Once A ‘Distraction,’ Jeff Bezos’ Amazon Web Services Bet Finally Pays Off
When I wrote what was likely the first major magazine story about Amazon.com’s Web services business way back in November 2006, most people thought it was yet another crazy idea from CEO Jeff Bezos.
Heck, even most of my colleagues at the magazine thought I was crazy to bother writing about it. Understandably, many didn’t understand what I was talking about — selling access to Amazon’s huge cloud computing infrastructure for its own operations to outside companies — let alone believe that Amazon Web Services was sufficiently important to merit a cover story. “I have yet to see how these investments are producing any profit,” one analyst griped about the engineering and capital expenses involved. “They’re probably more of a distraction than anything else.”
Today, Amazon revealed just how big that “distraction” is. In its just-reported first-quarter earnings report, Amazon said AWS revenues have hit $5 billion on an annual basis. In the first quarter, revenues rose 49% from a year ago, to $1.57 billion.
Even more surprising, perhaps, it’s making money: $265 million in operating income, up from the $245 million it earned in the first three months of 2014. That may not be seen as a positive by some investors. In the odd calculus of Wall Street, the more money AWS is losing, the better. That’s because, as Macquarie Securities analyst Ben Schachter wrote in a recent note to clients, it would indicate that Amazon’s main retailing business is more profitable.
No matter. Amazon’s shares shot up 15% today, dragging the entire Nasdaq along with them. That’s partly because, well, ultimately any profits are good profits. And the growth of AWS, which now boasts more than 1 million active customers ranging from General Electric to every startup you’ve ever heard of, means it’s now a significant contributor to Amazon’s market value. Schachter values it at $75 billion, nearly half as much as the rest of Amazon’s business at $145 billion.
AWS isn’t cheap for Amazon. Thanks to more anticipated spending on AWS along with other content and fulfillment costs, S&P Capital IQ analyst Tuna Amobi trimmed his 2015 earnings estimate by 8 cents a share, to 36 cents, and his 2016 estimate by 94 cents a share, to $2.25. But as a result of the AWS numbers, he upgraded his rating on Amazon from sell to hold and raised his 12-month target price by $100, to $400.
The journey from “risky bet” to $5 billion payoff seems long in an era when two-year-old “unicorn” startups almost routinely net billion-dollar valuations. But as I wrote then, Bezos’ vision was neither as crazy nor as impulsive as the suits assumed:
Amazon has spent 12 years and $2 billion perfecting many of the pieces behind its online store. By most accounts, those operations are now among the biggest and most reliable in the world. “All the kinds of things you need to build great Web-scale applications are already in the guts of Amazon,” says Bezos. “The only difference is, we’re now exposing the guts, making [them] available to others.”
At the same time, Bezos even then realized this was not going to be a quick moneymaker — and his willingness to spend years to prove it is an abject lesson that patience is one of the greatest virtues of a corporate leader:
“We think it’s going to be a very meaningful business for us one day,” he says. “What we’ve historically seen is that the seeds we plant can take anywhere from three, five, seven years.”
OK, so maybe nine years, or more — though arguably AWS has been a significant factor in Amazon’s growth for at least a couple of years now. It’s growing far faster than Amazon’s main business.
More than that, it’s clear that Bezos viewed Amazon Web Services as the linchpin of a strategy to turn Amazon the retailer into Amazon the platform — a strategy that, it’s easy to forget, was not the goal of every tech company nine years ago:
Google and Microsoft, in particular, are each angling to be the Net’s kingpins: Just as Microsoft ruled the PC world (and its profits) with Windows software, so Google and Microsoft want to build what techies call the “platform” for the Web — the powerful layer of basic services on top of which everyone else builds their Web sites. “Amazon’s a pretty serious dark horse” in that race, says Internet visionary Tim O’Reilly, CEO of tech publisher O’Reilly Media Inc. “Jeff really understands that if he doesn’t become a platform player, he’s at the mercy of those who do.”
Indeed, there were glimmerings even then that his vision, and that of Google and others, was opening the way for the Ubers of today:
Google, MySpace, and YouTube cracked open for the masses the means to produce media and the advertising that sustains it, creating tens of billions of dollars in market value and billions more in new revenues. Now, by sharing Amazon’s infrastructure on the cheap, Bezos is taking that same idea into the realm of physical goods and human talent, potentially empowering a whole new swath of businesses beyond the Internet itself.
More recently, Bezos has provided a little more clarity on how he views the business. In an interview during an AWS conference in November 2012, he drew analogies to another of Amazon’s crazy bets:
It’s very similar to our Kindle device business. We sell our hardware near break-even, so we make money when people USE the device, not when they BUY the device. That is very aligning with customers. It causes us to have the right behaviors.
AWS is very similar. It’s a pay-as-you-go service. We’re not incented to get people to overpay for hardware. In the long run, that will work out very well for customers, and it will work out very well for Amazon.
It’s far from clear how well, even as the acknowledged leader. Google, IBM, Microsoft, and many other well-heeled companies and upstarts are picking away at its leadership and seem sure to make some inroads.
But Bezos still seems patient — more patient, no doubt, than many investors will be willing to stomach. In the 2012 interview, he said that low-margin businesses like it are hard to run, but ultimately, perhaps, more satisfying:
Operating a low-margin business is hard. I sometimes have waking dreams that someday I might operate a high-margin business. It’s impossible to be efficient if you have high margins because you don’t need to be. We wouldn’t know any other way. It keeps you honest.
It also keeps competitors at arm’s length long enough to carve out a long lead:
“You have to have a willingness to fail, to be misunderstood for long periods of time. Then, you can ramp up your rate of experimentation. Successful invention requires you to increase your rate of experimentation. … We are willing to go down a bunch of dark passageways, and occasionally we find something that really works.”
In his annual letter to shareholders, released April 24, Bezos was surprisingly bold about the prospects for what he conceded is a very capital-intensive business:
I believe AWS is one of those dreamy business offerings that can be serving customers and earning financial returns for many years into the future.
And so it seems that his nine-year-old “distraction” is here to stay.