Working Backwards, Amazon's Anti-trust Paradox, and The Future of Sonos
In which I reference many previous issues and collaborations
Hey everyone,
Greetings from Washington, D.C.!
For some reason, this time of the year brings many collaborations in Snapshots-land. The first one of this year’s collaborations is now published. I enjoyed working with Mario Gabriele and the brilliant crew over at the S-1 club to write about the South Korean e-commerce giant Coupang. The company is fascinating in many ways, but most interesting to me are 1) how the company transformed from a daily deals company into a logistics-centric behemoth and 2) what does the “future of commerce” look like through the founder Bom Kim’s eyes as the firm expands beyond South Korea. I hope you’ll check it out.
In this issue of the newsletter, I want to explore:
A book review of Working Backwards about the unique systems at Amazon
Amazon’s Anti-trust Paradox by Lina Khan
The future of Sonos and a collaboration from the past
Printing presses, How vinyls are made, and the HSMC scam
Book of the week
Spend enough time in the business writing genre and you’ll come across the aphorism “The team you build is the company you build.” To add to this newsletter’s rich tradition of proposing amendments and corollaries to aphorisms, I’d like to add another one today:
The systems you build is the company you build.
For me, that’s the most generalizable lesson to be taken away from Working Backwards by Colin Bryar and Bill Carr. In a crisp ~250 pages, two former Amazon executives share the origin stories, the specific tactics, and examples of what makes working at Amazon a unique experience.
The second half of the book (see notes on the first half here) covers the infamous six-page narrative memos, the “bar raiser” criteria for hiring, and “single-threaded leadership” among other important systems that has transformed Jeff Bezos’ brainchild into one of the most valuable companies in the world.
I appreciate the specificity of the book. Most company biographies go into the untold origin stories, but few go into day-to-day operations. This is not that kind of book. Here is a chapter that describes a meeting with Bezos about the Kindle that did not go well:
A few weeks later we were back with rough mock-ups in hand. Jeff listened carefully to our presentation and then began asking detailed questions about every button, word, link, and color. For music, he asked how our service would be better than iTunes. For e-books, he wanted to know how much the e-books would cost. He asked if people would be able to read their e-books on a tablet or a phone as well as their PC. We answered as we had before. We hadn’t figured out all that stuff! We just needed his basic approval so we could hire the team, start negotiating deals with media companies, and get something launched. That answer did not go over well. At all. Jeff wanted to know exactly what we were going to build and how it would be better for customers than the competition. He wanted us to agree on those details before we started hiring a team or establishing vendor relationships or building anything. It was clear that half-baked mock-ups were no better, perhaps worse, than no mock-ups at all. To Jeff, a half-baked mock-up was evidence of half-baked thinking. And he was quick to say so, often using strong language to make his point inescapably clear. Jeff wanted us to know that we couldn’t just charge down the first available and most convenient path to chase after this opportunity.
The book is full of anecdotes like that and these alone are worth the price of admission.
The book is not without its faults however. Perhaps my biggest gripe is how they don’t tie back principles to the specific make-up and unique conditions at Amazon. For example, I felt there is a decent level of hand waving of how these systems got implemented by saying something along the lines of “well this is what Jeff [Bezos] wanted, and Jeff gets what Jeff wants.” Outside of a handful of cases, CEOs don’t enjoy that kind of a cult of personality. Normal executives and managers are under real organizational constraints. And so while these systems and others like it can be adopted by any company, the ease with which they got implemented across Amazon in its early days is exceedingly rare.
So who do I recommend this book to? I recommend it to the Jeff Bezos-anecdote aficionado, aspiring Amazon employees, and other Amazon-curious folks. For that last category, I’d also recommend The Everything Store by Brad Stone.
Long read of the week
Amazon’s Antitrust Paradox by Lina Khan [My heavily annotated copy with highlights and notes] [Original]
Lina Khan is about to be appointed to the Federal Trade Commission. If that name sounds unfamiliar, expect that to change. Her 2017 on Amazon’s anti-competitive behavior is about as close to a viral hit an academic paper can become—and she was just a law student back then!
But she is not unfamiliar to long-time Snapshots readers. In February 2020, I wrote a summary of this famous paper. Since she is going to be an important figure in the years to come, I thought it would be useful to re-visit some of her core arguments in that original paper:
A mini-history of antitrust laws
There are two pillars of antitrust laws that Lina explores – predatory pricing and vertical mergers.
Predatory Pricing: Predatory pricing is defined as “the pricing of goods or services at such a low level that other suppliers cannot compete and are forced to leave the market.”
Current anti-trust doctrine, dominated by the Chicago School, maintains that although this is theoretically possible, it rarely occurs in practice. They argue that firms operating under a profit-maximization framework would never engage in such tactics. And even if it is used as a tactic to drive out competition, the predator would need to recoup their losses over a long enough horizon that it would invite too much competition. The uncertainty of the success of this strategy makes predatory pricing unappealing.
Lina argues that this argument falls apart in the context of online platforms. Often, “below-cost” pricing is rational, since they invite scale and network effects are what make online platforms powerful. Therefore, “reasoning that originated in one context has wound up in jurisprudence applying to totally distinct circumstances, even as the underlying violations differ vastly.”
Vertical Mergers: Vertical mergers is defined as “the combination in one company of two or more stages of production normally operated by separate companies”
Again, the dominant Chicago School doctrine maintains that antitrust concerns from vertical mergers are largely unfounded. They argue that under the profit-maximization framework, if retailers started to favor manufacturers they owner, this would invite competition for the retailer since the other manufacturers would look for a more level playing field in alternatives. Even if it persisted, they argue that any efficiencies found would be passed on to the consumer in the form of lower prices. Their upshot is that any “law against vertical mergers is merely a law against the creation of efficiency.”
Lina argues that this narrow view of customer welfare doesn’t consider the entire structure of an industry. Specifically, vertical mergers increase the barriers to entry across multiple domains and create inevitable conflicts of interest. Unless we agree to be beholden to benevolent dictators, we should scrutinize vertical mergers of online platforms.
With the history of antitrust laws under our belt, we can move to the core criticism of the current antitrust regime.
Focus on outcomes vs. structure
Lina’s overarching critique is that the current antitrust laws focuses too much on outcomes like lower prices versus maintaining a competitive industry structure. It’s based on markets with non-zero marginal costs with weak network effects – the opposite of the dominant companies today. These characteristics make the historic interpretation of predatory pricing and vertical mergers outdated.
She argues for a more structure-oriented approach which looks out for the influence that a company exerts on the whole ecosystem of an industry. She isn’t worried about companies behaving badly, she wants to ensure they never get the opportunity to do so in the first place.
It is worth summarizing why she is particularly concerned about Amazon. According to her, there have been at least three domains in which Amazon has behaved badly.
Amazon’s conduct
These three domains are the pricing of e-books, the establishment of Fulfillment by Amazon, and the spread of AmazonBasics.
E-books: Amazon has frequently locked horns with publishers over e-book publishing. They have a significant first-mover advantage in the space and have solidified that lead through the ecosystem lock-in created by the Kindle. When the Kindle first launched in late 2007, Amazon priced best sellers at $9.99 to create this lock-in. This worked – through 2009, it sold around 90% of all e-books. Publishers were scared by this since most titles cost between $12 to $30. They worried that this would “permanently drive down the price that consumers were willing to pay for all books.” They were handed a lifesaver by Apple’s iBookstore, where they were allowed to price books however they wanted and give Apple a 30% cut. When MacMillan, one of the big publishers, demanded that Amazon adopt a similar pricing structure, Amazon delisted MacMillan’s books. They ultimately brought them back and since other publishers placed similar demands, Amazon’s ability to price e-books at $9.99 became limited. This was critical to a healthy ecosystem since publishers fund up-and-coming authors through the sales of bestsellers. Reduced revenue (and corresponding reduced profits) from bestsellers would have meant that publishers would not have been able to fund new authors – a critical component of a healthy information ecosystem. Although Amazon was thwarted in its attempt, the fact that the information ecosystem had to be saved by Apple is itself a testament to the immense power wielded by platforms.
Fulfillment by Amazon: Independent sellers can use Amazon’s delivery infrastructure to sell their goods. In many cases, this is cheaper than using UPS or Fedex for these sellers. But the UPS and Fedex have increased their pricing for independent sellers in large part due to razor thin margins from their business with Amazon. Amazon also uses UPS and Fedex for its delivery infrastructure but gets more preferable rates due to the volume of its business. As Amazon becomes more dominant, it is in a position to extract more favorable terms with these delivery companies. Since they don’t want to risk the massive volumes of business that Amazon brings, these companies typically comply to these demands. But in order to stay financially successful, they have to compensate for lost revenue from Amazon with increased revenue from independent sellers looking to use their services. This in turn moves more independent sellers to Amazon due to their lower rates. So, in essence, Amazon has inserted itself as a middleman between independent sellers and delivery companies in a self re-enforcing feedback loop. As a result, these independent sellers have to give increasingly larger cuts of their revenue to Amazon. This means less resources for product innovation and expansion – ultimately harming consumers.
AmazonBasics: It’s no secret that Amazon uses data from its marketplace and creates private label versions for popular and profitable products under the AmazonBasics umbrella. While private labels are not a new phenomenon, Lina argues that “the difference with Amazon is the scale and sophistication of the data it collects. Whereas brick-and-mortar stores are generally only able to collect information on actual sales, Amazon tracks what shoppers are searching for but cannot find, as well as which products they repeatedly return to, what they keep in their shopping basket, and what their mouse hovers over on the screen.” A difference in quantity becomes a difference in quality. It sheds typically risks associated with innovating by leveraging its marketplace data and reaps the benefits of it. This limits the ability of firms to innovate because any potential profits are eliminated by Amazon.
Where do we go from here?
There are obvious anti-competitive concerns with internet platforms. So what do we do about them?
Lina suggests two potential options:
Stop them from becoming dominant: If we decide that we should not let online platforms become powerful, we can stop them from ever getting there through regulation.
For Lina, this occurs across the dimensions predatory pricing and vertical mergers.
Predatory pricing laws should expand their scope to include the winner-takes-all effects associated with online platforms which makes it rational to lose money for long periods of time in order to recoup them later.
Vertical mergers should be more strictly scrutinized when exchange of data is involved. For example, the merger of Facebook and Instagram brought together two very large databases of advertisers and user behavior, largely eliminating competition in the social media ad space.
Accept a “natural monopoly” position and regulate them: If we come to the conclusion that we want to keep the benefits associated with the economies of scale of online platforms, then we can regulate them. There are a variety of tools that could be used for this. Nondiscrimination schemes can ensure that Amazon cannot privilege its own goods and limits can be set on the cut that Amazon is allowed to take from its merchants. Regulators can definitely get creative here.
Lina is in the early innings of her career and has already made a huge impact in the field of anti-trust legislation. FTC commissioners have a lot of power, should they choose to wield it.1
Business move of the week
The Future of Sonos and a collaboration from the past
I came across this interview with Sonos CEO Patrick Spence this week. In short, there were three big points that stood out:
Sonos has done better than ever during COVID as people have invested in their home audio setup. As a part of this ramp up, they are launching more accessible speakers.
It wants to grow its services business which it started with Sonos Radio last year. This was described by me as “too little, too late” in a previous edition of the newsletter.
It’s complaining to the government about how companies like Google, Apple, and Amazon are using their market power to dominate the audio business.
That last point would seriously concern me if I was a Sonos shareholder. While it is the government’s job to ensure a healthy and competitive market, it’s not a good sign for it to be part of your business strategy.
So what’s the Sonos endgame? In May 2020, I co-wrote an article titled, Spotify’s New Customer, with the brilliant and understated Brett Bivens about how Spotify should acquire them:
Spotify has emerging market power both in music and increasingly in podcasting, distribution chops, and discovery features. Yet it struggles because of its treatment as a second-class citizen on iOS and Android platforms. Sonos has superior hardware, customers that love its products, and deep audio competency. Yet, one of its core utilities is held hostage by Google and Amazon and offered at onerous terms.
So, what if these two Davids didn’t try to beat Goliaths by themselves? What if they joined forces and took on the King Kongs of tech together?
I think those points still stand—especially those around Spotify’s podcasting ambitions—and I don’t really see alternative endings for Sonos unless they want to continue to stay in the high-end speaker market. Their ventures into the lower price points and services indicates they don’t want to do that.
Check out the whole post here:
Odds and ends of the week
This week's odds and ends are a mixed bad of interests—books, physical processes, and human behavior:
📖 How Books Are Handmade At The Last Printing Press Of Its Kind In The US: I image that centuries from now, our descendants will find this video and make an NFT about how they used to do things in ancient times. Of course, we won’t be around for that, so let’s enjoy it right now.
🎵 How Vinyl Records Are Made: As I’ve mentioned many times in this section, these “How it’s Made” videos are my favorite. I could watch them all day.
💸 China's "Semiconductor Theranos": I am fascinated by scams. I think it's because at the root of it, they expose about how things really work instead of how we think they work. This article on a recent scam in China highlights this in vivid detail.
As an aside, federal trade commissioners always remind me of the story of Leland Olds and Lyndon Johnson from Robert Caro’s The Master of the Senate. Leland was up for re-nomination to the Federal Power Commission but his ideas conflicted with those of Lyndon Johnson’s political contributors. To give you a flavor of what was to come, Caro starts the chapter about this conflict with the following sentences: “Another quality that Lyndon Johnson had displayed on each stage of his march along the path to power was an utter ruthlessness in destroying obstacles in that path. The obstacle in his path now was a man named Leland Olds.” What followed was a foreshadowing of Johnson’s tight grip over the Senate for years to come.
That wraps up this week’s newsletter. You can check out the previous issues here.
If you want to discuss any of the ideas mentioned above or have any books/papers/links you think would be interesting to share on a future edition of Sunday Snapshots, please reach out to me by replying to this email or sending me a direct message on Twitter at @sidharthajha.
Until next Sunday,
Sid