Why Amazon's Cloud Business Is Like Kindle Sales

Dec 07, 2012 (08:12 AM EST)

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10 Cloud Computing Pioneers
10 Cloud Computing Pioneers
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Amazon Web Services (AWS) had a coming out party of sorts when it staged its first partner and customer event, dubbed Re: Invent, and held in Las Vegas Nov. 27-29. The most revealing moments came when Amazon CTO Werner Vogels took the stage Nov. 29 to pitch questions at CEO Jeff Bezos.

In creating its infrastructure-as-a-service (IaaS) unit in 2002, Amazon did something both risky and bold. It concluded it had a new type of infrastructure behind its retail operation and further services could be created on it. Better yet, it could create a new service on an infrastructure optimized to work with end users. There were no cloud users back then. There were hosted service providers and managed service providers and colocation facilities. But letting people commission and control infrastructure on an hourly basis, paying as they go with a credit card, was unique.

Vogels started his conversation with Bezos by pointing out that the last time they shared a stage was at the announcement of Amazon's second-generation tablet, the Kindle Fire. This was a soft pitch, of course. Bezos picked up the cue and drew an analogy between the $159 Kindle and IaaS.

"One of the unusual things we do in the Kindle device business is we sell our hardware at near breakeven. We make money when people use the device, not when they buy the device ... If I buy the device and put it in my desk drawer and never use it, then Amazon doesn't deserve to make any money," said Bezos.

[ Want to know how Amazon drives down computing service prices? See Amazon Web Services Slashes Storage Prices. ]

Amazon Web Services uses the same principles, Bezos continued, closing the loop. "It's a pay-as-you-go service. We are not incented to get people to overbuy hardware and operate at low utilization rates," he said, taking a shot at traditional hardware businesses.

Furthermore, such an approach is a good discipline for any business because it will stay tuned to what customers actually need, not what they can produce. "Our point of view is if we can arrange things in such a way that our interests are aligned with our customers', then in the long term that will work out really well for customers and it will work out for Amazon," Bezos added.

In the same vein, he threw in a plug for how Amazon's tablet business is different from Apple's: "Likewise, it causes us to have the right kinds of behavior. If we're not making money when people buy the device, then we don't need people to be on the upgrade treadmill. We have people using 5-year old Kindle Ones and we're perfectly happy with that.

I find this analogy strained but still revealing of the core of AWS. Selling a hardware device is different from providing a cloud service, although the analogy works somewhat when the hardware device becomes a platform for the same vendor to sell services. That part's OK. The main point of these comments is that Amazon is not making money until its customers decide what has value to them in the form of an Amazon service. That's a major differentiator between Amazon and HP, Dell or IBM. And the fact that it sells hardware at breakeven is a major differentiator between Amazon and Apple. Point established.

Next, Vogels solicited Bezos to address the notion of staying focused on essential business services. "I'm always amazed that you talk about the notion of flywheels," he prompted.

To Bezos, a business must be built around building out long-term services, not chasing short-term profits with short-lived devices. "I frequently get the question, 'What's going to change in the next 10 years?' I almost never get the question, 'What's not going to change in the next 10 years?' I submit that second question is the more important of the two -- because you can build a business strategy around the things that are stable over time. We know the customers want low prices. We know that's going to be true 10 years from now. I can't imagine a customer coming up to me and saying, "I just love Amazon. I just wish the prices were a little higher. I just wish delivery would take a little longer." Invest in those things today (that will) pay dividends 20 years from now."

Bezos again closed the loop to show how this core Amazon ideal is part of AWS. "At AWS, the big ideas are also pretty straightforward. It's impossible for me to imagine 10 years from now someone would tell me, 'I love AWS but I just wish you were a little less reliable. I love AWS but I wish you would raise prices ... I wish you would innovate and improve APIs at a slower rate.'

"The big ideas in business are often very obvious but it's very hard to maintain a firm grasp of the obvious. But if you can do that, if you can continue to spin up those flywheels, and put energy into those things, like we do with AWS, over time, you build a better and better service for your customers," he said.

Concentrating on core competencies is not a new idea, but what Bezos said next sets up what must be the tension between and its AWS business unit. If you are setting up a new business, you can't be sure where you'll find the next "flywheel." Having gotten a new style of retail going online, had a chance to generalize upon it and move beyond retail into specific services based on the lessons learned.

It wasn't part of the Vogels-Bezos discussion, but to do so, Amazon followed the path recommended in The Innovator's Dilemma by Clayton Christiansen: it created a separate unit, isolated it from the main organization and rewarded it for its ability to pursue an opportunity other than that of the main business.

"First of all, innovation is a point of view. You have to actually select people who want to innovate and explore. Being a pioneer, an explorer, isn't for everybody. Some people wake up in the morning and they get their energy, the thing they think about in the shower is who are three companies we're going to kill this year. That's the conqueror mentality, it's a competitor-focused mentality instead of a customer-focused mentality.

"When you attract people who have the DNA of pioneers, you build a company of like-minded people who want to invent, and that's what they think about when they get up in the morning ... If you're the right kind of person, you like to invent, you like change, that's just fun ... over the last 18+ years, we've attracted a bunch of people who like to do it.

"There are a couple other things that are not as fun. One of them is, you have to have a willingness to fail. You have to have a willingness to be misunderstood for long periods of time. If you do something in a new way, people are initially going to misunderstand it relative to the traditional way. They'll be well-meaning critics who genuinely want the best outcome, but they're worried ... And there'll also be self-interested critics who have a vested interest ... If you never want to be criticized, then don't do anything new," Bezos said.

In this segment, he was directly answering Wall Street critics who have put pressure on Amazon by asking when the company will stop investing so much for the future and realize more profit. Bezos doesn't like this criticism, but he can live with it, given the nature of his company. He responded further by saying innovation is the only way to continue to discover what's useful to customers. At the end, he said, don't chase a wave, hoping to gain profits. Instead, do what you're passionate about, and wait for the wave to come to you.

"Successful invention is invention that customers care about. It's actually relatively easy to invent new things that customers don't care about. For successful invention, you have to increase your rate of experimentation. You have to think about, how do you go about organizing your systems, your people, all of your assets ... to increase your experimentation. If you double the experiments per year, you're going to double your inventions," Bezos said.

What he didn't say was the AWS experiment has its own expenses, and it's possible in doubling experiments to also double expenses without gaining offsetting revenue. AWS is doubtlessly a revenue producer. I've heard estimates that say that it will produce $1-$1.5 billion in 2012, and there's a chance revenue will grow rapidly from this takeoff point. But Amazon's reports don't give us a glimpse of the relationship between revenue and expenses.

Nevertheless, Bezos said repeatedly that he runs a high-volume, low-margin business. And to do so, you must practice certain disciplines that some of Amazon's higher margin competitors -- Oracle, Microsoft and Google spring to mind -- don't necessarily have to practice.

"Let's put it this way, in old days, you might be best advised to put 30% of effort and energy into building a product or service and 70% into shouting about that service. That has flipped around. The balance of power is shifting from the providers of offerings to the consumers of offerings. I believe that's a great thing for society. I believe it's even a great thing for the providers of services, provided the companies acknowledge it and embrace it. If you have a business model that relies upon your customers being misinformed, or let's just say incompletely informed, you better start working on changing your business model," Bezos said.

Brave words from a founder who is proud of the company he's created.

It remains to be seen how far Bezos and Vogels can drive the AWS experiment, but it's clear the battle lines have been drawn with the old, high-margin software companies, such as Oracle and Microsoft, and the new high-margin Web services companies, such as Google. And throw in Apple as a high-margin device maker as well.

If Amazon really is discovering the long-lasting flywheels of the coming era, its revenues will more than match its commitments. And competitors will find it tough to move in on a low-margin firm that is constantly realigning its goals with its customers. This was Amazon's first big, public statement of how its new cloud computing business is a natural outgrowth of its overall culture and approach to business.

Bezos seemed to be saying that AWS, far from being a stepchild, is a long-term extension of what the parent company is all about. And despite the critics, Amazon will find ways to make it work.