One of the best ways I learned how to identify great companies was to study a handful of successful companies, how they started, how they disrupted large incumbents, continued to grow, and fended off disruptors once they became the dominant force. To do this, I looked at both qualitative and quantitative characteristics, what were they doing during periods of large share price growth and decline?

Once I did a couple of these, it became clear to me great companies had many common traits. I was then able to look for these traits in companies that were earlier in the lifecycle. Here is an example of the case study I did on Amazon.

Note: everything written below is my own opinion and analysis and is not meant to be taken as financial advice.

Disclaimer: I am not an Amazon shareholder, but I am an Amazon Prime subscriber :)

The rise of Amazon – [1994 – 2004]

Jeff Bezos founded Amazon in 1994, which started as an online book retailer competing against brick-and-mortar stores before expanding into a store that sells almost everything. Amazon's core strategy focused on customer obsession and thus, it never limited itself to an internet company. Amazon now operates across many industries, with e-commerce, retail, cloud computing (AWS) and subscription services (Prime) being the largest divisions.

In this first section, I focus on Amazon’s formative years and how it grew its e-commerce platform. I look at some of the key strategies Amazon employed as an emerging challenger and the way it changed how consumers shopped to become the biggest retail company in the world.

Amazon faces the difficult task of attracting billions of consumers, over and over again, in a highly competitive environment where people can switch to an alternative at any time, with minimal cost. Amazon's strategy focused on customer obsession and invested heavily in the user experience to win and retain customers.While Amazon's business model has evolved, the core ethos remains the same.

After extensive research, Amazon found that customers cared most about three core features when shopping online:

A large selection of products
Low or competitive prices
Seamless delivery and returns.

Rather than focusing on margins and profitability in its early years, Amazon's sole purpose was to deliver on these three features and change how consumers viewed and felt about online shopping. The strategy required significant time and financial investment. We include the Amazon flywheel below:

It is easy to envision Amazon delivering on these now. However, in its early years, how did Amazon, with much less capital, provide such competitive prices and an extensive product catalogue?

Jeff Bezos already had a vision for Amazon, and books were only the starting point. During this time, Barnes & Noble was the Goliath bookstore with hundreds of stores and more than $2bn in revenue. Jeff Bezos recognised very early that web commerce would become the next big thing that would transform consumer behaviour. He created a list of ~20 products that could benefit from online marketing, narrowing the list to compact discs, computer hardware and software, videos and books. The defining feature was that each product had to be homogenised and that consumers were sure of what they were purchasing, making price the primary decision driver.

Amazon ultimately commenced as an online book retailer, as it had many categories and only a handful of distributors to negotiate with. Amazon's initial strategy was to compete on price while providing a great customer experience. Despite not having the scale to negotiate the same prices with suppliers, it knew that as an online retailer, it had a competitive advantage with its lower cost structure. Amazon could carry a greater selection of products without facing the same floor space restrictions, ultimately allowing it to offer products at lower prices. To illustrate, by 1997, Amazon carried more than 2.5 million book titles compared to a local bookstore with a fraction of the amount.

The result?

Astronomical amounts of success. The online book shopping experience proved that there was a much better way for consumers to shop. Since Amazon was trying to change shopping behaviour that was ingrained for years, it had to start small, and books were a perfect product. Customers no longer needed to attend a bookstore, saving time and effort while also extending reach. As books were a homogenised product, customers did not need to try the goods and could effortlessly choose from an almost unlimited selection with a few clicks of a button at a price that was typically lower than the local bookstore, and the return policy was EASY. With minimal advertising, sales soared as more people became aware of this new way to shop.

In most circumstances, there was no longer a need to attend a store in person as purchasing on Amazon was simply easier, more enjoyable and sometimes faster (I will be the first to admit that I sometimes buy bulk household goods on Amazon as I am too lazy to go to the groceries). Amazon continues to invest in the customer experience, introducing features such as 1-click purchasing, Amazon Prime, Amazon Go (no check-out grocery), and I am sure many more to come.

Another feature born out of the large user base, creating a network effect that further reduced the friction for online shopping, was customer reviews. By having hundreds to thousands of user reviews for each product, shoppers could buy with confidence that each product had been tried and vetted.

What did Amazon look like as an investment?

Amazon IPO’d in 1997 with a valuation of ~US$438m. With its early success, Amazon’s peak valuation in 1999 reached over US$30bn. However, despite being a fantastic company, valuation cratered alongside other internet companies during the tech wreck of the 2000s. Amazon’s valuation fell ~90% from its US$30bn high to ~US$2bn low. This is a lesson and reminder for investors that no matter how great a company is or may seem, it is not immune to market cycles and volatility in the short term. Below is Amazon’s market cap from 1997-2004.

I would like to point out that right before the tech wreck, Amazon, in a lucky or timely manner, sold ~$700m of convertible bonds, which gave it the capital to survive the crash and ultimately grow its business as many competitors folded. Without this, Amazon could look very different today.

As we all know, Amazon survived, and its valuation eventually recovered. However, for owners of Amazon stock (especially those who purchased right before the tech wreck), it took almost until 2007 before it reached the same valuation. The timing of investment matters.

While Amazon was already a well-established company before the tech wreck, I see some similarities to what has happened in the current tech boom/bust. The Key Learning for me here is that in the last few years, some companies reached valuations on very high multiples based on their future growth prospects and earnings, which subsequently fell apart. In my view, however, at the time, some of them may be justified, and this could be one reason bubbles always fool us all.

Let’s take a hypothetical illustrative example. I opened a cafe with amazing coffee, clearly better than Starbucks. My business has taken off, and I opened 50 cafes across the country with plans to make that 5000 in the next three years. I am allocated a valuation multiple that rivals other superstar growth companies, with many thinking I will overtake Starbucks in the next decade as long as I keep opening stores.

Then, the environment changes, interest rates rise, capital becomes expensive, and funding dried up. I have committed all my money to opening the fanciest stores, paying top dollar to all my staff, and now, I no longer have access to money. It is clear I can no longer execute my three-year strategy. I can’t hire the best baristas or open cafes in the best locations with the nicest fittings. During this time, Starbucks had the financial flexibility to keep investing, hiring better baristas and opening stores in the spaces I originally wanted.

As such, despite seemingly being the same company, the valuation of JKH’s cafe plummets because, in fact, it was no longer the same company with the same growth aspirations. I could no longer execute my strategy to generate the same revenue growth. What this tells me is that market sentiment, environment, and macro conditions do matter.

The next steps - Global Dominance [2004-Present]

Amazon expanded into numerous verticals and regions by applying the same core principles. Sales and valuation growth followed (as shown below) until its e-commerce platform became the largest globally.

Amazon's early strategy revolved around growing as fast as possible, reaching every possible customer with its 'Everything Store' at the expense of early profitability. Amazon knew that once it built sufficient scale, it could continue to improve customer experience to a point that competitors could not replicate. Amazon also utilised its lower prices and eliminated many competitors with higher cost structures. To continue its growth trajectory, Amazon had to further lower customer acquisition costs and drive repeat purchases.

Amazon recognised that fast and seamless deliveries were essential for e-commerce to succeed against traditional retailers. It further invested and built out its global supply chain, embracing automation and robotic solutions.

Amazon envisioned that its platform could replace traditional retail stores for all products, but shipping costs posed a challenge for everyday household goods. Amazon Prime was born. Amazon Prime is a monthly subscription that consumers pay to reduce or cut shipping costs entirely. I could spend hours talking about the genius of Prime, but in short, as well as providing a high-quality recurring revenue stream, I believe it is one of the key drivers of repeat customers and provides synergies and exposure to Amazon's entire consumer ecosystem.

Amazon Prime launched in 2005, where customers could make an upfront payment of $79 and receive unlimited two-day deliveries compared to $9.48 when paid separately. Amazon's addressable market expanded as shoppers were more willing to buy everyday household goods, and the deliveries developed a reputation for being fast (sometimes with products available that were sold out in stores) and reliable.

Amazon Prime has surpassed 230m subscribers, generating ~7% of revenue (and growing). More importantly, research found that Prime members spend approximately four times more than non-prime members (Quartz, BAML), driven by both frequency and average basket sizes.

Amazon Prime evolved to include Prime Video, Prime Gaming, Prime Music and Prime Reading. Amazon Prime became an entertainment platform AND provided free shipping. In addition, Prime increases revenue through cross-selling and allows Amazon to spread costs over a larger revenue base, giving it an advantage over its competitors. What I mean by this is Prime can use revenue from subscribers who signed up for free shipping to procure and develop media content with far higher funding, driving further subscriber growth.

Open ecosystem strategy

I believe Amazon's open ecosystem strategy was one of the critical drivers of success and probably why it beat eBay. Like many companies before it, and even now, Amazon could have used its competitive advantages to eliminate competitors. However, going back to Amazon’s focus on customer obsession, it realized by opening its ecosystem, it could provide an even better experience for customers.

Amazon expanded its online store into an online marketplace, allowing other vendors to sell products on the platform (think eBay) and utilise Amazon's supply chain and delivery services for a fee, of course.

The Amazon marketplace essentially turned Amazon into an online 'shopping centre', allowing it to expand its product catalogue further, generate additional revenue streams and compete head-on with eBay while providing sellers the benefits of its supply chain. Think about it, rather than solely benefiting from its one-day deliveries and supply chain itself as a better experience for customers vs. its competitors, it let other retailers also provide this service to their customers and basically changed the world, or at least, my world.

Other sellers (retailers) joining the platform became customers or Amazon partners rather than competitors and benefitted from higher search traffic and lower costs. In addition, another key strategic difference compared to eBay is that eBay is seller-focused and treats the seller as its primary customer. The websites were tailored around a 'seller-store' with customer reviews also based on the seller. In contrast, Amazon is product-focused, with search functionality on products that could include multiple sellers at different price points and locations and user reviews also focusing on the product. While eBay may be preferred by sellers looking to establish their own brand, ultimately, Amazon proved a better platform for customers.

For a fee, Amazon could also manage inventory for sellers, meaning its end customers had access to Amazon's fulfilment and delivery systems, alleviating a significant pain point for sellers and customers. Customers essentially dealt with Amazon for any issues and product returns that arose rather than individual sellers on eBay. Third-party services (marketplace commission, delivery commission and fulfilment) now contribute ~24% of Amazon’s total revenue.

Amazon Web Services (AWS) further highlights Amazon's open ecosystem strategy. AWS is the cloud infrastructure arm of Amazon. As Amazon scaled from its early growth days, it faced infrastructure problems and had to build internal systems to deal with the hyper-growth it achieved. AWS became a critical element of Amazon and was so successful that it became an operating system for businesses.

Like how Amazon shared its logistics capabilities, Amazon again shared its internal systems with its retailers and prospective clients. Businesses could rent computer power, storage, servers, and networking. AWS offered online tools to businesses and other organisations on a pay-as-you-go basis. AWS again solved a customer problem and became a no-brainer for many businesses as they could save and outsource IT infrastructure and employee costs compared to managing it themselves. AWS generates ~16% (US$91bn) of Amazon's revenue.

The open ecosystem strategy Amazon employed meant that not only individual consumers but many businesses in the world are now customers of Amazon and use their delivery and supply chain or IT infrastructure. It turned competitors into partners, and while some people could argue that Amazon could have used its advantages to eliminate competitors, it is a riskier strategy. We have seen many times in the past where a competitor eventually displaced established companies. It is much harder to displace an ecosystem than a company.

I include a graphic of Amazon’s ecosystem in 2019 as follows:

Financial profile, valuation and how Amazon became even bigger.

With Amazon's evolution as a business, let's look at what happened to its valuation. Amazon IPO'd in 1997 with a market value of US$438m. By 2004, Amazon was worth ~US$18bn, while its online rival and internet darling eBay was worth nearly US$33bn. Today, eBay is worth ~$25bn while spinning off its more valuable PayPal division. Amazon? At the time of this article, its market capitalisation was ~US$1.33 trillion.

We present a historic earnings table for Amazon:

Amazon averaged 27% revenue growth annually from 2005 to 2023 (this is downright ridiculous), with EBITDA margins improving from ~6.5% to ~14%. From 2005-2023, Amazon achieved 20%+ revenue growth almost every year, which is remarkable given the business scale. As the company grew, its gross profit margin improved from 20% to ~47% today.

During this time, Amazon invested, on average, ~29% of gross profit into R&D, notably increasing in recent years. Similarly, investments in sales and marketing averaged 14%. Despite its growth, Amazon continued its investment strategy (R&D and S&M as a % of gross profit remained consistent, even increasing). Instead of taking profits, Amazon improved profitability by efficiency and scale (as shown by improvement in gross margin)

While Amazon's enterprise value skyrocketed, it achieved consistent annual earnings growth, meaning multiples remained somewhat consistent. This just goes to show that as long as you can achieve consistently strong revenue growth, investors will reward investment.

As Amazon grew, it earned investors' trust, essentially unlocking an unlimited supply of capital. Amazon could test other ideas at relatively low risk compared to other companies. Once Amazon reached critical mass, it flexed its financial power to continue growing through acquisitions. I want to highlight Amazon's top five acquisitions:

Whole Foods (US$13.7bn, 2017) – Dramatically expanded Amazon's brick-and-mortar footprint and gave Amazon a much stronger position in grocery deliveries.
Metro-Goldwyn-Mayer (MGM) (US$8.5bn, 2021) – American media company specialising in film and television production to grow Prime Video.
One Medical (US$3.9bn, 2022) – As Amazon looks to grow its healthcare operations
iRobot ($1.4bn, 2022) – Amazon expands its automated robotic devices (Roomba!)
Zappos $1.2bn, 2009) – An online shoe and clothing retailer, acquired to expand Amazon's footprint in clothing goods.

As a gamer, I would like to give a special shout-out to Twitch Interactive ($970m, 2014) – An online video game streaming platform.

Amazon was able to utilise its e-commerce cash cow and treasure chest of funding to continue to expand. All five of Amazon's most significant acquisitions helped it enter a new market, grow its presence, unlock potential cross-sell synergies, and ultimately grow the Amazon ecosystem.

KEY TAKEAWAYS

Below are my key takeaways from the Amazon case study. Note that these are my opinions and should not be taken as factual. What stood out to me was Amazon’s innovative strategy as an emerging competitor and the open ecosystem strategy once it had already won. To change how people do things, you need to be different, but you also need to be better. Amazon’s latter strategic move, in my view, allowed it to develop a competitive moat and continue to scale beyond a company into an ecosystem to generate the valuation it has today.

Amazon solved a problem - and actually improved the consumer buying experience
Strategy - Amazon had one primary focus; customer obsession and built its strategy around this ethos and stuck to it.
1. As the challenger - Amazon had to allocate its resources to where it could provide a differentiated service. Ultimately, Amazon was able to enhance buyer experience utilizing its lower cost structure
Market cycles are important: Despite already being a successful business, Amazon almost collapsed during the dot-com bubble had it not raised sufficient, timely capital. Valuation cratered ~90% from high to low.
1. The timing of your investments matter
2. The same company operating in different market conditions can have very different growth trajectories, commanding different valuation multiples
Investing in growth - Amazon has always invested in improving the customer experience. Amazon consistently spends 20-30% of its gross profit on research and development and 10-20% on sales and marketing. Instead of scaling back on spending, Amazon continues to invest in growth opportunities and its ecosystem both in absolute and percentage terms. Instead, Amazon improved profitability from efficiency and scale, as highlighted by the improvement in gross margin.
1. Investors will reward investment if it is backed up by revenue growth
2. If Amazon ever chose to completely scale back investment, it would be a significant cash-generating business
Open ecosystem and scaling beyond a business - For its next phase of growth, Amazon embraced an open ecosystem, allowing other sellers, customers and competitors to use its services (deliveries, marketplace, AWS).
1. As a result, Amazon built its own ecosystem turning potential competitors into customers and partners, with participants also benefiting from the network effects.
2. Amazon generated 24% of its revenue from third-party services and 16% from AWS.
M&A to drive further growth - Once it reached critical mass, Amazon flexed its financial power and began an aggressive M&A strategy to buy out competitors, expand into other sectors and grow its existing business.
Quality business – Amazon is a high-quality business and ticks my three checkboxes when looking for long-term structural growth companies.
1. Large addressable market and growing
2. High-quality, best-in-class product
3. Favourable market structure vs. competitors.

Case Study: Amazon - the customer obsessed retailer