The degree to which an industrys outlook is attractive or unattractive is not the same for all industry participants and all potential entrants. After learning how organizations eval

This case was prepared by Senior Lecturer Christopher Noe and Professor Joseph Weber. Research assistance was provided by Julia Cho.

Copyright © 2019, Christopher Noe and Joseph Weber. This work is licensed under the Creative Commons Attribution- Noncommercial-No Derivative Works 3.0 Unported License. To view a copy of this license visit http://creativecommons.org/licenses/by-nc-nd/3.0/ or send a letter to Creative Commons, 171 Second Street, Suite 300, San Francisco, California 94105, USA.

17-183 Revised February 19, 2019

Amazon.com, Inc. Christopher Noe and Joseph Weber

On May 15, 2017, Amazon.com celebrated the 20th anniversary of its initial public offering (IPO).1 Over the preceding two decades, Amazon had grown from a small e-commerce startup to the fourth largest U.S. public company, trailing only Apple, Alphabet (Google’s parent), and Microsoft.2 The company reached such a size, however, with little to show in terms of profitability. Amazon chose to invest in expansion and research and development with the idea that sacrificing profit in the short-term would allow the company to maximize profit in the long-term.

Company Background

Amazon was founded by Jeff Bezos. Prior to starting Amazon, Bezos worked in New York as a vice president at D. E. Shaw & Co., a global investment management firm, but decided to quit his job and move to Seattle to take advantage of the incredible growth of the Internet. The Amazon website launched on July 16, 1995. Amazon began as an online bookstore, but the company had innovative strategies that set it apart from competitors. It offered discounts up to 30%, allowed customers to post their own book reviews on its website, and continually worked to improve the ease of placing orders with technological features like “1-Click” shopping.3 These strategies derived from Amazon’s customer-focused mission statement:

1 Dawn Kawamoto, “Amazon.com IPO Skyrockets,” CNET, May 15, 1997, https://www.cnet.com/news/amazon-com-ipo-skyrockets/ (accessed August 2017). 2 Center for Research in Security Prices. 3 Richard L. Brandt, “Birth of a Salesman,” The Wall Street Journal, October 15, 2011.

AMAZON.COM, INC. Christopher Noe and Joseph Weber

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“Our vision is to be the Earth’s most customer-centric company; to build a place where people can come to find and discover anything they might want to buy online.”4 On May 15, 1997, Amazon’s IPO, priced at $18 a share, raised $54 million.5 By day’s end, the company’s stock closed up 30% at $23.50, giving it a market capitalization of $438 million.6 The stock price (split-adjusted) increased by 7,000% over the next few years but lost 95% from its peak value during the 2000-01 dot-com crash.7 Throughout this tumultuous period, Amazon steadily branched out beyond books by adding other product categories to its website, including CDs, DVDs, consumer electronics, video games, software, and office products.8 Amazon’s expansion was also aided by acquisitions. For example, the 2008 purchase of Audible, the audiobook seller, helped the company broaden its digital media offerings; the 2009 acquisition of Zappos.com helped the company increase its share in the market for shoes, clothing, and accessories; and the 2010 purchase of Quidsi, owner of diapers.com and soap.com, moved the company further into the market for consumer goods.9 In 2005, Amazon introduced its Prime membership program as a means to increase customer loyalty.10 The program started out as a free two-day shipping service for an annual fee but later expanded to include free access to streaming movies, TV shows, music, and audiobooks; free unlimited photo storage; free ebook rentals; and early access to special shopping deals.11 In July 2015, Amazon introduced an online shopping holiday called Prime Day, where the company offered discounts only to Prime members.12 Amazon reported that the third annual Prime Day in 2017 was the biggest day in its history with sales surpassing 2016 Black Friday and Cyber Monday.13 Moreover, the number of new members joining on 2017 Prime Day pushed Prime membership to nearly 50% of all U.S. households.14 Prime’s growing popularity reflected the broader trend of consumers increasingly embracing online

4 Patrick Hull, “Be Visionary. Think Big.,” Forbes, December 19, 2012. 5 Dawn Kawamoto, “Amazon.com IPO Skyrockets,” CNET, May 15, 1997, https://www.cnet.com/news/amazon-com-ipo-skyrockets/ (accessed August 2017). 6 Ibid. 7 Center for Research in Security Prices. 8 Amazon.com History & Timeline, http://phx.corporate-ir.net/phoenix.zhtml?c=176060&p=irol-corporatetimeline (accessed August 2017). 9 Justina Vasquez and Imani Moise, “A Run-Down of Large Deals in Amazon's History,” The Wall Street Journal, June 16, 2017. 10 Amazon.com History & Timeline, http://phx.corporate-ir.net/phoenix.zhtml?c=176060&p=irol-corporatetimeline (accessed August 2017). 11 Description of Prime program benefits on amazon.com (accessed August 2017). 12 Lauren Thomas, “Amazon Prime Day Breaks Record; Sales Grew by More Than 60 Percent,” CNBC.com, July 12, 2017 https://www.cnbc.com/2017/07/12/amazon-prime-day-breaks-record-event-grew-by-more-than-60-percent.html (accessed August 2017). 13 “Prime Day 2017 Doesn’t Disappoint; AMZN’s Biggest Day Ever,” Cowen and Company, July 12, 2017. 14 Ibid.

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shopping, a trend that was predicted to continue. Worldwide total ecommerce retail sales were expected to double from $1.8 trillion in 2016 to $4.5 trillion in 2021.15 Building off its beginnings as a purveyor of books, Amazon introduced the Kindle e-reader in 2007.16 It was the first device developed by the company, and it fundamentally changed the way people read books, newspapers, and magazines. Amazon followed the Kindle with other in-house developed devices — for example, Fire tablets, Fire TV streaming media players, and Echo smart speakers with the voice assistant Alexa. In 2006, Amazon decided to rent out excess space on its computer network to other companies.17 That decision essentially represented the genesis of the cloud infrastructure as a service (IaaS) industry. As of 2016, worldwide total IaaS industry sales had grown to $25 billion and were expected to grow to $63 billion over the next five years.18 Amazon’s a la carte services, known as Amazon Web Services (AWS), initially appealed to Internet startups attracted by flexibility and cost savings. Over time, however, more established companies such as Juniper Networks, Intuit, and Netflix, decided to unplug their private data servers and run their businesses entirely on Amazon’s IT backbone.19 Not all of Amazon’s actions have proven successful. In 2014, for example, the company introduced the Fire Phone, but the device was a major flop and was discontinued the following year.20 Other examples of Amazon failures include Amazon Destinations, a hotel booking site; WebPay, a peer-to-peer payment service; Amazon Auctions, an auction website; and a line of premium diapers.21 None of these botched efforts fazed Bezos, however, who engrained a tolerance for failure into Amazon’s culture because of his belief that failed experiments are a necessary evil to create successful inventions.22

Financial Performance

Exhibit 1 shows Amazon’s stock price during its first 20 years, a period over which the company’s shareholders earned a nearly 64,000% return. Amazon reached the 20th anniversary of its IPO with a market capitalization of $458 billion.23 This exhibit also shows Amazon’s net income and cash flow from operations between 1997 and 2016. Cumulative net income over this period totaled only $4.9

15 https://www.emarketer.com/Report/Worldwide-Retail-Ecommerce-Sales-eMarketers-Estimates-20162021/2002090 (accessed August 2018). 16 Amazon.com History & Timeline, http://phx.corporate-ir.net/phoenix.zhtml?c=176060&p=irol-corporatetimeline (accessed August 2017). 17 Robert McMillan, “Amazon to Offer Window into Web Services Business,” The Wall Street Journal, April 22, 2015. 18 Gartner. 19 Julie Bort, “Netflix, Juniper, and Intuit Explain How Amazon Is Eating the $3.5 Trillion IT Industry,” Business Insider, January 13, 2016. 20 Kia Kokalitcheva, “Amazon Is Killing Off the Fire Phone,” Fortune, September 9, 2015. 21 Eugene Kim, “Jeff Bezos Says Amazon Is Not Afraid to Fail – These 9 Failures Show He’s Not Kidding,” Business Insider, October 21, 2015. 22 Eugene Kim, “How Amazon CEO Jeff Bezos Has Inspired People to Change the Way They Think about Failure,” Business Insider, May 28, 2016. 23 Center for Research in Security Prices.

AMAZON.COM, INC. Christopher Noe and Joseph Weber

Rev. February 19, 2019 4

billion with 60% coming from just 2015-16. Exhibit 2 provides Amazon’s 2014-16 financial statements. Exhibit 3 provides descriptions of expense line items on the income statement. Exhibit 4 provides 2014-16 segment information for Amazon’s retail and AWS businesses.

Focus on Long-Term Cash Flow Growth

Amazon’s two decades of meager profitability originated from a strategic choice made in the company’s early days to focus on the long-term. In 1997, Bezos articulated Amazon’s philosophy in his first letter to shareholders:24

We believe that a fundamental measure of our success will be the shareholder value we create over the long-term. 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, higher profitability, greater capital velocity, and correspondingly stronger returns on invested capital…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.25

And, 20 years later, Amazon continued to emphasize a long-term focus:

Our financial focus is on long-term, sustainable growth in free cash flows. Free cash flows are driven primarily by increasing operating income and efficiently managing working capital and cash capital expenditures, including our decision to purchase or lease property and equipment. Increases in operating income primarily result from increases in sales of products and services and efficiently managing our operating costs, partially offset by investments we make in longer-term strategic initiatives. To increase sales of products and services, we focus on improving all aspects of the customer experience, including lowering prices, improving availability, offering faster delivery and performance times, increasing selection, increasing product categories and service offerings, expanding product information, improving ease of use, improving reliability, and earning customer trust.26

Exhibit 5 provides Amazon’s voluntary disclosure of non-GAAP financial information about free cash flows. Despite Amazon consistently downplaying the significance of short-term accounting profitability, some market observers were of the opinion that the company’s GAAP earnings were poised for considerable growth as the 20th anniversary of its IPO neared. For example, Barron’s commented, “Ironically, now 24 Jeff Bezos has attached his first letter to shareholders to each of his subsequent letters as of the writing of this case study. 25 Jeff Bezos, Letter to Amazon.com Shareholders, 1997. 26 2016 Amazon.com Form 10-K.

AMAZON.COM, INC. Christopher Noe and Joseph Weber

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that Amazon has convinced the investing public of the unimportance of profits, its earnings are on the verge of soaring. Within five years, they could total $20 billion a year, a level only six U.S. companies are expected to reach this year. True enough, those forecasts have a way of coming down over time, but unless Amazon’s next venture is launching a small nation-state, it will have a hard time investing away such a sum, not to mention its free cash flow, which is much higher.”27

27 Jack Hough, “Amazon’s Next Move Amazon in Its Prime,” Barron’s, May 8, 2017.

AMAZON.COM, INC. Christopher Noe and Joseph Weber

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Exhibit 1 Amazon.com, Inc. 1997-2016 Stock Price, Cash Flow from Operations, and Net Income

Source: YCharts.

AMAZON.COM, INC. Christopher Noe and Joseph Weber

Rev. February 19, 2019 7

Exhibit 2 Amazon.com, Inc. 2014-16 Cash Flow Statements ($ Millions)

Year Ended December 31, 2016 2015 2014

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 15,890

14,557

8,658 OPERATING ACTIVITIES: Net income (loss) 2,371

596

(241)

Adjustments to reconcile net income (loss) to net cash from operating activities:

Depreciation of property and equipment, including internal-use software and website development, and other amortization, including capitalized content costs

8,116

6,281

4,746

Stock-based compensation 2,975

2,119

1,497 Other operating expense, net 160

155

129

Other expense (income), net (20)

250

59 Deferred income taxes (246)

81

(316)

Excess tax benefits from stock-based compensation (829)

(119)

(6) Changes in operating assets and liabilities:

Inventories (1,426)

(2,187)

(1,193) Accounts receivable, net and other (3,367)

(1,755)

(1,039)

Accounts payable 5,030

4,294

1,759 Accrued expenses and other 1,724

913

706

Additions to unearned revenue 11,931

7,401

4,433 Amortization of previously unearned revenue (9,976)

(6,109)

(3,692)

Net cash provided by (used in) operating activities 16,443

11,920

6,842 INVESTING ACTIVITIES: Purchases of property and equipment, including internal-use software and website development, net

(6,737)

(4,589)

(4,893)

Acquisitions, net of cash acquired, and other (116)

(795)

(979) Sales and maturities of marketable securities 4,733

3,025

3,349

Purchases of marketable securities (7,756)

(4,091)

(2,542) Net cash provided by (used in) investing activities (9,876)

(6,450)

(5,065)

FINANCING ACTIVITIES: Excess tax benefits from stock-based compensation 829

119

6

Proceeds from issuance of long-term debt 621

353

6,359 Repayments of long-term debt and other (354)

(1,652)

(513)

Principal repayments of capital lease obligations (3,860)

(2,462)

(1,285) Principal repayments of finance lease obligations (147)

(121)

(135)

Net cash provided by (used in) financing activities (2,911)

(3,763)

4,432 Foreign currency effect on cash and cash equivalents (212)

(374)

(310)

Net increase (decrease) in cash and cash equivalents 3,444

1,333

5,899 CASH AND CASH EQUIVALENTS, END OF PERIOD 19,334

15,890

14,557

Source: Amazon.com, Inc. 10-K, December 31, 2016.

AMAZON.COM, INC. Christopher Noe and Joseph Weber

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Exhibit 2 (cont.) Amazon.com, Inc. 2014-16 Income Statements ($ Millions)

Year Ended December 31, 2016 2015 2014

Net product sales 94,665

79,268

70,080 Net service sales 41,322

27,738

18,908

Total net sales 135,987

107,006

88,988 Operating expenses:

Cost of sales 88,265

71,651

62,752 Fulfillment 17,619

13,410

10,766

Marketing 7,233

5,254

4,332 Technology and content 16,085

12,540

9,275

General and administrative 2,432

1,747

1,552 Other operating expense, net 167

171

133

Total operating expenses 131,801

104,773

88,810 Operating income 4,186

2,233

178

Interest income 100

50

39 Interest expense (484)

(459)

(210)

Other income (expense), net 90

(256)

(118) Total non-operating income (expense) (294)

(665)

(289)

Income (loss) before income taxes 3,892

1,568

(111) Provision for income taxes (1,425)

(950)

(167)

Equity-method investment activity, net of tax (96)

(22)

37 Net income (loss) 2,371

596

(241)

Source: Amazon.com, Inc. 10-K, December 31, 2016.

AMAZON.COM, INC. Christopher Noe and Joseph Weber

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Exhibit 2 (cont.) Amazon.com, Inc. 2014-16 Balance Sheets ($ Millions)

December 31, 2016 2015 2014

Current assets: Cash and cash equivalents 19,334

15,890

14,557

Marketable securities 6,647

3,918

2,859 Inventories 11,461

10,243

8,299

Accounts receivable, net and other 8,339

5,654

5,612 Total current assets 45,781

35,705

31,327

Property and equipment, net 29,114

21,838

16,967 Goodwill 3,784

3,759

3,319

Other assets 4,723

3,445

2,892 Total assets 83,402

64,747

54,505

Current liabilities: Accounts payable 25,309

20,397

15,459

Accrued expenses and other 13,739

10,372

9,807 Unearned revenue 4,768

3,118

1,823

Total current liabilities 43,816

33,887

28,089 Long-term debt 7,694

8,227

8,265

Other long-term liabilities 12,607

9,249

7,410 Stockholders’ equity:

Common stock 5

5

5 Treasury stock, at cost (1,837)

(1,837)

(1,837)

Additional paid-in capital 17,186

13,394

11,135 Accumulated other comprehensive loss (985)

(723)

(511)

Retained earnings 4,916

2,545

1,949 Total stockholders’ equity 19,285

13,384

10,741

Total liabilities and stockholders’ equity 83,402

64,747

54,505

Source: Amazon.com, Inc. 10-Ks, December 31, 2016 and December 31, 2015.

AMAZON.COM, INC. Christopher Noe and Joseph Weber

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Exhibit 3 Amazon.com, Inc. Expense Line Item Descriptions

Cost of Sales Cost of sales primarily consists of the purchase price of consumer products, digital media content costs where we record revenue gross, including Prime Video and Prime Music, packaging supplies, sortation and delivery centers and related equipment costs, and inbound and outbound shipping costs, including where we are the transportation service provider. Shipping costs to receive products from our suppliers are included in our inventory, and recognized as cost of sales upon sale of products to our customers. Payment processing and related transaction costs, including those associated with seller transactions, are classified in “Fulfillment” on our consolidated statements of operations. Vendor Agreements We have agreements with our vendors to receive funds for advertising services, cooperative marketing efforts, promotions, and volume rebates. We generally consider amounts received from vendors to be a reduction of the prices we pay for their goods, including property and equipment, or services, and therefore record those amounts as a reduction of the cost of inventory, cost of services, or cost of property and equipment. Vendor rebates are typically dependent upon reaching minimum purchase thresholds. We evaluate the likelihood of reaching purchase thresholds using past experience and current year forecasts. When volume rebates can be reasonably estimated, we record a portion of the rebate as we make progress towards the purchase threshold. When we receive direct reimbursements for costs incurred by us in advertising the vendor’s product or service, the amount we receive is recorded as an offset to “Marketing” on our consolidated statements of operations. Fulfillment Fulfillment costs primarily consist of those costs incurred in operating and staffing our North America and International segments’ fulfillment and customer service centers, including costs attributable to buying, receiving, inspecting, and warehousing inventories; picking, packaging, and preparing customer orders for shipment; payment processing and related transaction costs, including costs associated with our guarantee for certain seller transactions; responding to inquiries from customers; and supply chain management for our manufactured electronic devices. Fulfillment costs also include amounts paid to third parties that assist us in fulfillment and customer service operations. Marketing Marketing costs primarily consist of targeted online advertising, television advertising, public relations expenditures, and payroll and related expenses for personnel engaged in marketing and selling activities. We pay commissions to participants in our Associates program when their customer referrals result in product sales and classify such costs as “Marketing” on our consolidated statements of operations. We also participate in cooperative advertising arrangements with certain of our vendors, and other third parties. Advertising and other promotional costs are expensed as incurred and were $3.3 billion, $3.8 billion, and $5.0 billion in 2014, 2015, and 2016. Prepaid advertising costs were not significant as of December 31, 2015 and 2016.

AMAZON.COM, INC. Christopher Noe and Joseph Weber

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Technology and Content Technology costs consist principally of research and development activities including payroll and related expenses for employees involved in application, production, maintenance, operation, and development of new and existing products and services, as well as AWS and other technology infrastructure costs. Content costs consist principally of payroll and related expenses for employees involved in category expansion, editorial content, buying, and merchandising selection. Technology and content costs are expensed as incurred, except for certain costs relating to the development of internal-use software and website development, including software used to upgrade and enhance our websites and applications supporting our business, which are capitalized and amortized over two years. General and Administrative General and administrative expenses primarily consist of payroll and related expenses; facilities and equipment, such as depreciation expense and rent; professional fees and litigation costs; and other general corporate costs for corporate functions, including accounting, finance, tax, legal, and human resources, among others. Other Operating Expense, Net Other operating expense, net, consists primarily of marketing-related, contract-based, and customer- related intangible asset amortization expense, and expenses related to legal settlements.

Source: Amazon.com, Inc. 10-K, December 31, 2016.

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Exhibit 5 Amazon.com, Inc. 2014-16 Segment Information ($ Millions)

Year Ended December 31, 2016 2015 2014

Net sales Retail 123,768

99,126

84,344

AWS 12,219

7,880

4,644 135,987

107,006

88,988

Year Ended December 31,

2016 2015 2014 Operating income

Retail 1,078

726

(280) AWS 3,108

1,507

458

4,186

2,233

178

Source: Amazon.com, Inc. 10-K, December 31, 2016.

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Exhibit 6 Amazon.com, Inc. Non-GAAP Financial Measures ($ Millions)

Free Cash Flow Free cash flow is cash flow from operations reduced by “Purchases of property and equipment, including internal-use software and website development, net,” which is included in cash flow from investing activities. The following is a reconciliation of free cash flow to the most comparable GAAP cash flow measure, “Net cash provided by (used in) operating activities,” for 2014, 2015, and 2016 (in millions):

Year Ended December 31,

2016 2015 2014 Net cash provided by (used in) operating activities 16,443

11,920

6,842

Purchases of property and equipment, including internal-use software and website development, net

(6,737)

(4,589)

(4,893)

Free cash flow 9,706

7,331

1,949

Free Cash Flow Less Lease Principal Repayments Free cash flow less lease principal repayments is free cash flow reduced by “Principal repayments of capital lease obligations,” and “Principal repayments of finance lease obligations,” which are included in cash flow from financing activities. Free cash flow less lease principal repayments approximates the actual payments of cash for our capital and finance leases. The following is a reconciliation of free cash flow less lease principal repayments to the most comparable GAAP cash flow measure, “Net cash provided by (used in) operating activities,” for 2014, 2015, and 2016 (in millions):

Year Ended December 31,

2016 2015 2014 Net cash provided by (used in) operating activities 16,443

11,920

6,842

Purchases of property and equ

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