Technology

Amazon, the Company That Ate the World


(Corrects to magazine version.)

Jeff Bezos is channeling Steve Jobs. It’s mid-September and the wiry billionaire founder of Amazon.com (AMZN) is at his brand-new corporate headquarters in Seattle, in a building named Day One South after his conviction that 17-year-old Amazon is still in its infancy. Almost giddy with excitement, Bezos retrieves one by one the new crop of dirt-cheap Kindle e-readers—they start at $79—from a hidden perch on a chair tucked into a conference room table. When he’s done showing them off, he stands up, and, for an audience of a single journalist, announces, “Now, I’ve got one more thing to show you.” He waits a half-beat to make sure the reference to Jobs’s famous line from Apple (AAPL) presentations hasn’t been missed, then gives his notorious barking laugh. With that, Bezos pulls out the Kindle Fire, Amazon’s long-anticipated tablet computer—and the first credible response to the Apple iPad.

Unlike a wave of other tablets that have emerged hopefully only to flop, such as the HP TouchPad, the Motorola Xoom, and the RIM PlayBook, the Kindle Fire has a good shot at turning the newest theater of war in high-tech into a two-tablet battle. With a 7-inch display, the Fire is about half the size of the iPad. At $199, it’s also less than half the price of the cheapest Apple model. Amazon has painted over the rough surfaces of Google’s (GOOG) Android operating system with a fresh and easy-to-use interface and tied the device closely to its own large and growing content library. Kindle Fire owners can watch the film Rio, scroll through magazines such as The New Yorker or Esquire, and access their music collection on Amazon’s servers.

“What we are doing is offering premium products at non-premium prices,” Bezos says. Other tablet contenders “have not been competitive on price” and “have just sold a piece of hardware. We don’t think of the Kindle Fire as a tablet. We think of it as a service.”

To demonstrate the Kindle Fire, Bezos pulls up a chair. He proudly shows off a lightning-fast Web browser that runs on Amazon’s EC2 cloud computing engine and Amazon’s version of the Android app store, with over 10,000 games, e-mail programs, shopping guides, and the like. Bezos pauses briefly to exhibit his dexterity at a game called Fruit Ninja, zapping watermelons and kiwis that fly across the screen, and appears to momentarily lose himself in the effort. “I do find it strangely therapeutic, uncomfortably therapeutic,” he says.

There are some limitations to the Kindle Fire. Unlike the iPad 2, it doesn’t have embedded cameras or a microphone, and there’s no 3G cellular connection, only Wi-Fi. Its diminutive size, which makes it so handy for stashing in a coat pocket, also makes it unlikely to satisfy more than one antsy kid on a long car ride. The versatile iPad 2, with its video chatting capabilities and exquisite screen resolution, is a lifestyle-defining objet d’art. The stripped-down Fire is more of a sit-back-on-the-sofa-and-shop device. It crystallizes the difference between Apple, which tends to keep prices (and profit margins) high, and Amazon, which likes to start low and drive lower in an effort to knee-cap the competition. The tablet is symbolic of Amazon’s remarkable ability to adapt and reluctance to cede the future to anyone. If the Fire and its inevitable sequels are successful, they will add even more might to one of the fastest-growing retail operations the world has ever seen.

 

Amazon’s 1990s slogan—”Earth’s largest bookstore”—stood for an ambition that now seems cute. Amazon boasted of its unlimited selection of books, even though in most cases it was simply having them shipped directly from distributors. Today, Amazon sells millions of goods and services, from toys and high-definition televisions to server space for other Internet companies and digital reading devices for book lovers. Borders found it impossible to match Amazon’s selection and went out of business earlier this year. Best Buy (BBY) has watched Amazon undercut it and commoditize whole product categories, and is now trying to shrink the square footage of its superstores. Wal-Mart Stores (WMT) has struggled to match the ease and reliability of Amazon’s shipping network, and posted nine straight quarters of declining same-store sales. Websites that have matched Amazon in selection, price, and customer service—Zappos, Diapers.com—Bezos has quickly acquired.

“Amazon is not a fight-on-their-knees kind of company,” says Rob Glaser, the Seattle entrepreneur behind RealNetworks (RNWKD) and now also a venture capitalist at Accel Partners. “Jeff’s a hyper-competitor.”

As its rivals steadily asphyxiate, Amazon is ringing up 50 percent growth in quarterly revenues, and could reach $50 billion in sales this year. Walmart needed almost twice the time—33 years—to cross that threshold. “Amazon is such a smart learning organization,” says Nancy F. Koehn, a professor of business administration at Harvard Business School. “It’s like a biological organism that through natural selection and adaptation just keeps learning and growing.”

Amazon is also facing a new kind of challenge that competitors like Walmart are intimately familiar with—cultural backlash, or at least the early signs of it. The company has been criticized for waging an expensive state-by-state battle to avoid collecting sales taxes, and more recently for skimping on air conditioning in its East Coast distribution centers during a brutally hot summer.

If the Kindle Fire is half as good as it looked in Bezos’ conference room, it will fan the fears about Amazon’s growing dominance. The tablet funnels users into Amazon’s meticulously constructed world of content, commerce, and cloud computing. Just like owners of Kindle e-reading devices tend to start buying all their books from Amazon, Kindle Fire owners are likely to hand over an increasing chunk of their entertainment budget to Jeff Bezos.

Tablets represent a huge opportunity for Bezos, not only to sell a new kind of device but also to entice people to buy more stuff. Even with only 28.7 million iPads sold, e-commerce sites say they see an increasing amount of traffic coming from tablets. Forrester Research (FORR) reported this summer that online purchases made on tablets now account for 20 percent of all mobile e-commerce sales, and that nearly 60 percent of tablet owners have used them to shop. Bezos says tablets “are a huge tailwind for our business.” Amazon once saw spikes in traffic during the workday lunch hours. Now traffic is more evenly distributed as people pick up their tablets anytime of the week, buying the books and albums they see on television and making impulsive decisions about replacing their dishwashers.

The Kindle Fire (internal code name: Otter) is designed to ensure that even more of those purchases go to Amazon. The company has built a tablet-optimized shopping application, with simplified and streamlined pages but none of the clutter of the main website. The app is pre-installed and sits at the bottom of the Fire’s main screen (users can get rid of it if they want). The device also comes with the enticement of a 30-day free trial of Amazon Prime, the company’s $79-a-year two-day delivery program that tends to convert members into Amazon addicts who triple or even quadruple the amount they spend on the site. Since March, Amazon has also administered its own app store for Android devices, culling Google’s more comprehensive selection and removing everything that’s offensive and unreliable. Kindle Fire owners will have access to apps from Pandora (P), Twitter, Facebook, and Netflix (NFLX). Other competitors such as Barnes & Noble (BKS) can submit their apps, but it will be much easier for Kindle Fire owners to find Amazon’s own content.

That’s one reason Amazon is in the best position to turn the tablet battle into a two-combatant war. The other is price. Analysts speculating on the new device widely pegged the Kindle Fire at $250 to $300. (Samsung, RIM (RIMM), and others have entered the tablet race with similar devices at those prices and above.) Bezos is able to go lower because he can make his profit on media content and with additional subscriptions to Amazon Prime—which then will drive additional purchases of toys, toasters, diapers, etc. He’s also exploiting his company’s popular cloud computing initiative, called Amazon Web Services. Amazon saves money on the Kindle Fire by packing it with only 8 gigabytes of memory (the costliest version of the iPad has 64 gigs), but owners of the device get to store as many books, songs, movies, and personal documents on Amazon’s cloud servers as they like for free.

Bezos won’t say whether he thinks he’ll lose money on the device itself, only that he’s at ease flirting with red ink. “Certainly this is a for-profit business,” he says. “Let’s put it this way. We are and always have been very comfortable at operating at extremely low margins.”

 

Although the decision to design and build its own hardware is a high-stakes bet, it’s equally true that Bezos had no choice but to enter the tablet business. About 40 percent of Amazon’s revenues comes from media—books, music, and movies—and those formats are rapidly going digital. Amazon was late to understand the speed of that transition; Apple, which launched the iPod in 2001 and iTunes two years later, wasn’t. The iPad has only strengthened Apple’s hold over digital media. There’s a Kindle app for the iPad, but Apple takes a 30 percent slice of all content that app makers sell on the tablet and has restricted Amazon from directing iPad users to its website in order to avoid giving Apple its cut. Doing business on the iPad threatens Amazon’s already thin profit margins.

Bezos claims he doesn’t think defensively. “Everything we do is driven by seeing opportunity rather than being worried about defending,” he says. Given Apple’s inroads into the media business, that’s hard to believe. Bezos is magnanimous toward Jobs. “On a personal level we have a tremendous amount of respect for Apple and Steve. I think that’s returned,” he says. “Our cultures start in the same place. Both companies like to invent, both companies like to pioneer, both companies start with the customer and work backwards. There’s a like-mindedness.” Pause. “Are two companies like Amazon and Apple occasionally going to step on each others toes? Yes.”

Amazon has recovered more quickly than other tech companies in the race to catch up with Apple in digital media. Amazon introduced an online TV and movie store in 2006, the Kindle e-book store in 2007, and the MP3 digital music store in 2008. Earlier this year, Amazon also aimed its sights on Netflix with an Instant Video streaming service that’s free for members of Amazon Prime, and it’s now spending hundreds of millions to increase its catalog with TV shows and movies from studios like Fox (NWS) and NBCUniversal. The music and video stores haven’t been huge hits. That may change on the Kindle Fire. On a tablet those apps will give users the impression that most songs, TV shows, and movies are just a click away. “We are leaning into this,” Bezos says. “It’s not a small initiative for us.” Amazon is also among the companies in the final round of bidding for the online video site Hulu, according to people with knowledge of that process who were not allowed to speak on the record.

Apple’s success with the iPod taught the entire tech industry another valuable lesson. There were other digital music players on the market back in the 1990s, but Apple’s device, which seamlessly blended hardware, software, and eventually an online service in iTunes, made the experience simple and unintimidating for non-techies.

There is a sense, as one easily holds the Kindle Fire in one hand (try doing that with an iPad), that Bezos is working from the same set of principles as Jobs: Content matters. Simplicity is key. How do companies allow users to easily buy songs, movies, and other digital goodies? They persuade customers to entrust them with their credit cards—as both Amazon and Apple have done. How do they ensure that the device is easy to use? They design and build it themselves.

 

“What should Amazon be doing in 20 years?”

That was the first question Bezos asked Jateen Parekh, a Silicon Valley systems engineer who had worked for the digital video recorder pioneer Replay-TV, an early TiVo (TIVO) rival, and Philips Research, a division of the Dutch consumer electronics maker. It was August 2004, and Bezos and his new senior vice-president in charge of worldwide digital media, Steven Kessel, were exploring what seemed like a radical idea for an online retailer: making their own hardware. “The question impressed me,” recalls Parekh, who is now the founder and chief technology officer of digital radio startup Jelli. “The fact that the CEO was thinking that far out was huge.”

Parekh joined Amazon that September, becoming the first employee of Lab126, a secret Silicon Valley skunkworks. At first, Parekh didn’t have an office to report to: He and the few industrial designers and engineers hired soon after, including Gregg Zehr, a former vice-president of hardware engineering at Palm Computing, set up shop in an empty room in the offices of A9, Amazon’s Palo Alto (Calif.)-based search subsidiary. Parekh recalls spending his first few weeks investigating the possibility of building Internet-connected set-top boxes and even an MP3 player.

Bezos loved reading far more than listening to music, and Amazon had deep expertise in the book market, so the next decision was a natural one. Amazon’s new hardware geeks would build an e-reader. Parekh and Zehr, who became president of the new division, researched existing e-readers of the time, such as the Sony Librie, which required AAA batteries, sold poorly, and never made it out of Japan. They concluded the market was wide open. “It was the one thing that wasn’t being done well by anyone else out there,” Parekh says.

First, though, Amazon’s engineers needed a better name for the original “A2Z Development Corp.” Parekh and his colleagues hated it, and thought it ill-suited to luring the best and brightest engineers from places like Apple and Palm. They eventually settled on the more mysterious “Lab126.” The 1 stands for a, the 26 for z, a geeky naming convention inside Amazon where groups like the personalization team are referred to by the abbreviation P13N. (If you’re confused by that, count the letters in the word “personalization.”)

Other people who worked for Lab126 in those early years recall it as a loosely managed startup. The group piggybacked on A9′s infrastructure for most of the next year. When the search division moved to the former offices of a Palo Alto law firm, Lab126 moved with them and took up residence in the old law library.

Lab126 was eventually given nearly unlimited resources. It also had to contend with the unfettered imagination of Bezos. Amazon’s founder wanted his new e-reading device to be drop-dead simple to use and argued that configuring devices to Wi-Fi networks was too complicated for non-tech-savvy users. He also didn’t want to force customers to connect the device to a PC, so the only alternative was to build cellular access into the device, the equivalent of embedding a wireless phone in the hardware. Nothing like that had been tried before. Bezos insisted that customers should never have to know the wireless connection was there or even pay for access. “I thought it was insane, I really did,” Parekh recalls.

The effort to develop the first Kindle ended up taking more than three years. Nearly everything went wrong. The black-and-white displays from E Ink, an offshoot of the Massachusetts Institute of Technology Media Lab that makes screens resembling the printed page and requiring very little power, would look good for one month and then degrade alarmingly. Qualcomm (QCOM), which was set to provide the wireless chips, was sued by a competitor, Broadcom (BRCM), and for months was enjoined by a judge from selling its wares in the U.S. The Lab126 team repeatedly urged Bezos to make their project easier by considering a Wi-Fi-only connection for the Kindle. He rejected the idea, constantly suggesting new ones for complicated features, like the notion that customers’ annotations of books should be backed up on Amazon’s servers.

That original Kindle, code-named “Fiona” after a character in Neal Stephenson’s futuristic novel The Diamond Age, was finally ready to go in the fall of 2007. Still, Amazon nearly blew it. Modeling demand after the first-year sales of the original iPod, Amazon dramatically underestimated what a hit the Kindle would turn out to be. The first batch sold out in just a few hours. Amazon then discovered that one of its Taiwanese suppliers had discontinued a key part and spent months getting a replacement. “You look at the history of the Kindle, they developed some real skills around the creation of that product. They’ve cut their teeth so to speak,” says Brian Blair, a New York-based analyst at Wedge Partners.

Making four successive versions of the Kindle e-reader also led Amazon down the path toward the Kindle Fire. For years the engineers at Lab126 tried to create a workable and reader-friendly color Kindle, according to three former employees. New color display technologies like Qualcomm’s Mirasol and another MIT IT-offshoot called Pixel Qi proved unreliable and difficult to produce in large quantities. In January 2010, the iPad demonstrated the broad appeal of a new kind of color LCD tablet with better image quality, wider viewing angles, and, near to Amazon’s heart, Apple’s own selection of e-books. People close to Lab126 say that work on tablets, including the Kindle Fire, started soon after.

Amazon’s devices division now employs around 800 hardware and software engineers in Cupertino, Calif., who fill up all but one floor of an entire eight-floor office building and part of a second building in the same office park, less than a mile from Apple’s corporate headquarters. In the unit’s industrial design lab, according to a person who has visited that top-secret floor but was not authorized to speak on the record, naked e-ink displays hang from the walls with images from books imprinted on their screens. They’re used to demonstrate to potential new hires how an e-ink screen can hold an image indefinitely without being connected to a power supply. There’s also another office of Kindle employees at Amazon’s new corporate campus in the South Lake Union district of Seattle, in a building nostalgically named Fiona. The group is cordoned off from other Amazon employees, whose company badges do not grant them access.

Bezos won’t say what kind of devices he’s cooking up next. People with knowledge of the division’s plans say that the Kindle Fire is only the first of a line of Amazon tablets, not an isolated product, and that the group has always considered the possibility of building Amazon cell phones and Internet-connected TVs. “We are a company with a lot of ideas,” Bezos says, when asked directly about his plans. And then, of course, he laughs uproariously.

 

For those already competing with Amazon.com, the Kindle Fire will not be good news. Kevin Ryan, the co-owner of Green Apple Books, a 44-year-old bookstore in San Francisco, says that Amazon has lowered the prices in the book business beyond his ability to match them. Amazon has also locked up several big authors to publishing contracts, and though it says it will produce their books in print as well as digital formats, that has competing retailers nervous. “They’re bullies. They really are. I think they really want to be a monopoly,” Ryan says from the 8,000-square-foot store that features tribal masks over the bookshelves, and which has watched sales drop for much of the past decade. Of the growing group of authors like George R.R. Martin, whose books have sold over a million digital copies through Amazon, he says, “You have to assume that people joining the million book Kindle club is taking business away from you.”

In the past year major chains like Toys “R” Us, Sports Authority, and Radio Shack (RSH) have teamed up to combat Amazon’s might, forming a free shipping program called ShopRunner that, like Amazon Prime, also offers free two-day shipping for $79 a year. It’s not clear yet how ShopRunner is doing; the group won’t release subscriber numbers. Fiona Dias, ShopRunner’s chief strategy officer, says that by locking in a new wave of customers with the Kindle Fire, Amazon will make their jobs even harder. “It’s a phenomenal concentration of power,” she says. “If we were scared of Amazon in the Web world, we should be absolutely terrified of them in the tablet world.”

It’s not just competitors that are assessing Amazon’s dominance. Over the past year, lawmakers, the media, and even some customers have begun weighing Amazon’s growing sales and size against the impact for communities, commerce, and the local job market.

Amazon has brought some of this scrutiny on itself. It touts its hiring of workers for its growing network of shipping centers, yet those jobs aren’t exactly plumb: They start at around $11 an hour (with health benefits), and conditions can be tough. The recent newspaper account in the Allentown (Pa.) Morning Call not only revealed that temperatures over the summer in a local Amazon facility reached 120F, but that workers who were slowed by the heat felt penalized by their bosses. (Amazon has promised to put in air conditioners.)

The report is consistent with a company that’s notoriously frugal with employees, who get few perks aside from 10 percent off $1,000 in annual purchases. Unlike Google and Apple, Amazon does not subsidize meals or provide free sodas. Even the pet dogs of Amazon employees get a better deal: There’s a bucket of free milk bones at the front desk of every company building in Seattle.

The vicious, multi-state battle over state sales tax has created perhaps the most controversy around Amazon. Legislators in more than a dozen states, pressed by such politically connected competitors as Walmart, have been pushing Amazon to collect the sales tax that their customers technically already owe on online purchases, to better repair widening budget deficits and pay firemen and school teachers. Bezos has tenaciously fought that effort, arguing that only federal legislation can overrule a U.S. Supreme Court ruling from 1992 that retailers with no physical presence in a state should not have to pay sales tax there. Critics have charged he’s just stringing out his price advantage as long as possible.

On Sept. 7, Amazon finally compromised in California, agreeing to start collecting sales tax in the state by November 2012. Bezos thinks that by then the federal government will uniformly set nationwide standards for the collection of online sales tax. “You have to do what you think is correct,” he says. “Obviously we care about perception, but we also value substance and the right place to fix this is in federal legislation.”

Losing the tax advantage may not be such a bad thing. If and when Amazon starts collecting sales tax, it will be free to set up distribution centers right outside major cities, which would enable even faster deliveries than it offers now. As part of Amazon’s deal with California, for example, the company has pledged to spend $500 million on new warehouses and hire 10,000 full-time workers and 25,000 seasonal employees. Customers in California could soon end up getting same-day deliveries of products and even produce. Amazon’s experimental “Fresh” grocery program is now active in Seattle, where the company already collects sales tax.

Nancy Koehn of Harvard Business School thinks Amazon may be getting big enough for people to finally start considering the ramifications—for towns, shopping centers, and jobs—of a world dominated by online buying. She recently discussed Amazon on Wisconsin Public Radio—not the most neutral forum—but was surprised when almost all of the phone calls from listeners were critical of the company. “Americans get very nervous about centralized power that affects their communities,” she says. “We get a little bit nervous about bigness, yet we want the convenience and the pricing and the material plenty that bigness allows.”

Amazon’s new Seattle campus testifies to that growing size. The company has leased 11 brand-new buildings in the burgeoning South Lake Union neighborhood from real estate developer and Microsoft (MSFT) co-founder Paul Allen. It’s classic Amazon: unostentatious, and no company signs on any of the buildings. The entire campus is due to be completed by 2013 and will host several thousand employees, but the company is growing so fast, it’s already looking for even more space.

In Day One South, Bezos would clearly rather discuss the Kindle Fire than real estate, sales taxes, or air conditioning. Former employees of Lab126 say the chief executive officer spends an unusual amount of his time delving into the gritty details of his fledgling hardware business, and can happily talk for hours about the location of this or that button on a device. “I spent a huge amount of time working on Kindle Fire,” he says.

He’s right to sweat the details, especially now that his competition has gone from slow-moving big-box retailers to tech giants like Apple, which has even deeper deep pockets and is as comfortable with long-term investments as Amazon. “I believe these industries are so big, there are going to be multiple winners,” Bezos says. He’s been saying that for 10 years, during which time he’s helped consign Circuit City, Borders, and others to oblivion. “When I look at something like the Kindle Fire, what I want is to be one of the winners.”

With Danielle Kucera and Andrew Fixmer
Stone_190
Stone is a senior writer for Bloomberg Businessweek in San Francisco. He is the author of The Everything Store: Jeff Bezos and the Age of Amazon (Little, Brown; October 2013). Follow him on Twitter @BradStone.

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Companies Mentioned

  • AMZN
    (Amazon.com Inc)
    • $333.57 USD
    • -1.47
    • -0.44%
  • AAPL
    (Apple Inc)
    • $119.0 USD
    • 1.40
    • 1.18%
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