How Amazon Innovates: Lessons in Strategy for Microsoft and Others

2/25/10Follow @gthuang

Sometimes a question that sounds naïve at first can lead to a revealing answer. So here goes: What is it about Amazon’s corporate culture that seems to foster creativity and innovation, while Microsoft gets ripped constantly for failing to innovate? Are there simple principles at work inside Amazon that might explain the difference?

I choose to compare these companies for a basic, if unscientific, reason: they’re the two biggest publicly-traded tech firms in town. And just as Microsoft (NASDAQ: MSFT) helped define a generation of entrepreneurs and technologists in Seattle—and around the world—many would argue that Amazon (NASDAQ: AMZN) will help define what comes next.

OK, so comparing these two tech giants is like discussing apples and oranges. They have vastly different customers, business models, and technologies. And one is a lot bigger and older than the other. We’re talking about a 35-year-old Microsoft that is more than triple the size of 16-year-old Amazon, after all.

But people forget how much Microsoft has grown in just the past decade. The Redmond, WA, firm more than doubled in size from 2000 to 2009, going from about 40,000 to 90,000 employees worldwide. In that period, its revenues increased by a factor of 2.5 (from $23 billion to $58 billion), while profits also climbed, albeit at a slower rate (from $9.4 billion to $14.6 billion). By comparison, Amazon had just over 24,000 employees at the end of 2009, when it made about $900 million in year-end profits (on $24.5 billion in revenues). So Amazon’s size and revenues are more comparable to Microsoft’s in 2000, though its profit margins are much lower. My point is that Amazon today looks a lot like Microsoft did a decade ago on some important measures of business success.

So for now, let’s focus our questions more carefully. How has Amazon managed to remain nimble even as it has grown to 24,000 employees? After starting with a simple website that sold books online, it now offers a huge diversity of products, from books and other physical goods to an e-commerce platform, cloud computing services, Kindle e-books and readers, and now, mobile applications. What deeper lessons can startups and big companies, including Microsoft, take away from its story?

Amazon is a hard company to get to know. For better or worse, its executives rarely talk to the press, and they almost never comment publicly on business strategy or competitors. (The company declined to comment for this story.) So instead I’ve been talking with former Amazon employees, as well as outside tech observers, to get a better feel for the culture and strategy there. And to get some insights straight from the horse’s mouth—from founder and CEO Jeff Bezos—I had to dig around a bit more (see further below).

Without a doubt, Amazon’s culture comes from the top. From the beginning, Bezos did things a little differently. Former Amazon executives say the CEO liked to hire people fresh out of college or business school who hadn’t logged time at other companies—so they didn’t have ingrained habits, ideas, or other corporate baggage. They could be indoctrinated in the Amazon Way. That these employees tended to be workaholics didn’t hurt. And somehow that culture has persisted to today. (Several current Amazon employees told me it’s common to work nights and weekends, especially before the holiday season.)

Interestingly, Bezos didn’t always follow best business practices or operations advice, according to one former senior exec. That led to some decisions being “poorly made” in the early days—I took this to mean things like handling relationships with partners, and gearing up for the company’s IPO in 1997. In some ways, it sounds like Amazon succeeded in spite of its operational missteps. What helped was Bezos’s vision and a lot of hard work from people to fulfill it. And of course, the company’s timing was excellent, getting established at the start of the dot-com bubble. Indeed, the rise of Amazon has coincided almost perfectly with the rise of the Web, e-commerce, and online recommendations; seemingly overnight, consumers have become willing (and they often prefer) to buy things online, share payment information, and give their opinions on certain trusted sites.

One obvious comparison with Microsoft is how Bezos stacks up against Bill Gates and Steve Ballmer in terms of leadership. “When I was at Amazon, I saw Jeff directly involved in driving a huge amount of innovation, largely by coming up with ideas on his own and getting the organization to implement them. He’s often involved in the smallest details,” says Josh Petersen of Seattle’s Robot Co-op, who has worked at both Amazon and Microsoft. (Disclosure: Robot Co-op is a subsidiary of Amazon.)

As for Gates, Petersen says, “I only met him once, but I was struck by how insightful he was about the product he was reviewing and how ready he was to toss questions to the team and delve into details…But I had the impression the job of the product team was to develop something and bounce it off Gates, whereas Bezos would generally be more intimately involved in the process rather than playing the role of exterior arbiter.” (The question remains how Bezos has the bandwidth to be that much more hands-on than Gates, or presumably Ballmer. But it speaks to the top-down culture at Amazon.)

Others see the way the companies’ respective product lines are set up as a key difference. Amazon is “selling other people’s products, or more specifically, figuring out the best ways to sell other people’s products,” says Brent Frei of Bellevue, WA-based Smartsheet, a former Microsoftie. “Kindle is a means to sell other people’s books. Mechanical Turk is a way to improve data around selling other people’s stuff. They rarely have a product line that is competing with another product line that prevents innovation.”

That’s as compared to Microsoft, which has a culture of internal product competition. That means when budget priorities are established, new ideas sometimes get crushed to protect cash cows like Windows and Office. Frei says of Amazon, “The innovative things they are doing to be better at their core businesses [are] invigorating. They don’t seem to have any sacred cows and will creatively destroy anything in the way of ‘better and more profitable.’”

From what I gather, product teams at Amazon tend to be smaller and less centralized than at Microsoft. It can take 10 times as long to develop a new product at Microsoft as it does at Amazon—sometimes years instead of months—and it’s clear Microsoft still thinks in terms of “shipping software.” So it maps out release plans and feature sets years in advance. “Amazon, when I was there, was much more seat of the pants,” Petersen says. “But what Amazon had that I never saw at Microsoft was an incredible focus on real-time metrics. Amazon projects would deploy, be tested, adjusted, re-tested and continuously tweaked.”

And then there are the products themselves. Petersen says, “The tone at Microsoft was that the product had to be good enough (or maybe not even that good) to win, but it wasn’t worth going beyond that. Several times I heard new ideas dismissed with responses like, ‘The competitor’s product doesn’t have that feature.’ To delight or amaze or entertain was never on the agenda. Business results and competitive position were probably focused on more than what I saw at Amazon, but that focus didn’t lead to better outcomes for Microsoft.”

These observations of Amazon’s culture fit well with what Bezos has said publicly—but he goes much further. One of his most compelling interviews to date is from the October 2007 issue of Harvard Business Review. In it, Bezos discussed an impressive range of issues—from Amazon’s “friendly and intense” culture to its willingness to plant innovative seeds and “wait a long time for them to turn into trees” (typically five to seven years before having any real economic impact). He also described Amazon’s focus on process management and its defining business principles and unique strategies.

Bezos explained his overarching philosophy partly as follows. Everyone else seems to focus on things that will change over time, he said—competitors, technologies, and other factors that force companies to adjust their strategy rapidly. Amazon bases its main strategy on things that won’t change—in this case, the fact that its customers want a wide selection of goods, low prices, and fast delivery; developers who use its e-commerce or Web services platforms want reliability; and sellers want sales. Because 10 years from now, those things will still be true, and will still pay off for the company.

At the same time, Bezos told HBR, it’s important to adjust quickly to customers—not to competitors whom you might be tempted to follow closely into various markets. “The strategic value of close following is in not having to go down all the blind alleys. You let smaller competitors check those out, and when they find something good, you just quadruple down. If you’re following close enough, and the arena is slow-moving enough, the fact that you’re not first down that path doesn’t hurt you much. But in our environment there’s so much rapid change on the Internet, in technology, that our customer-obsessed approach is very effective,” he said. “If you’re competitor focused, you tend to slack off when your benchmarks say that you’re the best. But if your focus is on customers, you keep improving.”

He told the story of when Barnes & Noble launched its website in 1997, and at least one prominent tech pundit predicted Amazon would get wiped out. After all, Barnes & Noble had 30,000 employees and $3 billion in annual sales, versus Amazon’s relatively puny 125-person staff and $60 million annual revenue line. Bezos said he called an all-hands meeting, where he told his staff: “Forget about this. We can’t be thinking about how Barnes & Noble has so much more in the way of resources than we do…Yes, you should wake up every morning terrified with your sheets drenched in sweat, but not because you’re afraid of our competitors. Be afraid of our customers, because those are the folks who have the money. Our competitors are never going to send us money.”

As for how to deal with self-competing product lines, Bezos said, “We take a simple-minded approach. There’s an old Warren Buffett story, that he has three boxes on his desk: in-box, out-box, and too hard. Whenever we’re facing one of those too-hard problems, where we get into an infinite loop and can’t decide what to do, we try to convert it into a straightforward problem by saying, ‘Well, what’s better for the consumer?’”

Indeed, some of the most important things Amazon has done have seemed like tactical losers to established companies who were looking at the short term. But Amazon has always been fixated on improving the consumer experience regardless of conventional wisdom, according to Bezos’s comments in HBR: “In the very earliest days (I’m taking you back to 1995), when we started posting customer reviews, a customer might trash a book and the publisher wouldn’t like it. I would get letters from publishers saying, ‘Why do you allow negative reviews on your website? Why don’t you just show the positive reviews?’ One letter in particular said, ‘Maybe you don’t understand your business. You make money when you sell things.’ But I thought to myself, We don’t make money when we sell things; we make money when we help customers make purchase decisions.”

Then, of course, there are plenty of features and products that didn’t pan out, because customers didn’t want them or didn’t care. Amazon’s failed online auction business (similar to eBay) comes to mind; Bezos says he learned consumers just wanted their sales to be done quickly on the site, instead of dealing with bids. In such cases, the company has been able to cut losses fast and move on. “The key, really, is reducing the cost of the experiments,” Bezos has said.

It will be interesting to see how well Kindle e-books and “active content”—essentially mobile applications for the Kindle device—end up selling. One advantage Amazon’s forthcoming mobile apps might have over Apple’s iTunes, for example, is that the demographics of the Kindle community might be more tightly focused compared to other devices—because users might tend to be business people, travelers, and academics, say. That could help outside developers target specific types of consumers. And Amazon Web Services, the cloud computing platform used by many companies to store data and run applications, is maturing; how will it stack up against the onslaught of other tech firms, like Microsoft, Google, IBM, and VMware, who are also providing fast, cheap, reliable services for businesses that want to save money on their IT infrastructure?

Another intriguing experiment to watch is Amazon Fresh, the delivery service for groceries (and other goods) currently offered only in Seattle. If the service can be expanded to other geographies, it would be a shrewd way to extend the psychological connection between Amazon and its customers right up to their front door—almost in real time. (It also wouldn’t hurt that the company’s fleet of grocery trucks could be like rolling billboards on every highway and arterial in the country.)

In the HBR interview, Bezos also reflected broadly on how he has adapted to Amazon’s growth. “When you start out, it’s a one-person thing, at least on the first day, and you’re not only figuring out what to do but actually doing it,” he said. “At a certain point the company gets bigger, and you get to where you’re mostly figuring out what to do but not how it’s done. Eventually you get to the point where you’re mostly figuring out who is going to do it, not even what to do. So one way to think about this is as a transition of questions, from ‘How?’ to ‘What?’ to ‘Who?’”

So, to answer my own question, it seems like Amazon has remained innovative by focusing on its customers much more than its competition; having visionary and disciplined leadership that sets the tone for every employee and product; avoiding too much internal product competition; and trying a variety of long-term experiments, but killing them off quickly if consumers don’t respond.

How does this relate to a company like Microsoft in the long run? Some would argue that the Redmond firm has gotten worse in each of these areas as it has continued to grow, especially in the past decade. It seems inevitable, with the world’s transition to Web software, that a company built on desktop software would become less relevant. And its size is a distinct disadvantage, regardless of what former IBM CEO Lou Gerstner once said about how elephants can be nimble enough to dance. Yet most observers aren’t counting Microsoft out, as it still has time to reinvent itself and find new ways to capitalize on its strengths in operating systems and business software.

Meanwhile, Amazon’s real growth—and the real challenges stemming from that growth—may be just beginning. It would do well to watch and learn from the giants that came before.

Gregory T. Huang is Xconomy's Deputy Editor, National IT Editor, and the Editor of Xconomy Boston. You can e-mail him at gthuang@xconomy.com. Follow @gthuang

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