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Why is Amazon so successful?

Amazon

At Movefresh we are obsessed by Amazon – they are a great role model for thinking long term (this isn’t that popular in the current economic environment)

I am still amazed that sophisticated investors can’t get their head around Amazon as a business and investment opportunity. Firstly, having been born around the dot com boom, it is certainly associated with the many businesses that failed within this cohort.

Secondly, investors really struggle to understand businesses that can continue to find ways to effectively invest their cashflow/profit. Many investors look at Amazon as a business that is “marginally” profitable, I see a business that can actively invest in the future and give bigger returns to shareholders who are willing be part of that.

I always recommend reading the Amazon letter to shareholders that have been published annually. The 2015 shareholder letter makes some interesting reading.

1. “The fastest company to reach $100 billion in annual sales”
2. AWS reached $10 billion pretty quickly too
3. “Customer obsession rather than Competitor obsession”
4. “Willingness to fail”
5. “Patience to think long term”

All of this is contained in the first paragraph – it is totally clear that that the business knows how to invest its cash flow.

They also included a copy of the letter from 1997 (reprinted from the 1997 Annual Report). They haven’t really changed their strategy since this original letter – something that I admire greatly.

Monty Python on Statistics

I was reminded today of my favourite Monty Python sketch on statistics. I had a look for it on YouTube but sadly couldn’t find it.

The sketch was set on election night with a reporter who did a vox pop and asked a lady in the street how she was going to vote. She said “Conservative”. They then went back to the studio and extrapolated this to their swing-o-meter which predicted a 100% swing to the Conservatives and all seats in the House of Commons switching to that party.

It was very funny. But like the best comedy it was also very true. We’ve all been in situations in business were very small datasets are extrapolated.

Interpolation is of course much more accurate. But to interpolate my experience of statistics in business I can say that interpolation is something that is much less common that extrapolation.

Michael Fish

Michael Fish announced on TV on 15 October 1987 that there was no hurricane on the way. That evening the worst storm to hit South East England caused record damage and killed 19 people.

Andy Haldane of the Bank of England recently said that the failure to predict the 2008-09 financial crash was a similar moment for economists and has resulted in economics forecasting being “in crisis”.

It is true that the record for prediction of economists, financial analysts and accountants is very poor. When we look back over the last half century it is indeed true that all three groups failed to predict the big crashes in US public companies.

But conversely they also failed to identify the ten days over the last fifty years which accounted for roughly half the return of the same US public companies.

In other words, out of 18,250 trading days just 10 days accounted for half of the return. So surely it was a failure of economists, financial analysts and accountants that they did not identify these days in advance? Or identify the days in 2008-09 that resulted in dramatic reductions in market value?

I would disagree with Andy Haldane on this. I don’t think it is reasonable to expect economists to identify in advance the 0.05% of days in which markets move dramatically.

My favourite book on this subject is A Treatise on Probability by John Maynard Keynes who wrote in Chapter 3:

Is our expectation of rain, when we start out for a walk, always more likely than not, or less likely than not, or as likely as not? I am prepared to argue that on some occasions none of these alternatives hold, and that it will be an arbitrary matter to decide for or against the umbrella. If the barometer is high, but the clouds are black, it is not always rational that one should prevail over the other in our minds, or even that we should balance them, though it will be rational to allow caprice to determine us and to waste no time on the debate.

Keynes understood that some probabilities are measurable. He gave an example in the book of pulling red and black balls out an ern of which half are red and half are black which is clearly a system that can be easily measured but many probabilities are inherently unmeasurable such as his example of the requirement for an umbrella or his discussion of an ern where the the proportions of red and black balls are unknown.

However although there are many probabilities that are not measurable but are comparable. The example Keynes gave was the possibility of surviving a walk home in a thunderstorm: this is not measurable but it is clearly less safe and therefore comparable to walking home during good weather.

So to get back to our trio of economists, financial analysts and accountants. It is unreasonable to expect them to expect any of them to predict a dramatic period of recession or growth however it is reasonable to expect them to suggest that a situation is more or less comparable i.e. more or less likely to result in a period of recession or growth.

I do not think that it is a failure of economics to predict the ten best trading days of the last half century. I do think that economics is useful in producing data that makes the best trading days comparable with poor trading days or the best investment opportunities comparable with the worst while accepting that neither are measurable.

So in my investments I accept that I cannot make predictions as to when it will rain. But I can see clouds in the sky as Micheal Fish did successfully over his career at the Met Office from 1962 to 2004.

Prana Protein

In early 2017 we are launching Prana Protein, this is one of our first steps away from dieting into the broader health and wellbeing category.

We have spent quite a bit of time this year looking at sports nutrition – a sector we have followed since starting Diet Chef in 2008. The sector is definitely in growth but we feel that the lifestyle consumer is badly served. Most online competitors have pushed the market into volume led discounting which does mean that it is very difficult to compete for a new entrant.

Our focus on wholefood nutrition (which has been growing strongly in the US for the last 18 months) is somewhere we are much more comfortable with. Not only is there a large megatrend towards “free from” we are also seeing demand for more natural protein sources (a lot of which taste terrible) so drawing on this we will make sure the brand appeals to the lifestyle consumer within this segment.

We have made very good progress with Diet Now this year and the business is now contributing after the initial investment. Our growth plans for this brand take us further into Europe.

Amazon Go

The future of convenience shopping is here and its called Amazon Go.

Amazon is one of our top technology holdings and we continue to be very bullish about the future of Amazon.

Amazon Go allows the vision of the future with no checkouts, no baskets, no staff, just great technology. All you need to get access is a simple barcode on the app. Everything else is done automatically.

Grocery shopping will never be the same – launching in Seattle in early 2017 this leapfrogs most other convenience retailers.

Bertrand Russell on Investment

Back in my youth I did a course on philosophy and one of the books we read was Bertrand Russell’s The Problems of Philosophy. This is a quote from Chapter 6 – On Induction:

Domestic animals expect food when they see the person who feeds them. We know that all these rather crude expectations of uniformity are liable to be misleading. The man who has fed the chicken every day throughout its life at last wrings its neck instead, showing that more refined views as to the uniformity of nature would have been useful to the chicken.

Philosophical induction is of course a very different beast from mathematical induction. In our home town, Edinburgh University have created a programming language Haskell which can be proven correct by proof by mathematical induction. Mathematical induction is based on proofs rather than the slightly flimsy enumerative deduction in philosophy which is based on observation.

Going back to Russell he creates a severe problem for the Chartist. This is a very common investment mistake and I will admit that I have fallen for it myself in the past. It’s very easy to look at a graph for a stock and assume that this has some link to the future.

An individual example would be Enron which of course won many awards before collapsing to zero. A bigger example would be the pre-revolution Russian stockmarket which outperformed all of its competitors for a whole century before total wipeout. Both these examples are very negative but the failure of proof by induction also applies in the other direction. An obvious example would be Walmart which went for a few decades in a fairly flat way before completely taking off.

So next time you are looking at a graph and expect it to continue on its happy trajectory remember the story of Bertrand Russell’s chicken. The past is not a predictor of the future – good or bad.

5 Vital Brand Attributes

One of our advisors has five things he believes a brand has got to get right in order to succeed:

  1. Show expertise – In the old days the only space available to show expertise was on the label which was limited to put it mildly. But customers now expect content (on web, apps and in print) that shows that a brand knows what it’s talking about.
  2. Personalisation – The day of the mass market brand has gone. Consumers now expect something unique for them such as Tails, Moonpig or Diet Chef with our unique recommendations and 360,000 combinations available for the diet.
  3. Trust – This is particularly important in food where the industry has generally got quite a bad reputation. Innocent would be a great example of a brand who have worked for deep levels of trust. Trust is of course earned over years but can be lost overnight.
  4. Care – This is quite a deep one covering production of the product, impact on the environment and the community and of course care of the customer.
  5. Innovation – It would be fair to say that the food industry has not got innovation deep in its DNA. Even heritage brands needs to innovate while preserving their provenance.

Vertical Integration in Grocery E-commerce

This is quite a hot topic in the sector. In general I’m not a fan of vertical integration, I much prefer a tightly focused business. However I think there are two specific instances where vertical integration makes sense:

  1. Customer experience – Certain processes are vital to the customer experience and are a true differentiator such as the website, mobile apps and fulfilment. However backend systems such as accountancy and warehouse management should just be bought rather than owned. Historically processes that were differentiators have become commoditised so it may be that outsourced options will emerge for the current differentiators in the future (but no doubt other differentiators will emerge).
  2. Using unique technology – Nespresso have (literally) hundreds of patents on their technology and use a very complex process to create their capsules. This is not something that could be outsourced as they would be risking their intellectual property and in addition the only possible customer would be Nespresso which would prevent the manufacturer from sharing costs with multiple customers.
  3. Provenance – Guinness or Perrier would both be good examples. Indeed Guinness did experiment with brewing outside St James’s Gate, Dublin but that beer was considered inferior and production was shifted back. Equally Perrier could not be outsourced to another water company. It is a key part of the respective brands that these products are made in a particular place under the control of the company.

I think there are some quite bad reasons for vertical integration:

  1. Margin/cost – Unless there is a market failure margin will typically land at cost of capital. Margin in UK food manufacturing is very low and it is almost certainly not a good use of capital for an e-commerce business. Committing to larger volume is or outsourcing to a lower cost country is nearly always a better way of reducing price than vertical integration.
  2. Reliability of supply – This is quite often given as a reason. I would accept that in certain locations (e.g. Tata running their own electricity supply in India) this may be valid. But with careful sourcing reliability is rarely an issue in a developed country.

Move Fresh’s core competencies are management of brands, sales, marketing and creating a great customer experience. Outside of these areas we are keen to find high quality partners to fill in the gaps.

Investment in the future

Although this is quite a heavy hitting title, many businesses say this but few actually believe it. Investment in the future sometimes is quite short term.

Building great brands takes a long time and investment sometimes takes years if not decades to recoup.

By building a balanced portfolio of brands that are at different lifecycles we can use the associated cash flows to invest in the future and for the long term. We are long term shareholders and our focus is to be measured in decades not quarters.

Marketing investment is frequently curtailed if immediate payback is not available (on your first order for example) but being able to take a longer term view allows you to really benefit from the long term value that customers see in a great product.

We see marketing as an investment – not a cost – and just like buying companies that require investment for growth – we want to ensure that marketing is measured as an investment. We are very analytical but don’t only listen to the numbers, we take multiple data points to measure our marketing investment.

A typical by-product of believing marketing is an investment is that we know that not every activity that we carry out will work, but we are relaxed as long as the majority work!

Amazon Robotics

One of the businesses everyone at Move Fresh respect (and invest in!) is Amazon.  The focus on growth and the vision of the founder Jeff Bezos is truly outstanding.

The entire company constantly thinks about the future and have convinced public market investors that long term growth is the best use of Amazon’s impressive cash flow.

The BBC just covered the robotics division that are rolling out in the UK.

Kiva the company that built this technology was acquired by Amazon in 2012.

There are approximately 30,000 robots in operation in Amazon warehouses!

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