How Jeff Bezos Rules the Retail Space

Bezos had been flying around the boondocks of West Texas to scout out a site for Blue Origin, a space tourism venture he’d long dreamed of starting. The helicopter ferried them to a remote area that a government report would later describe as “mountainous terrain next to a creek.” After a brief look around, Bezos and two employees hopped back into the helicopter, and the pilot tried to take off. That’s when things went bad.

“We had a full cabin and a full tank of gas, so the helicopter was heavy,” Bezos recalls, discussing the 2003 incident publicly for the first time. “The way a helicopter takes off is to lift off a few feet, then the rotors tilt and it needs to get some forward momentum to generate lift.” That didn’t happen.

Instead, as the aircraft skittered along the field, its tail boom struck a tree, causing it to roll and zigzag crazily. “Finally one of the sleds hooked into a mound of dirt, and the helicopter flipped and landed in a creek,” Bezos says. Does his life flash before his eyes? Does he think about all the things he might have done? Nope. “I thought, ‘What a dumb way to die,'” he says. Then, just as he always does, he laughs his signature Very Loud Laugh (VLL).

The close call with the chopper is a pretty good metaphor for the charmed life of Jeff Bezos and Amazon. (For more on his space ambitions, see box.) He and his company were the original dot-com highfliers, with Amazon’s stock hitting $361 just before its three-for-one split at the end of 1998. As it took off, so did the story of Amazon and its founder. One day in 1994, Bezos, a Princeton-educated financial analyst, was sitting at his desk at the Manhattan hedge fund D.E. Shaw when he noticed a shocking statistic: The number of users on the Internet was growing by 2,300% a year. On a cross-country trip with his new wife a bit later, he concocted a business plan for a company that would sell books online. With investments from family and friends, he launched his startup in 1995 from Seattle, evolving it from a bookseller to the world’s biggest online retailer, period. Bezos himself soared on the publicity as the model of the new Internet mogul and was, fittingly, Time’s last Person of the Year of the 20th century. (I should know: I wrote the piece.)

Then came the dot-com crash. Conventional wisdom pegged Amazon and Bezos as goners—Amazon.toast and Amazon.bomb were a couple of zingers making the rounds. It would never be profitable, the wise men said, and when heavyweights like Wal-Mart and Target finally put up credible websites, they would mop the floor with this upstart. “But guess what?” says Citigroup Internet analyst Mark Mahaney, who has been following Amazon from the start. Long after all the big-box retailers got their sites up, running, and debugged, “Amazon’s share of online retail has only increased.” Amazon now accounts for 6% of the $136 billion online retail market in the U.S.—up from 5.1% in 2006. At the same time, free cash flow grew an impressive 140%. Says Mahaney: “That’s pretty dramatic.”

By virtually any measure—market share, revenue, profit, stock price, customer satisfaction, international reach—Amazon is thriving. With $14.8 billion in revenue, it’s ranked 171 on the Fortune 500 (up 66 places from the previous year). It was the fifth-ranked company as measured by its 134.8% return to shareholders during 2007, putting it, surprisingly, two ranks above Apple. (Apple is No. 1 on the 500 if you go by its 51% ten-year return; but Amazon returned 34% over the same period, which puts it at No. 8.) Along the way Bezos has become enormously wealthy. One magazine lists him as the world’s 110th-richest man and estimated his worth at about $8.2 billion. And unlike so many other dot-com moguls, he didn’t take the money and run—most of that wealth is tied up in his company’s stock. He holds about a quarter of the outstanding shares.

So how did he turn Amazon into a real business? It’s easy to believe that Jeff Bezos is one of the great innovators, but that’s not exactly the case. His rise into Fortune 500–dom actually has little to do with innovation and more to do with iteration. If anything, Amazon demonstrates how a cutting-edge Internet company—of all things—can succeed slowly. The trick is taking a million tiny steps—and learning quickly from your missteps.

By doing just that, Bezos has created one of the all-time great retail operations. But he wants Amazon to be more than that. Now he’s trying to build his company into the web’s biggest seller of digital media—downloadable copies of books, music, and movies—and turn it into a provider of the fundamental services that power business itself. He doesn’t just want to be the Wal-Mart of the web; he wants to be its Con Edison too.

“THE TWO-TON DRILL PRESS HAS WORKED OUT JUST FINE,” BEZOS assures me during a visit to Amazon headquarters in Seattle. This is a bit of a private joke: Nearly a decade ago I was with Bezos on the day he took possession of Tool Crib of the North, a popular hardware store and catalog company based in North Dakota. I wondered then about the “two-ton drill press”—how could Amazon make money shipping monsters like that?

But big-ticket items weren’t an issue, he says: “What turned out to be a problem was something like the household broom—inexpensive to buy but expensive to ship.” Who wants to pay $8 for a popcorn popper and $8 to ship it? Part of Amazon’s success over the past few years was figuring out how to make low-end sales like that profitable.

He’s figured out a lot of things, actually. He seems more comfortable as a leader these days. Now 44, Bezos is aging well—a bit heavier than when I first met him, and what’s left of his hair is starting to gray. He’s also got four children now, three more than during his Person of the Year days, including a girl adopted recently from China. But his mood is unchanged: He’s as upbeat as ever. When I try to bait him into trash-talking Apple, which is now one of Amazon’s main competitors (music downloads), he refuses. Won’t even utter the word “Apple.” Who your competitors are and what they’re doing now, he insists, has little bearing on the fundamentals of running a business: “Whatever your set of competitors is today is transitory. You’d have to change your strategy all the time!”

For all of Amazon’s ups and downs during the past 13 years, Bezos’s strategy is one thing that hasn’t changed. Customers want three things, he says: the best selection, the lowest prices, and the cheapest and most convenient delivery. At Amazon, he explains, all decisions flow from those fundamentals. “What’s not going to change over the next ten years is incredibly important—you can build plans that are durable and meet important customer needs,” he says, adding, “It is impossible to imagine a world ten years from now where customers will say, ‘I love Amazon, but I just wish your prices would be higher.'”

He barks his VLL; everyone in the conference room cringes; he continues: “The trick is to position the company so even in a wide variety of scenarios you can pursue more fundamental things.” In other words, have a good fallback plan. A good example of this philosophy is Amazon’s decision to build excess warehouse capacity. In the late 1990s some executives argued in favor of building just enough of the giant, automated warehouses—four of the $60 million facilities—to meet projected demand. Bezos decided to build five. “From a financial point of view we should have built four rather than five,” he says, pointing out that in 1999, when the centers were built, “for a company that only had $1 billion in sales, spending $300 million on fulfillment centers is a very big investment.”

Instead he was positioning the company to pursue “more fundamental things”—that is, keeping Amazon’s customers happy. Remember all the post-holiday news stories at the turn of the millennium about little Timmy and Janie not getting their presents on Christmas because some fly-by-night toy site couldn’t handle the holiday crush? Amazon came out smelling like a 1-800-flowers rose. “A lot of companies stumbled and we didn’t,” says Bezos. “We had an insurance policy against that huge burst of demand”—the fifth fulfillment center.

Bezos makes gut calls too, of course, such as the creation of Amazon Prime, the company’s express-shipping program. (You pay $79 a year and get your stuff, no matter how much you order, within 48 hours of ordering it, no extra charge.) It was scary at first, since, he says, “the one thing you do know when you hold an all-you-can-eat buffet, the heavy eaters show up first.” But over time the program caught on because it turns out that Prime customers tend to buy more than they would normally. In fact, it’s working so well that the company expanded it late last year to Britain, Germany, and Japan.

“A lot of decisions around consumers are like that,” Bezos says. “When you do the math, it’s not clear what will happen.” This approach works. More people shop at Amazon every year, and its loyalty rate is at an all-time high, according to the University of Michigan’s customer satisfaction index. On that list Amazon is way above Wal-Mart, and comes in higher than such beloved retailers as Costco and Target. It even beats Apple. In fact, the only company of any kind it doesn’t beat is Heinz. No arguing with ketchup.

SO WHAT MISTAKES HAS AMAZON MADE? WHAT WOULD HE LIKE TO DO over? “You’re giving me a root canal now, with no anesthesia!” he says, letting fly another VLL. “We were investors in every bankrupt, 1999-vintage e-commerce startup. Pets.com, living.com, kozmo.com. We invested in a lot of high-profile flameouts. The only good thing is we had lots of company. It didn’t take us off our own mission, but it was a waste of capital.”

He could have mentioned, but didn’t, other misfires. For instance, the A9 project, a search engine Amazon started in 2004 to take on Google. It didn’t work and mostly faded into Amazon’s infrastructure. While it’s early to call it a loser, the Kindle, an e-book reader, got mixed reviews when it launched last year—in numbers small enough to immediately sell out. (All the better to iterate. For more on the Kindle, see box below.) While the device does have a clever, always-on connection to a high-speed data network, enabling users to download books on demand, the design isn’t so different from Sony’s e-book reader, which has gone nowhere.

Bezos may have better luck with another work in progress: music downloads. Music is as much a part of what we think of as Amazon.com as its book-selling business—the company sells more CDs than any other online retailer. Last year Amazon became the first site to sell unlocked digital tunes—meaning that unlike iTunes, you can copy and recopy your purchases ad infinitum—on behalf of the four major labels.

So how’s it doing? It’s still a small part of the business. Bill Carr, Amazon’s VP of digital media, would say only that the MP3-download business is “going very, very well.” The music industry folks I talked to say they like what they see, both in terms of sales volume and, even more important, the way Amazon sells digital music. One exec I know at a big label, who asked to remain anonymous, says he’s excited by one trend in particular: At Apple’s iTunes store, two-thirds of the music sold is single tracks and one-third is albums. But at Amazon, two-thirds of the music sold is albums and one-third is tracks. “It’s fantastic,” the music exec says. “We make a bunch more money from albums than if you buy one track at a time.”

My friend said his label’s experience with Amazon could well point to some relief for the music industry down the road: “As soon as we wise up and realize that online albums are worth about $5, the music industry will be fixed.”

RETAIL IS AMAZON’S BIGGEST BUSINESS BY FAR. BUT THE COMPANY IS also starting to make significant money from third-party retailers that range in size from mom-and-pop stores to Target. That business accounts for a third of all unit sales. The company makes money by taking a cut of the sale and, in some cases, by charging a fee to fill orders. That is, merchants can pay Amazon to hold on to their inventory and ship direct from an Amazon facility.

Aside from the sheer sales volume of Amazon’s retail business, analysts like its geographic diversity: 50% of revenue comes from international sales, says Citi analyst Mahaney, with Germany, Britain, and Japan each accounting for 10%. With Amazon’s third-party seller program rolling out internationally only a year ago, he sees this as one more area where Amazon can continue to expand.

Clearly Amazon’s retail business is working well. But that doesn’t mean he’s reattained can-do-no-wrong status with Wall Street, which still views him a bit warily. Why? Two words: operating margins. In 2007, Amazon’s operating margins were 4.4%; by comparison, Wal-Mart’s were 5.9%. (Wal-Mart’s fiscal year ended on Jan. 31.) Mahaney points out that when you chart Amazon’s stock over the past decade, it maps to the ups and downs of those margins. From 2004 to 2006, when the company invested in R&D to improve the user interface, he said, margins came down—and so did the stock. When margins climbed in 2007, up went the stock. That may not be fair to Bezos’s long-term vision, but, says Mahaney, “so what? Amazon’s revenue growth has been remarkably sticky over time. The only real delta has been the way the margins are going because we count on continued revenue growth.”

Of course, a great way to guarantee fat margins is to sell a product that costs virtually nothing to ship—like music downloads, for instance. If those really take off, that stream of revenue could make a big difference. But there’s another area Amazon has been exploring that could prove lucrative: Amazon Web Services. Simply put, it’s trying to become a one-stop shop for your company’s information technology needs: processing power, databases, and storage. Think of it as a digital utility company for businesses. Companies wouldn’t need to invest much in expensive hardware and big, messy software installations for their back offices. Amazon has been aggressively signing up large customers, ranging from Nasdaq to SanDisk to the New York Times. Bezos says around 300,000 developers already use Amazon Web Services.

Don’t look for any surge in revenue from Amazon Web Services in the near term, however. Mahaney says that thus far, this new business unit is immaterial to Amazon’s bottom line. It will take time to get customers to trust the service. Or not: On April 8, Google launched a competitor, dubbed AppEngine—and it’s giving its service away free to low-volume users.

It’s not so easy being an iterator. Too many innovators out there trying to eat your lunch. But whether it’s Google or Apple or anyone else, don’t expect Amazon to shift direction. Jeff Bezos has every intention of just doing what he does, taking a million little steps until he gets where he wants to go.

A version of the article originally appeared in the May 5, 2008 issue of Fortune.