December 26, 2013

The Disruptor

A few Boxing Day words about one of the country's biggest shippers of things in boxes.

In the Innovator's Dilemma, Clayton Christensen argues that companies tend to put too much emphasis on a successful current business model and fail to anticipate or adopt new technologies that will meet future needs.

This leaves them vulnerable to "disruption from below," competition they ignore because facing it directly would threaten profit margins and require adopting new strategies their long-established business cultures aren't comfortable with.

Paul Thurrott points to this anecdote featured in The Everything Store: Jeff Bezos and the Age of Amazon by Brad Stone as a near-perfect example of a businessman following Clayton Christensen's advice practically to the letter:

In a move straight out of The Innovator's Dilemma, Bezos in 2004 instructed the nascent Kindle team not to be hobbled by concerns about the firm's then-successful book business. "Your job is to kill your own business," Bezos told the man running the Kindle team. "I want you to proceed as if your goal is to put everyone selling physical books out of a job."

Eugene Wei take on the glib criticism (often, ironically, coming from the left) that Amazon just isn't making big enough profits (unlike, ironically, tree-hugger darling Apple).

If I were an Amazon competitor, I'd actually regard Amazon's current run of quarterly losses as a terrifying signal. It means Amazon is arming itself to take the contest to higher ground. The retail game is about to become more, not less, punishing.

And arriving just in time to provide a real-time, real-world case study of what happens when a company doesn't adapt to that "disruption from below," Blockbuster is closing the rest of its stores and shuttering its Netflix-style DVD mail service.

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# posted by Anonymous Dan
12/26/2013 3:33 PM   
It is understandable why consumers love Amazon - no other retailer gives its customers a better deal than it does. What begs explanation is what value Investors see in a company that has a 1% operating margin? The traditional answer would be that profits will come as the company grows more efficient. Yet Amazon is already very large and very efficient. So what will be its profit mechanism?

The obvious answer is for Amazon to give customers less good of a deal. But doing so is counter to Amazon's core philosophy!

The appearance of a good deal is crucial to Amazon's success. But the challenge is Amazon must do this in an environment where there is so much transparency on what the cost of the deal really is!

This explains Amazon's strategy of bundling products and services. Perceived value increases but the company is able, in theory to get take a larger share of the consumer surplus for itself.

Thus, I can make sense of Amazon's business model. I still cannot make sense of the Investor model. Current buyers of the stock are very greedy, very generous or very patient. Those taking profits ought to consider themselves very fortunate.

Questions include how well will Amazon accomplish this with Apple, Google and Netflix

I suspect what Bezos hopes to achieve is to make Amazon

No company can compete against
Thus the Investor attitude towards Amazon and other e-commerce companies is most curious (just as it was in 1999). If in fact the future is in moving bits what are the profit margins of doing so? More importantly, what are the long term returns to investors, other than buying low and selling high?
# posted by Blogger Joe
12/28/2013 5:04 PM   
Clayton Christenson takes one part of one concept and flogs it to death. His arguments are entirely ex post facto, failing to look at all the business that tried to be innovative in legitimate ways and failed (and even some who were innovative in loony ways and succeeded.)

I don't disagree that businesses should be forward looking, but in the end, to be successful businesses need to do very traditional things very well. A big irony of Amazon is that it hinges on a very traditional, albeit very well run, warehouse system. Walmart already broke the major ground here; Amazon just refined it and sped it up. In the end, though, they still make lower margins than your typical grocery store chain.

There's a few lessons I've picked up over the years and one is that any business that forgoes traditional business principles, especially as an expense of innovation, won't last.

(I've also learned that picking up the pieces of the wreckage of innovators can be quite successful.)
# posted by Blogger Joe
12/29/2013 6:24 PM   
One more thing: for all it's low prices and convenience, is a remarkably crappy site. It's search and filtering functionality is bare bones and it has a multitude of bugs and quirks with creating orders (especially with picking the wrong shipping address and inadvertently ordering multiple items.)
# posted by Anonymous Dan
1/01/2014 4:24 PM   
I agree with Joe that every successful business does some fundamental aspect of business well. Amazon is clearly successful and it is not because it is "paranoid" or constantly reinventing itself. No, Amazon is focused on reducing costs all while maintaining consumer value. Yes, Amazon is willing to develop products that might cannibalize another department but it is not the first nor last company to do this. The iPad cannibalizes sales of Macs and the iPhone cannibalizes sales of iPads. This process of innovation is something every successful company must do.

I am more curious about how long investors will be willing to invest "at any price" in businesses that operate in low margin businesses. The dotcom bubble was summed up in the observation that companies without sales were being valued in the billions of dollars. Currently we are seeing profitless dotcom companies being valued in the tens of billions of dollars. As usual the hook is that the business can scale or otherwise monetize its users. But as Sailor observes the reality of these new dotcom companies is their billions in market cap are based on getting suppliers to sell their time and capital for pennies on the dollar. This is not a sustainable business model as eventually those providing the low cost taxi service or bed will demand higher compensation.

These will be viable businesses but just not worth billions and billions. Although the pizza and newspaper delivery businesses show that there is no shortage of people willing to undervalue the wear and tear of miles on their vehicles.

"In recent years, Silicon Valley fortunes have been made by taking yesterday's depressing ways to eke out a few bucks -- taking in lodgers, hacking a gypsy cab, selling your possessions, etc. -- and giving them a 21st Century gloss."
# posted by Anonymous Dan
1/04/2014 12:05 PM   
Excellent critiques of a real limitation of the Netflix streaming service. Amazon Prime faces the same challenge but then Prime is a compliment product and not the company's raison d'etre. In any case, just more evidence to me that investors have greatly exaggerated views of the long term profitability of digital streaming.

BTW, I had assumed the Netflix streaming library was much more comprehensive than it actually is. Turns out the cupboard is rather bare, at least when it comes to headline movies of the past 30 years.