Permanent Equity: Investing in Companies that Care What Happens Next

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Amazon: Gorilla Mode –Introduction

Sarah George

THE UPSTART GETS DISRUPTED

In 1965, 24-year-old Len Riggio invested $5,000 to open the Student Book Exchange, a single bookstore near New York University. Six years later, he had the opportunity to expand his business by buying a reputable bookstore at Fifth Avenue & 18th Street. That bookstore was Barnes & Noble.

Throughout the seventies, Riggio refined his company’s approach to selling books. They offered 40 percent off best sellers. They encouraged customers to buy lesser known, full-price titles. They marketed heavily, including television commercials - the first bookseller to do so. They built a 40,000 sq. ft. Sales Annex across from the flagship store on 5th Avenue. Then, Riggio’s team spent the next two decades building Barnes & Noble into the top bookseller in America through every method imaginable at the time: acquisitions, mail order, merchandising, and new store concepts.

By the mid-1990s, Barnes & Noble superstores had put small shops out of business and created a dedicated company for college campuses called Barnes & Noble College Bookstores. The college business alone was estimated to be worth more than $1 billion at the time.

While the brick-and-mortar business thrived, brothers and Barnes & Noble executives Len and Steve Riggio did begin to look at the Web in the nineties, as detailed in a revealing 1999 retrospective by Warren St. John in Wired. They recruited younger employees to work on a website. But, the initiative wasn’t considered a high priority.

They’d heard about this guy selling books online. He was 30 with no industry experience except for a four-day lecture at the American Bookseller Association. He had a website too - but this was in mid-1990s - and had raised $1 million. Who was Jeff Bezos? A competitor or a curiosity?  

In 1996, The Wall Street Journal published an article about Amazon: “Wall Street Whiz Finds Niche Selling Books Online.” That caught the Riggios’ attention. The $16 million in sales Amazon did that year was fairly inconsequential compared to Barnes & Noble’s $2 billion, but the Riggios requested dinner with Bezos in Seattle anyway. He said yes.

As an ironic aside, when Jeff Bezos started Amazon in the early 1990s, he, his wife MacKenzie (a novelist who studied under Toni Morrison at Princeton University) and the only outside employee, Shel Kaphan, would conduct meetings at the local Barnes & Noble.

As Brad Stone explained in The Everything Store, the Riggios met Bezos and Tom Alberg, an Amazon investor and board member, at the Dahlia Lounge in downtown Seattle.

“They told Bezos and Alberg they were going to launch a website soon and crush Amazon. But they said they admired what Bezos had done and suggested a number of possible collaborations, such as licensing Amazon’s technology or opening a joint website…”

As we all now know, the confident Riggios of 1996 didn’t predict the future for themselves, or Bezos’ enterprise. Apparently Len Riggio wanted to call Barnes & Noble’s website Book Predator. In the 1999 Wired article, one former Barnes & Noble employee is quoted as saying that the team believed that because of “the deep pockets of Barnes & Noble… we could outlast… and out-discount [Amazon].” What they undervalued in calculations, along with the difficulty of selling online, is that Barnes & Noble had physical bookstores, mostly very large ones, scattered throughout the country on prime pieces of real estate. With thousands of employees and expensive rents, overhead was a far greater consideration in their strategy than in Bezos’.

Adding further nuance was the issue of taxes. Barnes & Noble had physical real estate in each state and paid taxes in each state - even for online orders. By contrast, Amazon only charged sales tax for Washington and Nevada orders. To compete on price, Barnes & Noble had to offer deeper discounts.

In 1997, Amazon posted $148 million in revenue, and Jeff Bezos drafted his first - and still often quoted - shareholder letter. That year, Barnes & Noble filed a lawsuit against Amazon over slogans; Amazon countersued. As St. John wrote in his Wired article, “[The lawsuit] reinforced the view of Barnes & Noble as an old, tired, unhip giant – exactly the wrong image to project to the burgeoning Web audience.”

By the end of 1998, Barnes & Noble’s position was painfully clear. The company had spent over $100 million on its own online efforts, but Amazon was clearly winning. Steve Riggio left his executive role by the end of the year, and an executive from AOL UK was brought in to try to improve the company’s competitive position, particularly online.

In the 1999 Wired piece, Len Riggio is quoted:

“At this point in time anyone who has a strategy that requires them ‘winning it’ is somewhat delusional. A much more appropriate strategy would be making it.”

In 2000, U.S. Patent No. 5,960,411 caused Barnesandnoble.com to have to intentionally complicate its online checkout process. The patent owner? Amazon.

Looking at today’s stock data, Barnes & Noble ($BKS) has a market cap of $530.19 million. Amazon ($AMZN) has a market cap of $478.94 billion.

DEFINING A GORILLA

Barnes & Noble, and the book industry more broadly were Amazon’s first target. Many others overestimated their position, and underestimated Amazon’s goals and strategies.

Today, Amazon is a topic of conversation in virtually every sector of North American-based business. Reuters reported earlier this year that out of over 700 quarterly earnings calls so far in the season, one out of ten mentioned Amazon; that represents more than double the mentions of Google and more than three times that of Apple. Perhaps more telling, none of the retailers had held their calls when the article was published. It’s not just retail who’s concerned.

Amazon is the 800-pound gorilla, or as we stated in our last essay on Amazon, “the Borg.” While some youngsters in our office had to look up the reference, it is undeniably fitting. Without diving into Star Trek storylines, the Borg stands for the idea that, “Resistance is futile.”

To illustrate the sheer scale of its operation, a few recent data points on Amazon include:

Still, haters are going to hate. Here’s a sampling of articles speculating on whether Amazon has already peaked or is in a downward spiral:

Noise is a persistent pest.

Hendrik Bessembinder, a finance professor at Arizona State University said in The New York Times, “[Amazon is] one of the greatest wealth creators since 1926, and it’s reached that status in a very short period of time… [with an] annualized return through 2016 [of] 37.4 percent.”

Before you’re inundated by more information on Amazon, we want to share some encouraging words. The reason Permanent Equity still invests in small to mid-size private companies and doesn’t just buy $AMZN was nicely summarized by the founder himself in an interview with Charlie Rose last year:

“Think about what are the things you know will be true even ten years from now… Your competitive set will change, the technologies you have available to you will change, but the customer needs, if you find the right ones, will tend to be stable in time… [They] won’t ever go out of style.”

… And then go read, “My Advice To Anyone Starting A Business Is To Remember That One Someday I Will Crush You” to even things out.