, continued improvements in bandwidth and the increased use of non PC devices. I should also note that he didn’t even mention his skyrocketing stock price in the 1999 letter, but he did mention the enormous opportunities that lied ahead for the company.

[00:23:38] Clay Finck: You know, that probably gave some investors a lot of hope in what the future holds was to bring for Amazon. He writes, it’s great to be participating in what is a multi trillion dollar global market in which we are so very tiny. We are doubly blessed. We have a market size unconstrained opportunity in an area where the underlying foundational technology we employ improves every day.

[00:24:04] Clay Finck: That is not normal. So from the start of 1998, on a split adjusted basis, the stock had risen from around 24 cents and then it topped out around 5 and 30 cents around the end of 1999. So that was a 22 X increase in just under two years. And then it came crashing down to around 30 cents just very briefly in October, 2001.

[00:24:28] Clay Finck: Before rebounding for the 2000 shareholder letter, he did reference the stock price hero. Ouch. It’s been a brutal year for many in the capital markets and certainly for Amazon.com shareholders. At the time of this writing, our shares are down more than 80 percent from when I wrote you last year.

[00:24:46] Clay Finck: Nevertheless, by almost any measure, Amazon.com, the company is in a stronger position now than any time in its past. There was a clip of Bezos around five years ago where he talked about the collapse of his stock price and how the stock is not the company and the company is not the stock. It’s a short clip here that I’m going to include from Jeff Bezos and David Rubenstein, which I’m going to play here.

[00:25:13] David Rubenstein: Your stock at one point I think went to a hundred dollars, but then it went down to six or something like that.

[00:25:17] Jeff Bezos: At the peak of the internet bubble, our stock peaked somewhere around 113. And then after the internet bubble you know, busted open, our stock went down to six. It went from 113 to six in less than a year.

[00:25:31] Jeff Bezos: My annual shareholder that year starts with a one word sentence. And that one word sentence is the word ouch.

[00:25:38] David Rubenstein: So most of those internet companies of the dot com era are out of business. You survived. What was that that made you to survive and virtually the rest of them are gone?

[00:25:47] Jeff Bezos: I, it’s very, that whole period is very interesting because the stock is not the company and the company is not the stock.

[00:25:53] Jeff Bezos: And so as I watched the stock fall from 113 to six, I was also watching all of our internal business metrics, number of customers, profit per unit. You know, everything you can imagine, defects, et cetera. Every single thing about the business was getting better and fast. And so, as the stock price was going the wrong way, everything inside the company was going the right way.

[00:26:17] Jeff Bezos: And, we didn’t need to go back to the capital markets, we didn’t need more money. The only reason you know, a financial bust like the internet, bubble bursting, is, you know, makes it really hard to raise money, but, you know, we already had the money we needed. So we just needed to continue to progress.

[00:26:31] David Rubenstein: Wall Street kept saying, well, Amazon’s not making any money, they’re just getting customers, where’s the profits? Where are the profits? And Wall Street kept beating you up on that. And your response was, I don’t really care what you think.

[00:26:42] Jeff Bezos: Amazon was you know, when people always accused us of selling dollar bills for 90 cents and said, look, anybody can do that and grow revenues.

[00:26:51] Jeff Bezos: That’s not what we’re doing. We always had positive gross margins. It’s a fixed cost business. And so what I could see is that from the internal metrics is that at a certain volume level. We would cover our fixed costs and the company would be profitable.

[00:27:06] Clay Finck: So there you see Bezos talking about how the stock and the business are not correlated one to one.

[00:27:12] Clay Finck: Sometimes the stock gets way ahead of the intrinsic value of the business. And sometimes it falls far below the intrinsic value. In 2000, customers served increased from 14 million to 20 million. Sales grew from 1. 6 billion to 2. 7 billion. Average customer spend was 134 up 19%. International sales grew from 168 million to 381 million.

[00:27:37] Clay Finck: And there’s about 10 more lines here of metrics that he highlights. And they’re all heading up into the right and the right direction. At least it’s no wonder that Bezos got the attention of value investors like Bill Miller and Nick sleep around this time. After he listed those metrics, he writes, so if the company is better positioned today than it was a year ago, why is the stock price so much lower than it was as the famed investor, Benjamin Graham said in the short term, the stock market is a voting machine in the long term, it’s a weighing machine.

[00:28:08] Clay Finck: Clearly, there was a lot of voting going on in the boom year of 1999 and much less weighing. We’re a company that wants to be weighed, and over time, we will be over the long term. All companies are. In the meantime, we have our heads down, working to build a heavier and heavier company. Amazon wasn’t a perfect company though.

[00:28:31] Clay Finck: Bezos had said many of their investments were going to be duds. They made an investment in Pets.com, which ended up shutting down operations in the year 2000. At that time, even Amazon got ahead of themselves and reinvesting back into this tech scene because they thought that they really needed to act quickly and getting that first mover advantage in many of these markets.

[00:28:53] Clay Finck: And it’s also no wonder that the stock saw a massive sell off when their hyper growth really slowed in 2001. Top line revenue in 2001 only grew by 13%. And, you know, this is probably partially due to management sort of dialing back that growth initiatives to ensure that the company was going to survive.

[00:29:14] Clay Finck: In the 2001 letter, Bezos again highlighted the intense focus on the customer. In the American Customer Satisfaction Index study conducted by the University of Michigan, Amazon was given the highest score ever recorded by any service company for the second year in a row. And he also highlighted that Amazon was started by focusing on a high level of selection and a high level of convenience.

[00:29:38] Clay Finck: And now they added a third pillar to enhance the customer experience. And that was by relentlessly lowering prices. And despite the share price being down significantly. He reiterated his focus on maximizing the free cash flow per share over the long term. And to achieve that end, Amazon needed to deliver on the best interests of customers and be the leader in e commerce.

[00:30:02] Clay Finck: He had stated, since we expect to keep our fixed costs largely fixed, even at significantly higher unit volumes, We believe Amazon.com is poised over the coming years to generate meaningful, sustained, free cash flow, end quote, and dilution is also a concern for investors in a high growth company like Amazon.

[00:30:23] Clay Finck: And he stated that his goal was to limit dilution to an average of 3 percent per year over the next five years. In 2002, he expanded more on the strategy of continually lowering prices. In most of the retail world, you either have a great customer experience with high prices, or a relatively poor customer experience with the lowest prices.

[00:30:44] Clay Finck: Amazon seeked to deliver on both. The reason they could offer a better value proposition was because the cost to deliver that superior customer experience was relatively fixed. The ability to deliver an unmatched selection, extensive product information, personalized recommendations for customers, and other software features were more or less a fixed expense.

[00:31:06] Clay Finck: He outlined a simple price comparison for books you could get on Amazon versus many of these physical bookstores. So he took a hundred of the bestselling books across various categories And they compared that to what was happening or what was being sold in the physical stores. So they visited all these super stores in Seattle and New York.

[00:31:25] Clay Finck: And they browse through different stores until they could run a price comparison on all 100 of the top selling books. They found that across those 100 books, it costed 1, 561 at the physical locations, but it only costed just under 1, 200 on Amazon. So that accounted for a 23 percent difference in the price or a 366 difference.

[00:31:50] Clay Finck: And on 72 of the books, Amazon’s price was cheaper than the physical stores. 25 of the books, they offered the same price. And then there were three books that they found that Amazon charged a higher price, which he mentions that they decided to lower the prices on those three bucks. In the physical stores, only 15 of the hundred titles were discounted.

[00:32:10] Clay Finck: And the other 85 were listed at full price. And then when you look at the Amazon list, 76 of the hundred titles were discounted and then 24 were sold at the list price. And he also acknowledges that physical stores have their place because sometimes you really need something now, but you’ll have to pay up for it oftentimes relative to Amazon.

[00:32:31] Clay Finck: And then Amazon, he says that Amazon just simply saved customers time and saved them money for those who are willing to wait two, three, four days to get their order. 2002 looked to be the first letter that he saved the financial results and sell the end sales grew by 26 percent to 3. 9 billion unit sales grew 34 percent and free cash flow reached 135 million.

[00:32:55] Clay Finck: In the following year’s letter, he kicked it off by stating, I quote, long term thinking is both a requirement and an outcome of true ownership. Owners are different than tenants. I know of a couple who’ve rented their house, and the family who moved in nailed their Christmas tree to the hardwood floors instead of using a tree stand.

[00:33:15] Clay Finck: Expedient, I suppose, and admittedly, these were particularly bad tenants. But no owner would be so short sighted. Similarly, many investors are effectively short term tenants turning their portfolios so quickly. They’re really just renting the stocks that they temporarily quote unquote own. We emphasized our long term views in our 1997 letter to shareholders, our first as a public company, because that approach really does drive making many concrete non abstract decisions.

[00:33:49] Clay Finck: I’d like to discuss a few of these non abstract decisions in the context of customer experience. At Amazon.com, we use the term customer experience broadly. It includes every customer facing aspect of our business, from our product prices to our selection, from our website’s user interface to how we package and ship items.

[00:34:08] Clay Finck: The customer experience we create is by far the most important driver of our business. As we design our customer experience, we do so with long term owners in mind. We try to make all of our customer experience decisions big and small in that framework. For instance, shortly after launching Amazon.com in 1994, we empowered customers to review products.

[00:34:32] Clay Finck: While now a routine Amazon.com practice at the time, we’ve received complaints from a few vendors basically wondering if we understood our business. You make money when you sell things. Why would you allow negative reviews on your website? Speaking as a focus group of one, I know I’ve sometimes changed my mind before making purchases on amazon.com as a result of negative or lukewarm customer reviews. Though negative customer reviews cost us some sales in the short term, helping customers make better purchase decisions ultimately pays off for the company. Bezos has some great examples here of renters versus owners and short term versus long term thinking.

[00:35:16] Clay Finck: I’m sure this ownership mentality really poured over to the people that were working within the company. And Jeff ensured that those who worked alongside him had significant skin in the game to ensure that they also thought like owners when they went to work within the company. As a longterm owner of Amazon shares, he’s targeting capturing significant market share rather than capturing significantly high margins.

[00:35:41] Clay Finck: In the jewelry business, for example, they would target a substantially lower margin than the industry because they believed that they could make more money selling at scale in earning their customers trust. And then, you know, those customers would come back to purchase time and time again. So over the short run, customers might not notice much of a difference in the pricing of one company versus another, but over the long run, you can count on most people generally figuring that out.

[00:36:08] Clay Finck: I think of all the physical stores you see today that are running, you know, 20%, 30%, 40 percent off sales all the time. And it makes you never want to really purchase anything at that store full price because you can just wait for that next sale. Amazon from the beginning has always just tried to offer the best price possible and not try and fool their customers.

[00:36:28] Clay Finck: And speaking of being an owner here in 2024, Bezos is no longer the CEO of the company. But when I look at their 2023 proxy statement, it shows that he still owns 1.12 million shares and that’s worth just over 200 billion. And that accounts for over 10 percent ownership in the company. Turning back to the 2004 letter, Bezos talked more about the most important financial metrics.

[00:36:54] Clay Finck: So the most important one to him is free cashflow per share. The question some people may be asking is why doesn’t he focus on earnings or earnings per share earnings growth? The reason is that earnings don’t directly translate to cash flows. And cash flows are what ultimately what shareholders want at the end of the day.

[00:37:13] Clay Finck: You can’t necessarily pay employees, reinvest in the future, pay back a dividend or buy back shares with earnings, but you can do it with cash flow. In fact, just looking at their income statement can at times be pretty deceiving and make investors believe that shareholder value isn’t being created.

[00:37:30] Clay Finck: Bezos writes, there are of course other business models where earnings more closely approximate cash flows. But one cannot assess the creation or destruction of shareholder value with certainty by looking at the income statement alone. It reminds me how a lot of companies, they put a lot of focus on EBITDA or adjusted EBITDA.

[00:37:50] Clay Finck: Maybe these types of companies are ensuring you don’t look at other areas of the business and try and fool you into thinking that shareholder value is being created when in fact it isn’t. Just because a company has impressive EBITDA growth doesn’t necessarily mean that the business is cashflow generative.

[00:38:07] Clay Finck: Bezos actually showcases an example in that letter that shows how an income statement can show positive earnings, but from a cash flow perspective, it’s deeply negative because of all the reinvestment that’s occurring to fuel that growth. So in that example he shared, one could easily just run an IRR calculation to see that it The investment opportunities within that business, and then you get to see the return is actually less than the cost of capital, meaning that it actually isn’t a worthwhile investment, even though the income statement might look like a value is being created.

[00:38:44] Clay Finck: And in a hypothetical example, it might be easy to run these sort of calculations, but the real world is just infinitely complex, which means it’s easier to fool investors into thinking that shareholder value is being created. And that’s why I think it’s so important to really assess the management team and try and find those people that act honestly, ethically, and try and share what they’re trying to do with the company and how the business’s results are delivering shareholder value.

[00:39:12] Clay Finck: So the lesson is that when you’re analyzing a business, he’s trying to say, don’t just stop at the income statement, understand the cashflow statement as well. And even the balance sheet and understand the cash return a company is receiving for each incremental dollar invested. So to give an example of the complexity around assessing the creation of shareholder value, consider how Amazon made a commitment to offering the lowest prices available.

[00:39:39] Clay Finck: Mathematically, you know, one could argue that if you want to deliver high returns to the shareholders, Amazon should be raising prices, not lowering them, but raising prices will actually boost earnings in the short term, but it could potentially hurt earnings in the longterm as customers eventually go and shop somewhere else that offers a better value proposition.

[00:40:00] Clay Finck: So rather than focusing on some sort of models, Bezos really made a judgment call that the most value is going to be created in harnessing that trust with customers and keep them coming back time and time again. He writes, our judgment is that relentlessly returning efficiency of improvements and scale economies to customers in the form of lower prices creates a virtuous cycle that leads over the long term to a much larger dollar amount of free cash flow.

[00:40:29] Clay Finck: And thereby to a much more valuable Amazon.com. We’ve made similar judgments around free super saver shipping and Amazon prime, both of which are expensive in the short term, and we believe important and valuable in the longterm end quote. So the same judgment call was made when they allowed third party sellers to offer their products on Amazon’s website.

[00:40:50] Clay Finck: Although this could in theory cannibalize their own retail business, they figured that if a third party could offer a better price or a better product, they wanted the customer to have access to that. As a result of that decision, third party sales reached 28 percent of total units sold in 2005. So shifting gears here, and this.

[00:41:12] Clay Finck: Ever fast changing world, many people are asking themselves what is going to change? Jeff Bezos asked himself the opposite, what is not going to change? In his 2008 letter, he shared his strong conviction that customers will continue to value low prices. Bask selection in fast, convenient delivery. He couldn’t imagine that 10 years from then, customers would want higher prices, less selection or slower delivery.

[00:41:41] Clay Finck: This is what helped give them the confidence in reinvesting in needs that likely weren’t going to change. One of Amazon’s genius moves was cloning the idea of an annual membership fee, which I believe he copied straight from Costco after discussing that idea with the CEO. Amazon Prime was launched in 2005 for 79 a year, and it gave its members unlimited express two day shipping, free of charge, and upgrades to one day delivery for 3. 99. Offering the annual membership fee helped increase customer loyalty, And allowed Amazon to deliver higher value to their most loyal customers. And I believe that at the time Amazon offered two day delivery to regular customers, but it costed, you know, around 9. So if Amazon prime member were to place nine orders a year, then essentially prime would pay for itself.

[00:42:35] Clay Finck: So, oftentimes, when you shopped online, you’d pay, say, four or five dollars for shipping. You’d wait four or five days to get your order. But if you were a member of Amazon Prime, you wouldn’t pay shipping and you’d get your order in two days, oftentimes. Because of this, Amazon really raised the bar for everybody on what it means to shop online.

[00:42:55] Clay Finck: If you had an item you needed soon, or you were buying a last minute gift. Amazon was a very legitimate threat to the local brick and mortar retail stores. And I think of it as building this habit of when you need something, just log on Amazon. And I think about how today I just have the Amazon app on my phone.

[00:43:13] Clay Finck: And I can get something ordered and well under 60 seconds rather than having to drive to the store, get parked, go inside and you know, it takes 20, 30 minutes of my time to get that same item. Amazon prime was obviously a game changer because it meant customers spent more, they purchased more frequently and it further accelerated their flywheel.

[00:43:35] Clay Finck: After going through their 2008 and 2009 letters, there was no mention of the change in the stock price and there was just total focus on the underlying business and communicating the results to shareholders. I liked this piece in the 2009 letter on focusing on what they can control. I quote, Senior leaders that are new to Amazon are often surprised by how little time we spend discussing actual financial results or debating projected financial outputs.

[00:44:04] Clay Finck: To be clear, we take these financial outputs seriously, but we believe that focusing our energy on the controllable inputs to our business is the most effective way to maximize financial outputs over time. Our annual goal setting process begins in the fall and concludes early in the new year after we’ve completed our peak holiday quarter.

[00:44:25] Clay Finck: Our goal setting sessions are lengthy, spirited, and detail oriented. We have a high bar for the experience our customers deserve and a sense of urgency to improve that experience. We’ve been using the same annual process for many years. For 2010, we have detailed 452 detailed goals with owners, deliverables, and targeted completion dates.

[00:44:49] Clay Finck: These are not the only goals our team set for themselves, but they are the ones we feel are the most important to monitor. None of these goals are easy and many will not be achieved without invention. We reviewed the status of each of these goals several times per year among our senior leadership team and add, remove and modify goals as we proceed. End quote.

[00:45:10] Clay Finck: Now 452 goals, what an amazing number in those 452 goals, the words gross profit, margin or operating profit aren’t used one time. So it points to their fundamental approach of starting with the customer and working backwards from there. This also reminds me of when I read Elon Musk’s biography by Walter Isaacson and this theme that just kept coming up in that book was this maniacal sense of urgency to be the best at anything. You shouldn’t wait until someone else is clipping at your heels, trying to take you down. Amazon was just laser focused on how they can improve the value proposition that was offered to the customer. In the 2012 letter, Bezos writes, one advantage, perhaps a somewhat subtle one of a customer driven focus is that it aids a certain type of proactivity.

[00:46:06] Clay Finck: When we’re at our best, we don’t wait for external pressures. We are internally driven to improve our services, adding benefits and features before we have to. We lower prices and increase value for customers before we have to. We invent before we have to. These investments are motivated by customer focus rather than by reaction to competition.

[00:46:28] Clay Finck: We think this approach earns more trust with customers and drives rapid improvements in customer experience. Importantly, even in those areas where we are already the leader, end quote. Now, some shareholders, of course, might not like this approach of continually putting focus on the customers. You know, what if they’re leaving money on the table for absolutely no reason?

[00:46:50] Clay Finck: Some shareholders might even view Amazon as sort of a charity service that provides value to so many people while giving nothing back to shareholders in the form of profits. But Bezos saw things differently. He saw high return on invested capital within the business and any free cash flows would then be reinvested to further enhance the customer experience and grow the business’s scale.

[00:47:14] Clay Finck: In the 2012 letter, he shares one of my favorite quotes. As I write this, our recent stock performance has been positive, but we constantly remind ourselves of an important point. As I frequently quote, famed investor, Benjamin Graham, and our employee all hands meeting. In the short run, the market is a voting machine, but in the long run, it is a weighing machine.

[00:47:34] Clay Finck: We don’t celebrate a 10 percent increase in the stock price like we celebrate excellent customer experience. We aren’t 10 percent smarter when that happens and conversely, we aren’t 10 percent dumber when the stock goes the other way. We want to be weighed and we’re always working to build a heavier company.

[00:47:54] Clay Finck: It’s a good reminder not to get carried away by what is happening in the short term. John Huber just shared with me on the show that most stocks are more volatile than the underlying businesses. A business might be growing by say 10 or 20 percent a year, but you can see these constant swings in the stock price, sometimes 40 or 50 percent swings in a single year.

[00:48:16] Clay Finck: When a stock in our portfolio goes up by 10%, it doesn’t necessarily mean we’re geniuses just like we aren’t dumb just because the stock goes down by 10%. Jumping to the 2013 letter here, this highlights many of the initiatives that were going on within the company. And it’s just amazing. The level of ambition this company has and taking on new projects.

[00:48:37] Clay Finck: I’m just going to list a few here. You have Amazon Prime, Kindle, Prime Instant Video, Fire TV, Amazon Game Studios, Amazon App Store, Spoken Word Audio, Fresh Grocery, Amazon Web Services. Like I could go on and on as he names more here, but it’s just insane the number of initiatives they have. And I could see why investors would be cautious to invest in such a business because it can just be so difficult to determine the value that’s being created and, you know, spreading your attention and spreading your capital across all these bets and so many different initiatives.

[00:49:12] Clay Finck: And as we know, many of them really didn’t create much, if any shareholder value at all. And then in the 2014 letter, Bezos highlighted the three initiatives that really moved the needle for the company. So these are the marketplace, Amazon Prime, and AWS. He kicked off this letter with a bit of a funny comment.

[00:49:33] Clay Finck: I quote, a dreamy business offering has at least four characteristics. Customers love it. It can grow to a very large size. It has strong returns on capital, and it’s durable in time with the potential to endure for decades. When you find one of these, don’t just swipe, right? Get married and quote, and of all the bets that Amazon made, they settled on three that they really found delivered the most value to shareholders.

[00:50:00] Clay Finck: So the marketplace, Amazon prime, AWS. And he highlighted the flywheel that the Amazon marketplace created. Customers were drawn to the vast selection, great customer experience, and the great prices on their website. So valuable real estate was essentially created because they had this large and growing customer base.

[00:50:19] Clay Finck: Then with the release of their third party service, other companies could go sell their products on Amazon, which made their website even more popular, produce more traffic, which would then attract even more third party sellers. So if your business and your competitor is much stronger as a result, because they’re selling on Amazon, then it’s pretty likely that you’re going to need to list your product on Amazon too, because financially it just made a lot of sense.

[00:50:44] Clay Finck: Plus, you didn’t want to lose customers to a competitor because they were listed on Amazon and you weren’t. And then when you look at AWS, this is really just a cash cow for Amazon today. AWS is essentially a cloud computing services that services startups, large enterprises, governments, and many more clients.

[00:51:03] Clay Finck: In 2023 alone, this segment generated 90 billion in revenue. So marketplace got Amazon dipping into the pocket of every single customer, say in the US or whatever other country. And then AWS was really the segment that captured revenue from so many of these businesses, because so many businesses depend on having high performing it services that comes at an affordable price.

[00:51:30] Clay Finck: Next, I wanted to transition here to play a couple of clips from Bezos’s early interviews. One of my favorite frameworks or mental models that’s been shared is one by Jeff Bezos and it’s what he calls regret minimization and how he came to the decision to leave his really good Wall Street job and start Amazon.

[00:51:50] Clay Finck: He explains it here in the interview from 2001.

[00:51:53] Jeff Bezos: I went to my boss and said to him, you know, I’m going to go do this crazy thing and I’m going to start this this company selling books online. And this is something that I had already been talking to him about in a sort of more general context, but then he said, let’s go on a walk.

[00:52:12] Jeff Bezos: We went on a two hour walk in Central Park in New York City. And the conclusion of that was this, he said, you know, this actually sounds like a really good idea to me, but it sounds like it would be a better idea for somebody who didn’t already have a good job. And he convinced me to think about it for 48 hours before making a final decision.

[00:52:31] Jeff Bezos: And so I went away and, and, and was trying to find the right framework in which to make that kind of decision. And, you know, I’d already talked to my wife about this and she was very supportive and said, look, you know, you can count me in 100%. Whatever you want to do, you know, it’s true. She had married this kind of, you know, fairly stable guy, stable career path and now he wanted to go do this crazy thing, but she was 100 percent supportive. So it really was a decision that I had to make for myself and the, and the framework I found, which made the decision incredibly easy was what, what I called, which only a nerd would call a regret minimization framework.

[00:53:16] Jeff Bezos: So I wanted to project myself forward to age 80 and say, okay, now I’m looking back on my life. I want to have minimized the number of regrets I have. And you know, I knew that when I was 80, I was not going to regret having tried this. I was not going to regret having wanted, you know, trying to participate in this thing called the internet that I thought was going to be a really big deal.

[00:53:39] Jeff Bezos: I knew that if I failed, I wouldn’t regret that. But I knew the one thing I might regret is not ever having tried. And I knew that that would haunt me every day. And so when I thought about it that way, it was an incredibly easy decision. And I think that’s a very good, it’s, it’s, if you can project yourself out to age 80 think, what will I think at that time, it gets you away from some of the daily pieces of confusion.

[00:54:06] Jeff Bezos: You know, I left this Wall Street firm in the middle of the year. When you do that, you walk away from your annual bonus. And that’s the kind of thing that in the short term can confuse you. But if you think about the long term then you can really make good life decisions that you won’t regret later.

[00:54:24] Jeff Bezos: Most regrets, by the way, are acts of omission and not commission. You know, I think most people when they’re 80 years old, you know, you can do bad things. You can go murder somebody and that would be bad and that would be an act of commission that you would regret. But most, you know, everyday ordinary non murderers, their big regrets our omissions.

[00:54:45] Clay Finck: So in this example, I just love how he mentioned that it helps remove you from the daily confusion or the daily noise. There’s so much that we focus our attention on today that is, you know, pretty important in the short term and it can sort of blind us to what is most important in the longterm. For example, it’s very easy to put off investing or get started investing early.

[00:55:09] Clay Finck: But when you zoom out and you look at the potential consequences of what’s most important to you, maybe it’s providing a good education for your kids or it’s having a comfortable retirement or giving money to a certain organization. You know, it helps you zoom out and figure out what is most important and what are the really key decisions that you need to make to get what it is you want most out of life.

[00:55:34] Clay Finck: So for the next clip here that I’m going to be transitioning to, this is related to working on things. that suit your personal skillset as being a host of the show and speaking with so many of these really successful investors. Time and time again, I hear that you really need to enjoy what you’re doing day in and day out.

[00:55:53] Clay Finck: Otherwise you’re just not going to be able to achieve things at a really high level, which I suspect many of our listeners want to do. Unfortunately, this lesson Bezos shares. Is one that I learned the hard way, but thankfully I eventually discovered a path that allowed me to leverage my own skill sets and interests.

[00:56:12] Clay Finck: So this clip from Bezos reminded me of that. So here, I’ll go ahead and play it.

[00:56:17] Jeff Bezos: I went to Princeton primarily to, because I wanted to study physics and which, and, and was, and it’s such a fantastic place to study physics and. And it went, and things went fairly well until I got to quantum mechanics, and I started, I wrote, there were about 30 people in the class by that point.

[00:56:38] Jeff Bezos: And it was so hard for me, and I just remember there was a point in this where I realized I’m never going to be a great physicist. There were three or four people in the class whose brains were so clearly wired differently to process these highly abstract concepts in, you know, so much more. I mean, I was doing well in terms of the grades I was getting, but for me, it was laborious, hard work.

[00:57:04] Jeff Bezos: And for some of these truly gifted folks it was, I mean, it was awe inspiring for me to watch them because in a very easy almost casual way, they could absorb concepts and solve problems that I would, you know, work 12 hours on. And it was a, it was a wonderful thing to behold. At the same time, I had been studying computer science and was really finding that that was something where I was drawn toward, drawn, I was drawn to that more and more.

[00:57:34] Jeff Bezos: And that turned out to be a great thing. So, I found one of the great things Princeton taught me is that I’m not smart enough to be a physicist.

[00:57:42] Clay Finck: Alright, so that wraps up today’s episode. If you enjoyed this episode, I’d really appreciate it if you shared it with just one friend. Your support of TIP means the world to us, so I’d really appreciate it.

[00:57:54] Clay Finck: Also, I can’t help but mention, if you know of any CEOs today who write such great letters like what Bezos has written, let me know. I would personally love to check them out as I’m reading these. I can’t help but think of the massive opportunity people had to invest in a company like this. You know, Bezos was putting these letters out to the world, but of course there’s also so much hindsight bias at play.

[00:58:17] Clay Finck: So surely, there are some other CEOs out there who are exceptional capital allocators and effectively communicate their strategy to shareholders and the competitive advantages they bring to the market. You can reach out to me on Twitter at Clay_Fink or shoot me an email clay@theinvestorspodcast.com. I’d love to hear from you, just hear what you thought of the episode. And if you’ve come across any letters nowadays that remind you of today’s episode.

[00:58:42] Clay Finck: All right. So thanks for tuning in and I hope to see you again next week.

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