The Everything Store: Jeff Bezos and the Age of Amazon (38 page)

Zappos’ sales soared from $8.6 million in 2001 to $70 million in 2003 to $370 million in 2005.
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Hsieh and his cohorts had outflanked Amazon in a key part of the apparel market, establishing Zappos as a strong, flexible presence in customers’ minds and forging good
relationships with well-known shoe brands like Nike. For the first time in years, Bezos had a reason to admire and closely track an e-commerce upstart that had the potential to expand and take away some of his business.

In August of 2005, Bezos e-mailed Hsieh and told him he was going to be in Las Vegas and would like to pay him a visit. The meeting was held in a conference room at a DoubleTree hotel a few blocks from the Zappos office. Bezos brought Jeff Blackburn. Hsieh brought Nick Swinmurn, Michael Moritz, and Alfred Lin, who had just joined Zappos as chairman and chief operating officer. Playing off Amazon’s famous two-pizza-team culture, the Zappos executives served two pizzas, one with pepperoni and one with jalapeño peppers, from a local restaurant. The meeting was brief and awkward. The Zappos executives suggested potential partnership arrangements, but Bezos politely said he would rather own the whole business. Hsieh replied flatly that he was set on building an independent company. Later, Amazon executives got the impression that Zappos could be acquired for around $500 million, but Bezos, who’d become a chronically frugal acquirer, imagined paying only a fraction of that amount.

At this point, the competitive landscape must have looked to Bezos like the chessboards of his youth. The positions of the pieces in this particular game heavily favored his opponent. By law, manufacturers are not allowed to set retail prices, but they can decide whom they want to carry their products, and they make those decisions judiciously. Shoe brands like Nike and Merrell viewed Amazon as a dangerous discounter, a company that would very likely consign their new in-season products to the bargain bin in an effort to garner new customers and gain market share. As a result, the top brands were reluctant to supply Amazon with merchandise, and the website’s shoe selection was sparse.

Amazon had other disadvantages in the shoe business. The Amazon website was not well suited to products that had lots of variations, like a shoe that comes in six colors, eighteen sizes, and several widths. Amazon.com listed all these variations on a single
shoe as separate products, and customers couldn’t perform searches for multiple variables, like both color and size.

Navigating through this complex matrix, Bezos came up with an unlikely gambit. He decided to build an entirely separate website from scratch, devoted solely to the categories of shoes and handbags. Bezos brought that plan to the members of his board, who braced themselves to make another costly and impractical investment at the same time they were betting heavily on the Kindle and Amazon Web Services. “How much money do you want to spend on this?” asked chief financial officer Tom Szkutak in the board meeting. “How much do you have?” asked Bezos.

The company worked on the new site for all of 2006, spending some $30 million to design it from scratch using the collection of Web tools known as AJAX, according to an employee who was on the project. Executives came close to calling it Javari.com, but then the owner of that URL reneged on a deal to sell it and demanded more money. The site finally launched in December as Endless.com. On its first day, Endless offered free overnight shipping and free returns. The deal ensured Amazon would lose money on each sale. But it would clearly apply pressure to a certain company in Las Vegas. The Zappos board members considered Amazon’s opening maneuver, gritted their teeth, and a week later matched it with free overnight shipping. The difference was that the new Endless.com, unlike its rival, enjoyed almost no traffic or sales volume and so lost little with its overnight-shipping offer; Zappos’ profit margins took a direct hit.

Over the next year, Endless made little progress as an independent retail destination. The site attracted brands like Kenneth Cole and Nine West and developed features such as a more flexible search engine and product photos that expanded when customers hovered over them with their cursors. But Amazon was walking an almost impossible precarious tightrope, trying to assuage the fears of brand-name companies with industry-standard pricing while also using Endless as a way to undercut Zappos on price. In early 2007, with apparel brands watching closely for any signs of discounting, Amazon added a five-dollar bonus to its free overnight shipping. In other
words, a customer was given five dollars just to buy something on the site. It was a clever but transparent ploy, an effort to inflict further pain on Zappos. Employees who worked on Endless say that, naturally, this was Jeff Bezos’s idea. Yet Zappos still continued to grow. Its 2007 gross sales hit $840 million and in 2008 it topped $1 billion. That year, Bezos learned that Zappos was advertising on the bottoms of the plastic bins at airport-security checkpoints. “They are outthinking us!” he snapped at a meeting.

But inside Zappos, a big problem had emerged. It had been acquiring inventory with a revolving $100 million line of credit, and the financial crisis, which intensified with the collapse of Lehman Brothers in the fall of 2008, froze the capital markets. With consumer spending declining, Zappos’ inventory constrained by new borrowing limits, and the competition with Amazon cutting into the company’s profit margins, Zappos’ previously spectacular annual growth rate collapsed to a modest 10 percent. The company rolled back its free-overnight-shipping guarantee, and Hsieh reluctantly laid off 8 percent of his workforce.

In his bestselling book
Delivering Happiness: A Path to Profits, Passion, and Purpose,
Hsieh wrote that Amazon continued to make acquisition offers during this time and that Zappos’ investors were increasingly interested because they were impatient to see a return on their investment. Michael Moritz has a slightly different take. When he invested in Zappos, he wanted it to become an independent, public company “that provided every item of clothing for consumers from head to toe.” But he had watched Amazon destroy one of his portfolio companies, eToys, a decade earlier and knew that to compete with Amazon, Zappos needed more engineers and more sophisticated fulfillment capabilities. “We just didn’t move quickly enough,” Moritz says. “You could sense it was going to be much harder to achieve, and we were squandering the opportunity. The hiring was too slow, the engineering department was not good enough, and the software was inferior to Amazon’s. It was very frustrating, and the Las Vegas location, plus an unwillingness to pay competitively, made it even harder to recruit talented people.
We were starting to compete with the very best in the business and they had a lot of arrows in their quiver to make life painful. The last thing we wanted to do was to sell. It was mortifying.”

Hsieh wanted to keep going but even he came to acknowledge that Amazon could be a good home for Zappos. One of the factors he considered was that Zappos employees in Las Vegas and near its distribution center in Kentucky lived at ground zero of the housing crisis. Many had seen the value of their homes plummet, and the only valuable thing they owned was Zappos stock. Hsieh saw that the acquisition could offer a sizable payout for employees at a moment when many desperately needed it. The Zappos board ultimately decided to sell to Amazon; the vote was bittersweet but unanimous.

Over the next few months, Alfred Lin negotiated the deal with Peter Krawiec, Amazon’s vice president of corporate development. Bezos and Krawiec consummated the deal at Hsieh’s house in Southern Highlands, a luxury residential neighborhood built around a golf course. A journey that had started with two pizzas ended with Hsieh cooking burgers on his patio. A few weeks later, Bezos recorded an eight-minute video for Zappos employees while traveling in Europe. “When given the choice of obsessing over competitors or obsessing over customers, we always obsess over customers,” he said, reciting a well-worn and, considering the past few years of competition with Zappos, credulity-straining Jeffism. “We pay attention to what our competitors do but it’s not where we put our energy.”

Some of Amazon’s own executives were now shaking their heads in awe. Bezos had pursued and captured his prey, spending what one Amazon executive estimates was $150 million over two years on projects like Endless.com, which perhaps saved the company money, since it might have been a far more expensive battle or acquisition after the recession. Yet Hsieh, Lin, and Moritz had fought back fiercely, dueling Amazon to what might best be considered a draw. The acquisition price of around $900 million was higher than Bezos originally wanted, and the Zappos board wisely demanded that
Amazon pay with equity instead of cash. By the time the deal closed, in November of 2009, the price of Amazon stock was once again zooming into the stratosphere, and Zappos executives, employees, and investors who had held on to their shares were lavishly rewarded. Amazon drew several lessons from its bloody battle with Zappos that it would tenaciously apply to its dealings with e-commerce upstarts in the years ahead.

The great recession that started in December 2007 and lasted until July 2009 was in some ways a gift to Amazon. The crisis not only drove Zappos into Amazon’s arms but also significantly damaged the sales of the world’s largest offline retail chains, sending executives scurrying into survival mode. Desperate to protect their profit margins, many retailers reacted by firing employees, cutting down their product assortment, and lowering the overall quality of their service, and this just as Bezos was investing in new categories and more rapid distribution. The economic crisis served as a kind of cloaking device, hiding Amazon’s evolution into a dangerous diversified competitor. Retailers were scared, but the bogeyman was the reeling global economy and declining consumer spending, not Amazon.

The brutal recession claimed the weakest national retailers and extinguished several historic brands. Circuit City was once the largest electronics retailer in the country. At its peak, the Richmond, Virginia–based chain had more than seven hundred stores and reported $12 billion in sales. Then, in the 1990s, a wave of changes undermined its commission-centered sales model. Companies like Best Buy, Walmart, and Costco ushered in a new age of self-service shopping and big-box stores. Customers could grab a television off the shelf and haul it to the checkout counter, aided (maybe) by an associate being paid a low hourly wage. Circuit City waited too long to drop its commission-based sales force. PCs became a major draw in electronics stores, but Circuit City was reluctant to bring a low-margin product line into its high-margin mix. In addition, its
executives were also heavily distracted in the 1990s, spinning off the retail chain CarMax and spending more than a hundred million dollars on a DVD-rental system called DIVX, which quickly failed.

Then Amazon came along with the ultimate self-service model, and again Circuit City was frozen by a disruptive change. Circuit City allowed Amazon to operate its website from 2001 to 2005 but afterward it didn’t establish a strong Internet presence. The company had lost touch with what customers wanted and it never embraced, as Rick Dalzell put it with regard to Bezos, “the best truth at the time.” When the chain needed to finance a turnaround in the midst of the financial crisis, the capital markets were dry. So in 2009, Circuit City, a sixty-year-old company lauded in one of Bezos’s favorite books,
Good to Great,
liquidated its operations and laid off thirty-four thousand employees.
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A few years later, the book chain Borders traveled down the same dismal path.

Brothers Louis and Tom Borders had founded the company in Ann Arbor, Michigan, in 1971 after developing a system to track book sales and inventory. The brothers left in 1992 when the company was acquired by Kmart, which later spun it out. All through the 1990s, Borders churned out huge, multistory bookstores in shopping centers around the United States and in Singapore, Australia, and the United Kingdom, among other countries, growing from $224.8 million in sales in 1992 to $3.4 billion by 2002.

But like Circuit City, Borders had a narrow operating philosophy and repeatedly missed the changing tastes of consumers. It was obsessively focused on opening new stores and increasing same-store sales while fighting Barnes & Noble on all fronts and dutifully guiding and meeting Wall Street’s quarterly expectations. The Internet didn’t fit into this traditional calculus and thus didn’t get the company’s capital or its most talented executives. Like Circuit City, Borders allowed Amazon to run its online business so it could focus on its physical stores. One longtime Borders executive, who asked for anonymity, says the early perception of Amazon was that
it “was just another catalog—a version of Lands’ End.” The executive suggests that this sentiment was now suitable for a bumper sticker.

In the last decade of its life, Borders was battered by rising online book sales, then by the Kindle, and then by the pullback in consumer spending after the financial crisis. Borders, like Circuit City, couldn’t cut costs fast enough because it was locked into fifteen- or twenty-year leases on its stores. At the time of its bankruptcy filing, half its stores were still highly profitable, according to its CEO, but the company couldn’t raise money to buy out the leases on its bad locations.
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Borders’ decline accelerated during the recession, and it went out of business in 2011, laying off 10,700 employees.
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Like some other chain stores, Target, the second-largest retailer in the United States, survived the downturn with layoffs at its Minneapolis headquarters and by closing one of its distribution centers.
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Target had outsourced its online operations to Amazon in 2001 but the relationship was far from perfect, with joint projects frequently falling behind schedule. “We had no resources to build infrastructure for Target,” says Faisal Masud, who worked on the Target business at Amazon. “It was all about Amazon first and Target next.”