Profile: Amazon

 David Rubenstein, co-founder of alternative asset manager Carlyle Group, says the deal he most regrets passing on was for a first-time entrepreneur touting an electronic catalogue of book titles.

The reason – Jeffrey Bezos went on to set up Amazon, which at the end of last month had a share price of more than $200 and market capitalisation of nearly $100bn, initially through selling books but with a goal of selling practically everything online, including services to help others run their businesses.

To achieve its goal, Amazon invests for the long term, including its corporate venturing and deals strategy. In an interview with magazine Wired, Bezos said: "If everything you do needs to work on a three-year time horizon, then you are competing against a lot of people.

"But if you are willing to invest on a seven-year time horizon, you are now competing against a fraction of those people, because very few companies are willing to do that."

While Amazon’s most consistent investments to achieve its long-term goals have been in its distribution, customer service and product range, it has had two primary periods of dealmaking in its past 18 years reflecting the ebbs and flows of its cashflow and share price.

In the first, until 2001 during the dot.com bubble, Amazon bought at least nine internet companies to help it expand rapidly from bookseller to retail consumer goods platform.

The crucial deal in this transformation to a multi-product retail platform was Amazon’s purchase, or "acqui-hire", of Junglee for about $250m in 1998 from Ram Shiriam in order to recruit Anand Rajaraman, who later became an angel investor in social network Facebook.

During this period, Amazon also took corporate venturing stakes in more than 15 companies (see table below). Many of these deals were alongside Amazon’s own investors, including venture capital firms Kleiner Perkins Caufield& Byers (KPCB) and Madrona Capital Partners, and angel investor Ram Shiriam.

Many of its venturing deals from this period, however, were financial failures, such as a grocery delivery company that took in $280m from a consortium, including $60m from Amazon; eZiba, that sold its assets in 2005; and Pets.com that took in two rounds of money from a syndicate including Amazon in 1999.

Amazon structured many of its 2000 and 2001-vintage deals with warrants and revenue-sharing partnerships, including provisions for a 5% stake in retailer ToysRUs, but once the dot.com bubble burst after the millennium these partnerships struggled.

However, one that succeeded was Amazon’s backing of Audible.com in 2000 when it acquired a 5% stake and agreement for $30m in revenues over three years. In 2008, Amazon acquired Audible for a $300m enterprise value.

In the intervening years there was little dealmaking as Amazon consolidated its physical goods range for sale, developed its software-as-a-service (SaaS) model and started to become profitable even as revenues continued their rapid expansion.

To encourage developers to use its Amazon Web Services (AWS), which supported 762 billion files in its cloud last year, Bezos set up AWS Start-Up Challenge to offer a prize of $100,000 in cash and services to the winner.

This competition effectively started Amazon’s second period of venturing. During its first period of dealmaking, Amazon often followed venture capital firms into deals to expand from its core, but the second generation of dealmaking often favoured companies where Amazon had an edge by understanding the information flows among internet-based businesses.

While the winner of Amazon’s first challenge, Ooyala, has subsequently taken in four rounds of funding from third parties, including corporate venturing unit Motorola Mobility last year, subsequent finalists have welcomed Amazon as equity investor.

Yieldex, winner of 2008’s AWS Start-Up Challenge, saw Madrona and Amazon invest in its $8.5m series B round the following year, and provide a further $10m in 2011.

Sonian, a runner-up to Yieldex in 2008 had Amazon invest in its $9m series B round last year. Amazon has used the insights from start-ups using its AWS platform to understand which products and services are expanding rapidly – for example, by seeing which companies are increasing demand for servers most rapidly, such as Engine Yard, where Amazon invested in the 2008 and 2009 venture rounds.

As Adam Selipsky, a vice-president at AWS, told newswire Reuters: "AWS has great relationships with many young companies and there have been cases where we have been able to help with investment opportunities."

These opportunities also appear to be for the Bezos family office, Bezos Expeditions, which has backed AWS users AirBnB and Linden Lab.

But Amazon has also expanded its dealmaking beyond the AWS platform, including buying its venture portfolio company Lovefilm last year and investing $175m in daily deals site LivingSocial in 2010.

So far this year, Amazon has bought warehouse robotics company Kiva for $775m from venture capital firms (VCs) Bain Capital Ventures and Meakem Becker, and acquired TeachStreet from one of its former employees, David Schappell, and a consortium including local VC Madrona and Bezos Expeditions.

Amazon and Bezos have retained close links with Madrona, which has had partner Tom Alberg on the online retailer’s board since 1996 (see box below).

As well as TeachStreet, Bezos Expeditions and Madrona have backed Skytap.

One of Amazon’s earliest acquisitions, in 1999, was Madrona portfolio company LiveBid, which formed the backbone of the retailer’s auction house, and the venture capital firm has backed a number of Amazon alumni’s nascent businesses.

These deals include Redfin,where Brian Marsh was chief technology officer, Off & Away, led by Doug Aley, Mercent and Jambool, which was founded by former Amazon employees Vikas Gupta and Reza Hussein and sold to search engine Google for $75m.

Madrona in some ways has acted as an outsourced corporate venturing unit for Amazon, in a way similar to KPCB’s iFund for technology company Apple. When Madrona backed Searchandise Commerce for product search, news provider Xconomy was told by the portfolio company that it had "the kind of approach that would make sense to a huge e-retailer like Amazon".

In January, Madrona promoted former Amazon manager Scott Jacobson to partner after his deals, which included Yieldex and TeachStreet.

Amazon has also kept close to KPCB, which acts as a judge for its AWS Start-Up Challenge. But as Amazon keeps on growing, its relationships with other investors has moved towards the retailer compared with its earliest days as a nascent business itself.

Amazon’s regulatory filing for its initial public offering said that by December 31, 1996, Amazon.com had sales of more than $16m to about 180,000 customer accounts in more than 100 countries.

Last year, Amazon posted turnover of $48.1bn, up 41% from $34.2bn in 2010, while net income dropped 45% to $631m down from $1.15bn in 2010 as Amazon continued investing for the longer term through the launch of its  Kindle Fire tablet.

Selected Amazon dealmaking

1998:  Amazon acquires: PlanetAll, Junglee, Bookpages, German Telebooks, and Internet Movie Database1999: 
Amazon acquires: Livebid.com from Madrona, Exchange.com, Alexa, and Accept.com.
Minority investments: DrugStore.com (Amazon 46%, other investors KPCB, Maveron, Liberty Media), Pets.com twice (Amazon 50%, other investors Hummer Winblad and Bowman Capital), HomeGrocer.com (Amazon invests $42.5m for 35% stake), and Gear.com (Amazon 49% stake).

2000:  Minority investments: Greenlight.com (Amazon 5% with warrants for further 25%, others KPCB, Asbury Automotive), Drugstore.com (Amazon $30m), Audible.com (Amazon 5% stake), Living.com (Amazon 18% with extra 9% in warrants, others Benchmark, Austin, Comdisco Ventures, Pivotal, GE, Starbucks), Greg Manning Auctions (Amazon $5m), Basis Technology; Kozmo (Amazon $60m for minority plus warrants, others Softbank, Starbucks, Flatiron), eZiba.com (Amazon 20% plus warrants in a $70m round), and Wineshopper (Amazon $30m for 45%, KPCB another $14m).

2001:  Minority investments: ToysRUs (Amazon 5% in warrants); and Altura International (Amazon $5m)

2005:  Amazon acquires: Booksurge

2007:  Launch of AWS Start-Up Challenge: Ooyala wins. Amazon acquires: Brilliance Audio, CustomFlix Labs, and Dpreview.com

2008:  Yieldex wins AWS Challenge, Sonian a finalist.
Amazon acquires: AbeBooks, Without A Box, Fabric.com, and portfolio company Audible for $300m. 
Minority investments: Engine Yard (Amazon invests in $15m series B round alongside NEA, and invests again in October 2009). Merges European DVD distributor unit with peer Lovefilm in return for a minority stake

2009:  GoodData wins AWS Start-Up Challenge with investment offer, Bizo runner-up.
Amazon acquires: Zappos for up to $847m from Sequoia.
Minority investments: Engine Yard, Yieldex (Madrona and Amazon invest in $8.5m series B round).

2010:  M-Dot Network wins AWS.
Amazon acquires: Quidsi for $545m from VCs Accel Partners, Bessemer Venture Partners, BEV Capital, MentorTech Ventures and New Enterprise Associates, Woot for a reported $110m and BuyVIP from Bertelsmann, Active Venture Partners, 3i, Debaeque, Kennet Partners, Grupo Intercom and Digital Assets Deployment. 
Minority investments: LivingSocial (Amazon $175m, Lightspeed Venture invests extra $8m)

2011:  Fantasy Shopper wins AWS Challenge, Localytics is runner-up. Amazon starts KDP Select $6m fund for authors.
Amazon acquires: portfolio company Lovefilm (and VCs Index entures, DFJ Esprit and Balderton Capital), Quorus.
Minority investments: Sonian (Amazon in a $9m series B round), Yieldex (Amazon and Madrona in $10m round); Animoto ($25m from Amazon, Madrona and Specturm Equity), ParAccel ($15m E Round by Amazon, others Silicon Valley Bank, VC firms Menlo Ventures, Mohr Davidow Ventures, Bay Partners, Walden International and Tao Venture Capital Partners), and Ciceksepeti.com (Amazon 18%).

2012:  Amazon acquires: Kiva for $775m from Bain Capital Ventures, Meakem Becker; TeachStreet from Madrona Venture Group, Bezos Expeditions and others.

Source: Amazon, public records

Early years and funding

Amazon launched on July 16, 1995, in Seattle, Washington, US, nearly a year after Jeff Bezos had moved across the country from the east coast to be closer to his angel investors.

The first book Amazon.com sold was Fluid Concepts & Creative Analogies, by computer science professor Douglas Hofstadter. It was an appropriate title for Bezos given that he graduated top of his university class in computer science before joining short-lived financial services start-up Fitem.

Bezos then moved to investment bank Bankers Trust and on to hedge fund DE Shaw before deciding to set up what became known as Amazon in 1994.

In early 1994, Bezos drew up a list of 20 products that could be sold on the internet, from clothing to gardening tools, and then researched his top five – music CDs,  videos, computer hardware, computer software and books.

According to one biography, Le Livre 010101 de Marie Lebert – From the Print Media to the Internet, Bezos said: "I used a whole bunch of criteria to evaluate the potential of each product, but among the main criteria was the size of the relative markets. Books, I found out, were an $82bn market worldwide.

"The price point was another major criterion – I wanted a low-price product. I reasoned that since this was the first purchase many people would make online, it had to be non-threatening in size.

"A third criterion was the range of choice – there were 3 million items in the book category and only a 10th of that in CDs, for example. This was important because the wider the choice, the more the organising and selection capabilities of the computer could be put in good use."

A fourth reason, as Wired magazine said, was that books already had electronic lists. Wired said: "The most logical thing to sell over the internet was books, largely because two of the country’s largest book distributors already had exhaustive electronic lists.

"As Amazon.com has long since established, no single bookstore, even a superstore, can carry a comprehensive inventory of the books in print. The distributors, carrying thousands of titles, in effect act as the ware-house for most stores, particularly smaller independent booksellers.

"When customers ask a store for a book it does not have, the first place many of them will turn to fill the customer’s order is Ingram or Baker & Taylor, the two largest distributors.

"These companies’ inventory lists, once regularly circulated to bookstores on packs of microfiche, went digital in the late 1980s along with others in the book trade – an unheralded benchmark that would enable Bezos to offer books online through the virtual retailer he envisioned creating."

With the distributors apparently blind to the internet’s potential, Wired said Bezos gained $1m in seed capital from a group of 15 angel investors, including Tom Alberg, a former president of Lin Broadcasting, a subsidiary of phone operator McCaw Cellular, who became Amazon.com’s first board member.

Discussion board Quora said Alberg invested $50,000 for just over 1% of Amazon at the time of its flotationon the Nasdaq stock exchange in 1997. Venture capital firmKleiner Perkins Caufield& Byers owned 17% after investing $8m in Amazon’s sole institutional round before its initial public offering, with partner John Doerr a director on Amazon’s board.

Case Study: Amazon gives strong reviews to Lovefilm

When Nasdaq-listed online retailer Amazon bought out the remainder of the shares in UK-based movie rental company Lovefilm for an undisclosed sum in January last year, the companies said there would be developments but no immediate change to the logo or service terms.

Since then Lovefilm has continued to expand from a filmrental service by post towards an internet-streaming media distributor with more than 2 million members of its Lovefilm Instant service.

In January this year, Lovefilm said it was working with global electronics company LG to bring Lovefilms video streaming service to the Korean group’s smart TV platform.

Lovefilmhas also signed distribution deals with a number of major content producers, such as Disney, ITV and BBC Worldwide, and expanded into Germany.

For Amazon, the continued growth and maintenance of Lovefilm’s senior management represents a successful integration aided by the close working relationship formed between the two companies through owning equity.

It also represents a turnaround from its previous effort to expand in Europe’s film rental market. At the time of the acquisition, Greg Greeley, Amazon’s vice-president of European retail, said: "Lovefilm and Amazon have enjoyed a strong working relationship since Lovefilm acquired Amazon Europe’s DVD rental business in 2008, and we look forward to a productive and innovative future."

News provider Wall Street Journal said Amazon valued Lovefilm at about $320m but the cost was offset by its 42% holding. While Amazon reduced its cost of acquisition through its corporate venturing share ownership, for Lovefilms others investors, including venture capital firms Index Ventures, DFJ Esprit and Balderton Capital, which came together after the 2006 merger of Video Island and Screen Select and rebranding as Lovefilm, the exit was one of the largest of the year.