Episode 28: The Amazon IPO with original Amazon Board Member Tom Alberg

Ben & David welcome very special guest Tom Alberg, board member and first lead investor in Amazon.com, to cover the IPO of "earth’s most customer-centric company". From longterm thinking to flywheels to riding big waves, this episode is chock full of lessons and stories from the journey of building one of tech’s most iconic franchises. We hope you enjoy listening as much as we did recording it! 

Topics covered include:

  • Tom’s “prolific” bio from the Amazon S-1
  • Jeff Bezos’s journey from a Vice President at the New York hedge fund D. E. Shaw to founding Amazon in a Bellevue, WA garage in the summer of 1994
  • Jeff’s longterm thinking as evident in the early days of Amazon, and his approach that "failure is ok, but not trying things is not ok” 
  • Raising the seed money for Amazon before product launch, how Tom met Jeff and decided to invest despite the “high” valuation
  • Tom's (and Jeff’s) focus on the power of targeting large and growing markets 
  • Amazon’s actual overnight success after launching the website: according to Tom at the time, "By the second or third week… It was clear there was a trend here.”
  • How Amazon’s venture round, led by John Doerr of Kleiner Perkins, came together in the spring of 1996 
  • Amazon’s torrid growth through 1996, Jeff’s mantra of “get big fast” to win the land grab of online book selling, and the board’s decision to prepare for a public offering in the spring of 1997 
  • How Frank Quattrone and Bill Gurley, then of Deutsche Bank, won the lead position for the Amazon IPO, beating out more storied firms such as Goldman Sachs and Morgan Stanley 
  • Development of the flywheel concept within Amazon, as an outgrowth of maniacal focus on creating superior customer experience
  • Amazon's public offering on May 15, 1997 at $18 per share (effectively $1.50 relative to today’s stock price after splits), raising $54M at a market capitalization of $438M — and subsequently trading down during the first few months following the IPO  
  • Amazon and Jeff’s management of investor perceptions of the company, and ability to sell the longterm vision over short term profits — “you get the investors you ask for” 
  • The creation of the first annual letter to Amazon shareholders included in the company’s 1997 annual report (and republished every year since), and then-CFO Joy Covey’s role and contributions to it 
  • Raising convertible debt just before the peak of the dotcom bubble and subsequent ability to survive the burst, and the impact of the downturn on Amazon culture

The Carve Out:

Full Transcript below: (disclaimer: may contain unintentionally confusing, inaccurate and/or amusing transcription errors)

Ben:                 Welcome to Episode 28 of Acquired, the podcast where we talk about technology acquisitions and IPOs. I’m Ben Gilbert.

David:              I’m David Rosenthal.

Ben:                 And we are your hosts. Today’s episode is on the Amazon IPO, and we have an incredibly special guest with us today, Tom Alberg.

David:              So Tom, we know very well, because he was one of the cofounders of Madrona which actually brought Ben and me together, and none of us would be here if it weren’t for Tom. But in addition to being a cofounder of Madrona, he has had had another very special role over the last 20+ years which is board member of Amazon.com. Tom was the first investor and the first and, I guess other than Jeff, longest serving board member of Amazon.

Tom:                Right.

David:              So we thought it would be fun, we will get through the whole IPO story here but to read Tom’s bio from the S-1 that Amazon filed in advance of going public.

So “Mr. Alberg has been a director of the Company (Amazon) since June 1996. Mr. Alberg has been a principal in Madrona Investment Group, LLC, a ‘private merchant banking firm,’ since January 1996. From April 1991 to October 1995, he was the President and director of LIN Brodcasting Corporation, and from July 1990 to October 1995, he was Executive Vice President of McCaw Cellular Communications, Inc.; both companies were providers of cellular telephone services and are now part of AT&T Corp. Prior to 1990, Mr. Alberg was a partner of the law firm Perkins Coie, where has also served as Chairman of the firm’s Executive Committee. He is also a director of Active Voice Corporation, Emeritus Corporation, Mosaix Inc., Teledesic Corporation and Visio Corporation. Mr. Alberg received his B.A. from Harvard University and his J.D. from Columbia Law School.”

So, are any of those other companies still in business except for Amazon?

Tom:                No. I think, well, Visio was acquired for a good price by Microsoft. I think over a billion dollars. But you also left out, for example, that I learned the multiplication table since third grade and probably was class president in fifth grade. I mean, how can you miss these things?

David:              At Ballard High School, right? Here in Seattle.

Tom:                Right. Ballard High School eventually, right.

David:              Once again, thanks to Tom for joining us. We’re super honored to have him on the show. Let’s start with the Amazon story. So, I expect most listeners are familiar with the lore of how Amazon came to be, but we’ll retell it briefly here leading it up to the IPO and ask Tom some fun questions along the way.

So, Amazon was founded in the summer of 1994 but actually started the idea a little bit before that when Jeff Bezos as the vice-president at the hedge fund D.E. Shaw & Co. in New York. And David Shaw, the founder of D.E. Shaw, assigned Jeff to think about business opportunities enabled by this new thing called the internet. Jeff went off and did a bunch of research, and as legend has it, he came across this one report about the growth of the internet that projected that it would grow 2300% annually for the next decade or so. He kind of read that and decided, “That’s it. I got to be a part of this. I don’t want to miss this boat.”

So he and his wife MacKenzie who he also worked with at D.E. Shaw, they quit their jobs and they road tripped across country to the west coast with no particular destination in mind other than starting a company at the end of it. Jeff writes the business plan for what would become Amazon along the way and they end up here in Seattle where they start Amazon on July 5,1994 in a garage in Bellevue.

Speaking later about this journey, Jeff would come to talk a bunch about what he terms the “regret minimization framework”. And this is a quote, there’s a great piece in Wired magazine I think from 1999 interviewing Jeff and asked him about why decided to leave and start Amazon, and he said, “When I’m 80, am I going to regret leaving Wall Street? No. Will I regret missing a chance to be here at the beginning of the internet? Yes.”

So even in those early days, Jeff’s kind of long-term thinking is evident there. I’m curious, for Tom, is the regret minimization framework something that Jeff talks about in the context of Amazon? What’s your experience with that been?

Tom:                Well, Jeff, yeah, he’s a big picture, long-term thinker. So I don’t think we’ve really focused so much on that. I mean, I think it was important for him in terms of that decision. But maybe it underlies a lot of his feeling on “let’s try things and we can only regret that we didn’t try something. We can never regret that we tried something even it fails.” So he’s very much in the mode of “failure is okay. Not trying things is not okay.”

Ben:                 Awesome. Along those lines of thinking about the origin of the idea frame is on dotcom, as I was reading The Everything Store, it says that Jeff and David were on a walk through Central Park when Jeff told him he was going to leave and –

David:              It’s David Shaw, the founder of D.E. Shaw who Jeff worked for.

Ben:                 Yes. Thank you, David.

David:              Not me. Although that would have been awesome.

Ben:                 It occurred to me the intellectual property and all this original research that had been done for Amazon would have been done at D.E. Shaw. What did that look like and was that ever sort of a concern that D.E. Shaw would come back later with any sort of claim to the idea for Amazon.com?

Tom:                Well, Jeff had signed a non-compete and a non-solicitation agreement. I don’t remember actually worrying about the non-compete, which in retrospect is kind of interesting. Actually, Shaw did start a couple of early internet companies that Jeff was not a part of. They even had an email company that developed and then went public in the late ‘90s and merged with somebody.

But we did talk about and Jeff paid strict attention to the non-solicitation of employees, and it was a two-year limit. So there were people at D.E. Shaw, at least one person who really wanted to desperately come with Jeff and really –

David:              Was it Jeff Holden?

Tom:                Well, Jeff Holden might have been. It might have been Jeff Holden. Jeff was at D.E. Shaw. I mean, the story is that –

David:              And I think Jeff is now, I think, SVP of product at Uber?

Tom:                Yes, I think so. Holden has had an interesting career and we once looked at investing Madrona at a company he had started. The valuation was only about pre-money at $80 million or something. So, we passed on that one.

But the story is that when the two years expired, Jeff Bezos immediately called Jeff Holden and said, “Pack your bags and come to Seattle,” which he did. Then several other people from D.E. Shaw followed.

David:              So in the early days, the company before – It was obvious Amazon was doing well and could recruit all these former coworkers of Jeff from D.E. Shaw, they spend a whole year actually building the site. So from the summer of ’94 until the summer of ‘95, they build a site and then they launched Amazon.com almost exactly a year later in July 1995. Along the way, Amazon raises its first seed investment and Tom, you led the first round of Angels that invested in Amazon. How did that come together? How did you meet Jeff and end up deciding to do this?

Tom:                Well, the short part of the story is that Jeff was out raising that first million dollars and began in kind of early 1995. He was calling on people and a lawyer friend of mine, older lawyer called me and said his investment group, he had a little Angel investment group, that they had met with Jeff and they didn’t really understand this new internet thing, and when I meet with Jeff and give them advice as to whether this was for real.

David:              And your background was in the cellular industry.

Tom:                Yeah. I was at that time wrapping up, selling McCaw Cellular and Lin Broadcasting to AT&T. But I did know something about the internet. But this was very beginning. Netscape went public I think in like September, that fall of ’95. Three of the key employees at McCaw had been recruited by Netscape – the president, the CFO, and his general counsel. I was intrigued by it. But anyway, you never always say “no, I don’t know anything about it.” You say “sure.”

David:              That sounds like a very Bezos-like approach to things.

Tom:                Yeah. Well, it was a good thing I said “sure.” Anyway, Jeff then called me and I met with him, and he laid out what he was planning to do.

David:              The website hadn’t launched at this point, right?

Tom:                No. This was like in May of ’95 and the website launching in July. So, I was impressed by Jeff. To say that I foresaw what Amazon was going to become would be not true. I don’t think anybody, including Jeff probably didn’t fully – I’m sure he did not foresee what it became. I mean, he was excited about the growth of the internet. He had done a lot of research. He had focused on books because he had this ability to have this enormous catalog of books that no single bookstore could afford to carry.

So I reported back to my friend and said, “I think it's for real. It’s very risky, but – and Jeff is for real. He’s obviously a smart guy. He’s very passionate about it.” So then my friend who had referred it to me, a couple of weeks later he called me back and he said, “Well, we called Jeff then after we talked to you and we told him that the $6 million pre-money valuation was too high and asked him to lower it to $5 million, and he was unwilling to do it.”

Ben:                 Oh, my God.

David:              So, he passed.

Tom:                So, he passed. So years afterwards, and really a wonderful guy, years afterward he would give me a hard time.

Ben:                 I bet.

David:              About the huge price that he gave.

Tom:                So the point of it is, they took Jeff almost 12 months. So he didn’t close until December of ’95, this million dollars. Part of it came from his family and lots of people passed on it, which is not surprising. There were a couple of kind of small venture firms at that time in Seattle. They passed on it. It was too risky in their mind and they had a lot of risk.

Ben:                 So Tom, you've seen thousands of startup pitches and met with countless entrepreneurs over the years. Was Jeff like head and shoulders above any other pitch? Or was his super different? Or was it like, “Yeah, you know, I meet with a lot of really talented people with great ideas, and some work and some don’t.”

Tom:                I think looking back it’s a little hard but I don’t think he stood out as the only great entrepreneur I ever met, but certainly in the top 20 or 10 percent. But it was a combination. You know like a lot of venture, we tend to think the person is very important. But also, kind of what they’re doing. I mean, it’s not always exactly the business plan and the financial model, although that’s important. It’s often are they in the right kind of technology and the right growth area. Because you could come up with lots of reasons why this was not going to succeed. But the internet was growing, some commerce was probably going to work.

David:              At 2300% a year apparently, right? You know, it strikes me, one of the things – we talk about this a lot on this show about the importance of the market and targeting large markets. It struck me reading Jeff’s early writing about Amazon and particularly which we’ll get to later, the first letter to shareholders after they went public. He really focuses on the market and illustrates how large the market is even for just books but then everything Amazon expanded into is. When you’re operating in a large market, a lot can still go wrong and can go wrong, and you’ll still be successful.

So, that was 1995 and when the website finally launched in the summer – it’s funny, you know, we work at Madrona with Tom and many, many startups, and Ben and me several as well, it actually was an overnight success when by the – this is actually, Tom, a quote from you in that same Wired article. “By the second or third week, there was $6,000 or $10,000 in sales, and by the end of September,” they just launched in July, Amazon was doing $20,000 in revenue a week. And this is Tom. “It was clear there was a trend here.”

Tom:                Good understatement.

David:              Yeah. Understatement of the century. As that became clear later into 1995 and 1996, lots of VC firms came calling. Amazon and Jeff eventually decided to raise a larger venture round that Kleiner Perkins led in 1996, and John Doerr joined the board. How did that come together?

Tom:                Well, Jeff had formed a small advisory board of himself and three other Seattle investors including myself.

David:              So there wasn’t a formal company board at this point.

Tom:                No, the formal company board was Jeff. But he wasn’t ready for a board, but he was ready for an advisory board. So we would talk about, you know – like a board in the sense of what do we need to do. “Gee, it’s growing very fast. We got to improve the website. We need to do other things.” And so it was becoming clearer that it was growing fast that it was going to take more money than the million dollars partly just to satisfy growth. Venture capital firms around the country were calling.

So I came how one night after work at 6:00 or something, and my wife said, “Do you know some guy named John Doerr?” I said, “Well, actually I do.”

David:              “I’ve heard of him.”

Tom:                When I was on the Envisio board, one of his partners was on that board and I guess in, a couple of different ways, I had met John. She said, “Well, he calls every 15 minutes,” and he needs to talk to you now. It was one of John’s great strengths which is his persistence. Tells you something about how to sell yourself, show your interest.

David:              A critical trait for a successful venture capitalist.

Tom:                We don’t always follow that enough probably. So I talked to John and he said, “Well, I’m going to meet with Jeff. I really want to be in this deal. I hope you can help me,” etc. So, that was sort of partly the introduction.

So they were really eager. Another firm that was very eager was General Atlantic which is an east coast firm. Kind of one interesting point out of it, I think, is that there was some negotiation on price and both firms were eager, both were outstanding firms. General Atlantic proposed a complicated pricing because we’re starting to talk $80 million pre-money in. Although that area was starting to get hot, it was a reasonably high pre-money for a first venture round. But they proposed sort of a complicated thing. It would be a $90 million pre-money if it went public. But if it didn’t go public within two years at a certain valuation, then it was $50 million, and Kleiner came in, it was sort of like a straight $60 million at some point. I think we all kind of favored Kleiner Perkins anyway, but I picked Kleiner Perkins partly though on pricing complication.  

Ben:                 So when that round closed, is that when the formal board of directors was established with you, John, and Jeff?

Tom:                Yeah. And a little bit of story there that I think came out before, but Kleiner Perkins, John actually said, “Well, I love you but I’m so busy, I’m on all these other boards.” He was on the Netscape board I think at that time. “I really don’t have time. But here I’ve got a great partner here in the board.” Jeff sort of said, “Well, that’s too bad, it’s your thing. Talk to us.” And we said, “Well, why don’t you just tell them that Kleiner can only invest if John comes on the board?” So Jeff of course did, and John joined the board, which was good for Amazon and good for Kleiner and John, obviously.

David:              Yeah. I’m curious on that. So, in The Everything Store, he talks about how, I don’t know how much of this is causal but after that Kleiner invested and John joined the board, that Jeff kind of adopted as a mantra a “get big fast.” How did that come together? In truth, Amazon did get very big very fast. Was that associated with investment? What drove that mindset change for John?

Tom:                I think part of it just came from the fact that we were growing fast. The original business plan back when he was raising the million dollars was he had kind of a moderate growth and a fast growth but nothing like what he was achieving. The plan actually said he would break even in year 2. And again, unfortunately that didn’t happen.

David:              He meant at year 20.

Tom:                Right. But it was growing fast. Jeff also had one of his sort of thesis is sometimes there’s in launching a new business, there’s a land rush. You want to be first and get into the lead and stay there. Other times, this is true in launching new projects in Amazon. Sometimes he feels there’s a land rush and sometimes not. So, you really double down. Then the financial markets were really willing. I mean we were in a hot –

David:              Robust.

Tom:                Already the financial markets were bidding up other companies, and so he realized that could raise a lot of money. So, let’s grow fast and we had the specter of Barnes & Noble sort of saying they’re going to get in the internet. So there was a reason then to really step on the accelerator.

David:              And you and Jeff did. So in 1995, which is the first half year of operations, Amazon did about 500,000 in revenue. Then in 1996 and it was the summer when Kleiner invested, so only half a year with this extra capital to grown, Amazon did just a hair under $16 million in revenue which is, what’s that, a 20… that’s a large amount of growth. It’s so large I can’t even calculate it in my brain. Even today, we don’t see companies do that.

Tom:                No, not in the first year.

Ben:                 At this point, we were still in the era of Amazon.com was only a bookstore. When Jeff was putting together kind of the pitch deck for that $60 million round and showing around, was there any inkling that it was going to be more than books at this point? Did they start to foreshadow those other categories?

Tom:                Jeff in those early years was very focused on books. I mean, he declined to even talk about other things for the first 2 or 3 years. I think that was including through the IPOs, I remember. Partly it was “let’s do books well, and books is big.” But other people were starting to ask and talk about, “Well, what about other products?” I suspect Jeff was thinking about that, but it was good I think in the beginning, just let’s get this one right. I can’t remember when but it was probably ’98 or so that really launched music and started to launch some other things.

David:              And movies. So at the end of ’96, just on $16 million in revenue, Amazon hires Joy Covey as CFO who plays a central role in The Everything Store. The company makes the decision and the board makes the decision that they wanted to prepare for an IPO and go public in 1997 which – So at this point, we are two years into the life of Amazon as a company, one year into it being a publicly available website. You’ve talked a little bit about the financial markets being open. But how did those discussions – I mean, the board was you, John Doerr, and Jeff. Did Jeff come to you and say, “Hey, I think we’re ready to go public?”

Tom:                Well, I think pretty quickly investment bankers were even calling. Once something starts to get hot, whether there’s substance in these companies or not, there’s sort of this investment banker. And that was particularly true in the ’95 to 2000 era. People were going public and being worth $30 billion and really didn’t have much.

It didn’t quite happen that way with Amazon because even though there was interest – And I think one of Jeff’s motivations, I think the idea that we could raise money at hopefully good valuations and then use that money to grow further was attractive, he also felt that because it was kind of a small, relatively unknown retail company that it would help the brand to get better known. I think that’s true on some consumer-oriented companies. It actually can be true even on enterprise startups. We have one, Impinj that went public this year. They were not widely known among CEOs. The CIO knew them but once you get public, you start to get picked up more on the Wall Street Journal and the New York Times – certainly happened to Amazon after it went public.

David:              What was the preparation process like? In particular, I’m curious, so the lead-left bank on the Amazon IPO was Deutsche Bank. Not Goldman Sachs or Morgan Stanley. We covered the Facebook IPO a few episodes ago and talked about the jockeying between the two of those firms for the Facebook IPO. These are the gold-plated Wall Street firms that everyone wants one of them to be their lead book runner for the IPO. But Amazon went with Deutsche bank and in particular, the lead banker, Frank Quattrone, and the lead analyst, Bill Gurley who obviously is now a partner at Benchmark. How did that relationship come together?

Tom:                If you’ve met and know Quattrone and Gurley, the answer is quite Quattrone and Gurley. A broader answer is I think Jeff always had the view and we had the view that big name companies aren’t always the best. Goldman and Morgan Stanley have been the top two then and today. There’s a lot of merit in going with them. But it didn’t mean that others weren’t as good or potentially better and often it is the people directly working a deal. So I think they made a good impression and we thought they could do the job.

David:              There’s a great story told in the Everything Store that after the IPO, they organized a retreat in Hawaii, right?

Tom:                Mexico, I think.

David:              Oh, Mexico. That’s right. I think it was Cabo. They had an associate working on the deal who was Jeff Blackburn. Blackburn came along on this retreat and I’m sure had interacted with Jeff – there’s so many Jeff’s at Amazon – with Bezos and the company and the board beforehand. But the net of that was that Blackburn ended up joining Amazon, and they still have the company today, and a member of the senior team there.

Tom:                Right. One of the top executives.

Ben:                 Yeah. So, one of the biggest things that people who have studied Amazon look at now and is quite well known, is their ability to spin the flywheel, to add fuel at any given point and increased the momentum of other parts of the businesses in a very almost perpetual motion way. So that superior selection drives a better customer experience which increases more traffic, which brings more sellers to marketplace and on and on and on.

David:              Which lowers prices and increases selection. It’s a recursive loop.

Ben:                 It is. This early in the company before the IPO, was this something that was frequently talked about? Was this a thing on investors’ minds when they were thinking about investing in the IPO?

Tom:                So the actual flywheel concept developed in like 2001 or 2002 rose out of a board meeting and meeting with an outside consultant. But some of the basis of that, I mean, Jeff from the very beginning was very focused on customer experience. He talked in the meeting with me about we’re going to have the world’s best customer experience. It was hard to do in those days because the web wasn’t very good. When we launched, it was a black and white website. There was no publication date on the book so if you wanted to buy a – we’re not complaining about this – if you wanted to buy a travel book, you didn’t know if it was published 20 years ago or 6 months ago, and on a travel book, it’s very important.

But nonetheless, it was like it was genetic, that customer experience. And then so how do you do that? Well, prices, inventory. So it was in the background certainly and focused some of those elements. The flywheel metaphor became useful later, I think.

David:              Hearing you talk about that, one – as long-time listeners of this show know, we are great admirers of Ben Thompson and his Aggregation Theory. But one of the core tenets of that is that superior customer experience is “win” in a world where your accessible customer base is infinite and distribution costs are low, which is the internet. Really interesting to hear that even in those early days when the internet was so poorly understood by so many people, Jeff got that at his core that providing the superior customer experience would lead to winning the market.

Tom:                And not all companies get that. I mean, partly they’re focused on short-term. Partly, yeah, they will squeeze another two cents out of the customer. “Gee. We cut out this product and we saved money.”

David:              So all of this happens, Quattrone and Gurley win the business, leave the IPO and on May 15, 1997, so less than three years after the company was founded and less than 2 years after the product launch – I mean we’re talking last week about how Snapchat is to be lauded for going public, having the courage to go public four years after company founding, this was less than 3 years – Amazon prices its IPO at $18 a share, raises $54 million at an initial market cap of $438 million, which is thinking back today – well, we’ll wrap up at the end of the show with where the market cap is today. But it trades up on the first day, closes at $23.50. But then for the first couple of months, it actually trades down. It’s not until the company reports it’s Q2 revenue numbers later that summer that the shares, when they reported that they did $28 million in revenue in Q2 of 1997, which was more than – Well, much more than Q1 and more than they did in all of 1996, then the shares rise again.

What was it like in those first couple of months after the company went public and the stock traded down?

Tom:                You’re right. It didn’t have this enormous pop at the beginning and yeah, I think, I remember some of this, that it was pretty flat until the release came out. Even by the end of the second quarter, so late June I think it was, so the equivalent to today, there’s been three or four splits which are equivalent for 12 for 1. So if you divide 18 x 12, you get to a $1.50. And so, it was trading at about $1.50 in late June. Then, just a couple of other key points because you can do this endlessly but by the end of the year it was like $5 and then it went to $100 over three years or so in today’s numbers.

David:              Yup. And then the stocks split multiple times after that.

Tom:                But by 2001, when you had the recession and all the crashes, it was back down to like $6. There were moments when you could have bought in good prices and everybody, you know – it shows partly that the market is not perfect at valuation but on the other hand, the country was in a recession by 2001 and –

David:              And Amazon was a retailer.

Tom:                And it was losing a lot of money. Many people were predicting even then that was going to die. But yeah, it’s fascinating to go back over those numbers.

Ben:                 Oh yeah, I bet. One of the things we talk about a lot on this show is we try to assess whether an acquisition or an IPO was a good move and how successful was it. One of the measures that we use for that with IPOs is what going public enabled that company to do that they would not otherwise have been able to do. So, what in the kind of near-term those next few years after the IPO did they plough that new influx of capital into?

Tom:                I think Amazon has been rightly known for not making any money and being willing to invest and to the extent that the financial markets allow you to. So, I think if it had been in the hands of let’s say an acquiring party, you would not have seen this kind of growth and innovation and expansion. So, Jeff has had a unique ability to think long-term and make it clear that he’s thinking long term so that the investors understand that this is a long-term investment. He likes to say that “you get the investors you ask for.” Meaning that if you focus on two cents more profit per quarter, then you get investors who’d focus on that. It takes you a while I think to get the right kind of investors, but if you say long-term cash flow is how we measure the business, pretty soon you get investors who are willing to invest on that basis. I mean, it’s possible if you don’t grow, they aren’t going to like your message itself but you end up with fewer short-term investors and more long-term. I think that’s helped Amazon a lot.

David:              I’m super curious on this. We were chatting a little bit before the show and this is the perfect place in the story, too. So at the end of 1997, Amazon wraps up the year with 148 million in revenue, up from 16 the year before. Incredible growth. But I think, to my mind, the most incredible thing that happens at the end of 1997 is Jeff publishes his first annual letter to shareholders. So the company has been public for 7 or 8 months at this point and Jeff writes this amazing letter that is included in the annual report and he’s included every year since with his then current year letter as well. The document is a masterpiece of long-term thinking. How did that document come together? Did Jeff just walk into a board meeting one day and said, “Hey, I think I’m going to write a letter to all of our shareholders”?

Tom:                Well, I didn’t help him write it unfortunately. I wish I was a coauthor. But I think one of the key people in those early days was this Joy Covey who had been recruited as the CFO. Thinking back a little bit on that, when we started talking about going public, John Doerr said, “Well I’m going to vote against going public unless you bring in some more senior management. You can’t go public with you and a couple of technical people.”

Ben:                 Oh, wow.

Tom:                I mean, it’s been a rule that sometimes we violate but it’s a very good rule that you need – being private is different than going public. Even if you’re growing pretty well, you need a really first class CFO. You need some more marketing power. It’s when David Risher was recruited from Microsoft who was a very important, strong senior executive in those days. We brought in, hired some more. Rick Dalzell – he was actually at Walmart and Jeff started trying to recruit him in January of ’97 before the IPO. He didn’t get him until after the IPO. I think Jeff wasn’t reluctant on that either but it was really John in a lot of ways saying, “you’ve got to have a better, stronger team to go public.” And I think it’s a good lesson for lots of people.

Joy was unusual. She was very smart. She hadn’t graduated from high school. She ended up graduating from Harvard Business School. She came in second in the nation on the national accounting exam. So, clearly she was smart and somehow –

David:              She was an amazing woman, yeah.

Tom:                Yeah. All she had done, in some ways she had taken – she had been CFO of a small company in the East Coast that had gone public.

David:              I believe she was in her early 30s when she joined Amazon.

Tom:                Right. Very young. Jeff is a very tough interviewer in the sense that he will interview a whole bunch of people until he finds somebody that he likes and thinks can do the job. He talks about setting the bar very high. He had a great lunch with her. He was impressed with her. And she’s very smart, nicely aggressive, personable. So she really drove the IPO in a lot of ways and I like to say we set a record for start of the IPO to finish. But she was also involved in that letter I think.

Ben:                 Wow. Speaking of the IPO start to finish, was that hard for the company in an era where they had been doing so much PR and so much marketing, and Jeff had been doing all these public appearances to endure that quiet period?

Tom:                Yeah. It was an era when, yes, the company was starting to get a lot of attention. I don’t know that that quiet period made a lot of difference. We did get some criticism then and even today on how much we disclosed beyond what the securities laws in New York, you know, the NASDAQ requires that you disclose everything you have to. But there’s always this sort of area of, “well, what’s the cost of a customer? And how many customers do you have? How fast does books grow versus video?” Amazon’s always felt that that’s proprietary. They don’t want to let their customers know. So, don’t want people focusing on whether in some ways short-term small things and it will work out in the long term. I think maybe bricks and mortar retailers, do they release monthly sales numbers or something? You at least see them.

David:              Yeah. Same store, month-to-month growth.

Tom:                That’s an example then of something. So there’s always been a little bit of tension with the endless wanting more and feeling. Well, you know, it’s only going to help our competitor. So I think that was going on even then. It was sort of like, “Who are you to tell us these things?”

Ben:                 It’s interesting in thinking about company creation from the earliest stages. You get so focused on that cost to acquire a customer number and making that go down and increasing your lifetime customer value. In Amazon’s life as a public company, they’re so reserved about releasing that information. Have you ever experienced in other private companies, someone who felt that that was proprietary and that was not something they would divulge in their pitch decks or anything like that?

Tom:                I don’t know about that specific piece. I mean, I do think sometimes it also comes up. Well, another one for some of our companies that have gone public has been backlog. Backlog often if – some companies have backlog and some don’t in different ways. That wasn’t really an issue with Amazon because it was sort of instantaneous sales from any day. But a lot of companies don’t want to disclose it because it’s misleading sometimes and maybe it tells things –

David:              The computers.

Tom:                So I think a lot of companies refuse to do that and analysts would love to have it. It also relates to predicting a range for next quarter or next year. Some of our companies give you next year’s kind of general expectation and some won’t. Yeah, I think there’s a lot of variation.

David:              So one more. We’re now post IPO and we’ll wrap up the IPO story in a minute with some fun stats. But one topic that happened a couple years later that I want to ask you about, Tom, is in 1999 so 2 years after the IPO, Amazon did a convertible dead offering and raised a billion and a quarter dollars in the debt markets. I’m curious in that and then that ended up being I believe the last money into the company through the internet bubble. Getting that large capitalization at that point, did that help the company survive the crash that came thereafter? How did it dig itself out of – you mentioned the stock price went back down to $5 at that point.

Tom:                Money was available. We’re growing rapidly. Let’s take advantage of the fact that the interest rates were at 5%.

David:              I think it was 4.75 I believe or around there.

Tom:                Which today is sort of where maybe interest rates are. But given the 20-year history, those were low interest rates. I think we ended up, we did two or three debt deals totaling a couple, maybe $2 billion. So on the one hand, it did give us money to grow. Sometimes for companies, having a lot of money lead to bad habits. You acquire maybe some companies who wouldn’t have acquire that were marginal or you overbilled and so forth.

So, Amazon was increasingly losing money when that recession hit and I don’t think we were any better predicting recessions that anybody else or the peak of the market. But it was probably taking advantage of the fact that money was available and then when the recession hit and we’re losing a lot of money – because I remember some of the terms of some these debts had no interest for several years and then the interest kicked in.

David:              Then it kicked in.

Tom:                So we’re facing more interest payments. The debt holders, the value of the debt had gone down. There was a lot of pressure from the debt holders. So really in 2001 or so, the decision – Jeff and board felt we need to cut cost and expenses. I think we barely did it in time in some ways. We waited quite a while and because we’re hoping to kind of grow out of it and at some point said, “No, we really need to.” There were lots of Wall Street people calling it Amazon dot toast, all these famous –

David:              Yeah, famously.

Tom:                You know, we’re going to go out of business. So we cut costs and there was this famous saying, “cut the crap.” Which meant they were shipping bags of dog food was a great example. Twenty-pound bag of dog food and charging $3 for shipping and losing a lot of money. Well, let’s stop selling –

David:              Which is amazing because I now get dog food for my dog from Amazon.

Tom:                Well, we cut it out for a while.

David:              I assume Amazon has figured out how to do it profitably now.

Tom:                Again, so it isn’t blind all speed ahead. It is when you need to, you cut back.

Ben:                 It’s interesting to think about the fact that the pressure from that debt holders forced cost cutting which was ahead of the rest of companies who had to go to immediate emergency cost cutting mode, and most of them didn’t make it. What other factors do you think played into Amazon making it through –

David:              Survival.

Ben:                 Yeah. Surviving the burst when so many other companies didn’t?

Tom:                Well, it’s easy sometimes to look at these and think, “Boy, they’re just following crazy strategies.” But I don’t think that’s true. It was true even then at Amazon. They were still focused on customers and they were getting a lot of orders. Their leverage was concern or the problem. But underlying economics were not bad. So, I think that helped a lot. And I think having good management that stuck out and was then able to focus down on cost controls.

David:              There are great stories in The Everything Store about those years at Amazon and the impact it had on the culture. I think after those years, did Jeff put a moratorium on M&A because they’ve acquired so many companies? It wasn’t marketing?

Tom:                Amazon’s not famous for overspending on –

Ben:                 That’s one way to put it.

David:              We’ve talked about that on this show. We won’t ask you about it.

Tom:                Okay, good.

David:              So to wrap up, this has been an incredible story and having Tom join us for it has been special. So today, we’re seeing here in December 2016, as of this morning, Amazon’s market capitalization was $363 billion up. Not quite a thousand X from the IPO when it was $438 million market cap but a pretty healthy return. Let’s see. I was in middle school when Amazon IPO’d. So I really wish I had put my bank account into Amazon at that point in time. I was buying Amazon products but anyway, an incredible journey and super cool to relive this moment in history.

Let’s move to talking about what would have happened otherwise. We touched on this a little bit but had Amazon not gone public at that moment, where would we be? I guess in particular, I’m curious, was a path of being acquired by somebody in those early days, did it every come up? Were people seriously interested?

Ben:                 Even if not, it sounds like, from our conversation so far and just knowing the lore of Jeff’s mission that very unlikely that he wanted to sell to someone. Was it ever on the table to raise more private capital or wait it out longer?

Tom:                I think it would have been slower growth because you couldn’t have afforded. If you didn’t have access to capital and particularly when we began to broaden the product mix. When we started, we would get an order for a book and then we would contact the distributor and have him ship us the book and then we’d reship it. So we didn’t even really have inventory. So once you start buying product, building warehouses to put it in, you do need capital. So, obtaining capital in different ways has been, yeah, very important for Amazon. So I think it would have constrained growth.

I mean, I know a lot of companies these days, they want to stay private as long as they can and it does depend on their business model. If you've got a business model that doesn’t require a lot of capital, then that’s a viable thing. But Amazon’s business model particularly as a group did require cap.

Ben:                 Makes sense. I feel like Amazon exhausted all the options.

David:              Yeah.

Tom:                We did two kind of events relating to that financing and so forth. One, we had the famous meeting with Barnes & Noble back in pre-IPO where the Riggio brothers came to Seattle and wanted to do some kind of a joint deal with Amazon. They weren’t actually offering to acquire but they said, “Well, you can build our website and your own, and we can both have websites or we can do it jointly. We can jointly own it.” Jeff I think rightly decided he didn’t want to do that. Then they filed a lawsuit three days before the IPO because we were using the phrase “the world’s biggest bookstore.”

So there are lessons in all of that for anybody who wanted to go public that your competitors sometimes do try to take it. But really, neither they nor anyone else really made a run at us and partly because I think a lot of traditional companies always thought we were overvalued. So it was actually a benefit. Now, why nobody tried it when we were $5 in 2001, that’s when they should have tried. I’m not sure they would have succeeded but people, you know, everybody becomes pessimistic at the same time, everybody become optimistic at the same time.

David:              It’s interesting that Amazon obviously, it would be a shocker if anybody would buy Amazon today. I seriously doubt that’s even possible. But Amazon as an acquirer, it feels like has kind of internalized those lessons and I think about the Zappos acquisition during the 2008 recession, 2008-2009. Or the Quidsi acquisition, both of which are written about extensively in the everything store. It almost feels like Jeff and the company taking that lesson to heart, that when there are good businesses targeting large markets and for whatever reason are out of favor or in the midst of a recession, that’s the time to go shopping.

Tom:                You don’t always have the luxury but it will be nice if you could.

David:              Yeah. Should we move on to tech themes?

Ben:                 Let’s do it.

David:              Ben, you want to kick it off?

Ben:                 Sure. This part of the show is where we analyze specifically looking at the IPO or acquisition that we’re talking about what tech themes can we extrapolate either from a true technology perspective or sort of from an investment and technology perspective. There’s a few here. I think the biggest one that we’ve already touched on is the flywheel. When I think about Amazon, it’s just like the canonical colloquial example of how to build the world’s best flywheel business where so many things feed into so many other things and fuel the business.

But that wasn’t really part of the IPO, as Tom told us earlier, that that didn’t really get formalized until 2001. So, as we think about lessons learned from the IPO, it’s a lot about timing company creation correctly around new waves. I mean, the internet was… you have to believe that something is going to be a wave and be a little more contrarian than other people. I think that’s evidenced by the investors that passed in the earliest stages thinking that it was too risky. But the big thing for me is yeah, you have to believe wholeheartedly that you’re on the precipice of a wave and it’s not possible to create a top 10 world in the business without being on –

David:              Without riding a massive wave. I think for me the flipside of that coin that I think really shines through in reading about and reading this history of Amazon at that time is the long-term thinking that Jeff and the company and the board had. Even in those early days, if you believe you've identified a wave like that, if it truly will become as big as you think it will, it’s going to take a long time, decades. Jeff is, you know – and I don’t know if this was when he introduced the phrase but in that shareholder letter in 1997, he said, “It’s day one for the internet and for Amazon.” That perspective is really rare. Lots of people say they have it but to actually behave that way and make investments accordingly is quite impressive.

Tom:                It also applies even today when you talk about new projects or initiatives at Amazon or other companies. I know Jeff likes to say it often takes 10 years to prove it. So after you go public, it’s equally important to, one, continue to innovate. Don’t stop innovating just because you feel like you’re at the top of the mountain. You’re not going to survive if you don’t keep innovating and the others maintain that long-term thinking. An IPO gives you the opportunity to do that because you then have the money to do it, you have to somewhat ignore what the market is doing though. That’s another important part after you go public, I think.

Ben:                 It’s interesting you bring up Amazon today as a – Just an observation from the outside. One trend that I think we can observe from Amazon is actually doing corporate innovation well. I’ve long held this belief that every really great company has one multibillion dollar innovation in them, and it’s usually their founding insight. They build that business and they try desperately to build other ancillary businesses around it. Some are bigger and some are smaller. Sometimes you get a Microsoft that has an office and the windows but usually –

David:              Google. Not that there aren’t great businesses within Google, but it’s search.

Ben:                 Yeah. I mean, it’s 90% on Google display ads or search ads, that’s the most of the revenue. So the thing that’s amazing to observe in Amazon is an incredible DNA for experimentation and small teams and doing things in a lean way. As we’ve observed, there’s already been one business that’s on the scale of Amazon’s original retail business with AWS.

David:              Or bigger perhaps.

Ben:                 Yeah, yeah. It will be fascinating to continue to watch the company and see what else.

David:              I wanted to ask quickly. Obviously, this happened much later than the IPO story, but about AWS, the listeners to our show might also listen to Ben Thompson and James Allworth’s podcast, Exponent. On one of their recent shows, they were talking about platform mentality and the importance of that at Amazon and perhaps how much DNA came from Microsoft into Amazon in terms of thinking about AWS as a true platform. Ben showed you, they posit this great Bill Gates quote that a platform is when other participants on top of you realize the vast majority of the economics in the industry and you only collect a small percentage. It’s not like a high margin Google-like business. How much thinking on that level happened at Amazon during that creation?

Tom:                I don’t think we thought we were kind of falling in a Microsoft model although I think from the beginning, everybody in Amazon recognized that Microsoft had the potential in the cloud to be the most important competitor in that as they have become. But the difference in a way was platforms were somewhat considered static in the sense that you built a platform and then every couple of years you revised it or you sent out new software or machines. Internet was so much constant iteration. I have never heard this from Jeff earlier, but it seems to me with AWS the difference in a lot of ways, why it succeeded and had been able to take this lead and keep it partly was being first when others held back. But the constant iteration of AWS, it’s like revising your internet site. They had 600 new features this year or something. Well, in the old days, platforms didn’t do that. You came out with Windows 8 or 10 but it was 2 or 3 years of massive coding. So, I think the world even on that has changed a lot.

Ben:                 Right. That’s a great point. One other question before we move out of trends and themes is, as you’re looking at companies that are pitching Madrona for investment in recent history, what are things that you learned from Amazon being so successful that you sort of look for at other companies as a pattern matching based on Amazon?

David:              Well, you know, every company isn’t going to go public and every company isn’t in it probably for the long term. But I really do prefer founders who have a long-term vision and at least in the beginning say they’re going to stick with it. I think it’s almost genetic though and you don’t know it until it happens. There’s lots of reasons to sell your company and your market didn’t turn out quite what you thought but you’re going to get a good price But what I really hope is that a founder, if he’s riding the wave as you say or has other reasons doesn’t sell out when he could be in it for the long term.

Again, it’s somewhat personality and I think I was very fortunate that Jeff was in this for the long-term and so, even at moments when he could have gone out and sold the company, he wasn’t interested. He wanted to build something for the long term. When you think about a lot of the great companies, they've had founders who really wanted to accomplish something kind of beyond making the profit. We’re going to change how people think about software. We’re going to change how people do search. So, I think that isn’t guaranteed a successful company but I’ve always liked that longer term – they’re thinking about it and hopefully going to seek it.

Ben:                 Cool. Thanks.

David:              Should we wrap up?

Ben:                 Yeah. You want to grade it?

David:              Yeah. In some ways, this is tough. I’m thinking of the end, the quote to The Everything Store which is Joy Covey and the email that she wrote to Brad Stone. She was one of the key sources for the book. After having done all the interviews and just reflecting back on her time at Amazon and then the experience of talking about the story, she said, “You know, Jeff and the company, kind of like he knew in the very beginning exactly where he was going.”

In so many ways we talk about on this show. So many startup stories and IPO stories and M&A stories, or twists and turns and wild rides. It feels inevitable that the company went public when it did especially just hearing the story now. It was completely rational. It made sense and it gave the company the scale and the capital and the visibility that it needed to grow and outpace competitors.

So, in some ways, I think I’d give it an A. I do give it an A. But this might be like the least controversial or thought-provoking decision that we’ve had so far on this show for me.

Ben:                 It’s funny. I was just thinking the same thing. There’s actually not a lot of analysis that needs to go into it. I mean, you look at the scale of Amazon today and even the scale in the years shortly after the IPO. The only way that they could have achieved the outcome that they did was by going public. I think that one reason why we had so much trouble in that earlier section of what would have happened otherwise is it just doesn’t seem like there was a lot of choice.

David:              It feels like unnatural to think about an alternative history here.

Ben:                 Right. As someone who works on early-stage startups, a lot of the time there’s all this like really vague questions around, “Okay. We think we have an idea in this space and we’re learning as we’re going.” Should we be a platform provider or should we the business that sits on top of it? Should it all be combined or should we be a horizontal or a vertical business in this space?

You even go back and forth long after you've started the business kind of playing both sides there. It just doesn’t seem like Amazon had any ambiguity over what the long-term vision of the company was, at least the retail business.

David:              So Tom, hearing that, do you agree or are you laughing at us saying like, “easy to say from this vantage point”?

Tom:                Well, on the one hand I don’t think any of us really did understand what Amazon would become. But I think the fact that Jeff and several of us thought the internet was going to be a very big deal and there was lots of potential and who knew where this could take you. I think that often happens with technology where you realize that something is going to be very big but knowing the details that today, AWS would have come out of that, there was no way to predict that or think about that in those days.

But again, it fits very well when you look back and say what the assets of Amazon were but also what the technology developments. So I think Joy is right in the sense that it was in some ways inevitable. I’m just not sure we knew how inevitable it was. But it took fabulous commitment to innovation and really hiring good people. So you should not neglect that for inevitability.

Ben:                 Right.

David:              Okay. With that, Carve Outs. It will be interesting to think how many of our Carve Outs will be available on or in some ways served to you by Amazon.

Ben:                 I’m sure Amazon is in delivery there somewhere, either way.

David:              No matter what your Carve Out is, Amazon is involved in it.

Ben:                 That would be interesting to look back at our previous Carve Outs and figure out are there any that are not served to you either on AWS or be able to be shipped to you. We’d have to pick something that’s basically not a physical good. A physical good that’s on some very, very stubborn retailer that retails only on their own sites. I don’t know.

David:              A site that’s not hosted on AWS.

Ben:                 Yeah.

David:              Or uses technologies as part of the site that are not hosted by AWS. It would practically be impossible.

Ben:                 Yeah. I guess that’s why Amazon deserves that A that we mentioned a few minutes ago. So my Carve Out is a band called The Album Leaf. I actually went to their show last night here in Seattle. I’ve been a long-time fan of the band there. Some of the best working music that you can imagine. It’s a lot of percussion, it’s a lot of very like mellow synth but it’s got a little punch to it. It’s kind of hard to describe but check out The Album Leaf. They’re on Spotify. I’m sure they’re on Amazon. Great band.

David:              Cool I’ll do a quick side Carve Out then. Made me think. Jenny and I went to the Stevie Nicks show this weekend in Seattle. She was awesome. Her 24 Karat Gold Tour, so great. Some of her hits, some of Fleetwood Mac’s hits. But mostly and what I enjoyed the most was just songs from the vault, as she called them, that people don’t know. Super great.

My office Carve Out though is there’s a great article that we’ll link to in the show notes. Very fun. There’s a seminal paper in Harvard Business Review from the mid-90’s right around when Amazon was being started. By Brian Arthur and it’s called Increasing Returns and the New World of Business. It’s somewhat academic in topic but the thesis is that in an internet world where distributions costs are very low and your accessible market is everyone, you can actually – this old economic theory of diminishing returns that the bigger you got, the classic example is coffee plantations. The more coffee you produce, you’re going to worse and worse, less and less fertile ground and your coffee is going to get worse and worse, and so you get diminishing returns.

On the internet, you actually get increasing returns. That the bigger you are, the bigger you get and the better that your customer experience becomes. That contributes to sort of the spiritual antecedent to aggregation theory and Amazon and many of the things that have happened. Super fun thing that came out is, turns out, that Cormac McCarthy, the author/the novelist who wrote All the Pretty Horses, and No Country for Old Men, and many others; Pulitzer Prize winning author. Brian Arthur, the economist who wrote the article, he went to Cormac McCarthy for help writing this piece. So Cormac, like, basically dismantled the whole piece, they reassembled it together and when you read it, it reads extremely cogently. Not like a typical economic, academic paper. This story came out recently. Very fun.

Tom:                Oh well, I should appropriately say that on my Amazon Christmas gift list that I’ve actually given to my wife, is The Undoing Project book by Michael Lewis. I think a lot of us, you know – I like to read books on new technologies. Machine learning is a popular subject around Madrona and we’ve been reading books on things like that. But here’s one that’s not particularly focused on numbers or technologies. Well, a different kind of technology which is the psychology of people, which again, is super important in business. I think I look forward to reading it.

David:              Yeah. I haven’t read it yet either but I can’t wait. The book’s about Daniel Kahneman & Amos Tversky, Nobel Prize winners for basically developing behavioral economics. And Daniel Kahneman was and is now an emeritus professor at Princeton and Michael Lewis is an esteemed Princeton alum as well. I took Kahneman’s course when I was in school there and sadly, it was the first year that he had retired and he didn’t teach it, so somebody else did but I took his course and it had a huge impact on me. And looking forward to reading the book.

Ben:                 Great. Well, that’s all we’ve got. If you aren’t subscribed and want to hear more, you can subscribe from your favorite podcast client. If you feel so inclined and you’re a long-time listener of the show or if you’re new and just joining us for this episode, we would love, love, love a review on iTunes or if you share it on social media with your friends. So, thanks so much for listening and have a great day.

David:              Thank you to Tom for joining us.

Tom:                Thank you. That was fun.