The Insights of Bezos and Buffett: Those Who Focus on the Long Term Have a Significant Competitive Advantage

Source: Qile Club

The world's richest individuals, such as Jeff Bezos, Bill Gates, and Warren Buffett, are exemplary models of accumulating wealth through long-term thinking. It is said that one morning in 2000,$Amazon (AMZN.US)$Amazon founder Jeff Bezos called Buffett and asked him, 'Your investment system is so simple, why are you the second richest person in the world? Why doesn’t everyone do what you do?' Buffett replied, 'Because nobody wants to get rich slowly.' Bezos suddenly realized that those who focus on the long term have a huge competitive advantage over those fixated on the short term. This further solidified his resolve to focus on the long term and ignore short-term fluctuations.

Amazon disrupted traditional bookstores, conventional retailers, and the computing power market. Retail giants like Walmart, Carrefour, RT-Mart, Bailian Group, Dashang Co., Ltd., and Yiwu International Trade City either declined or were acquired. Traditional computing power providers such as Oracle, IBM, SAP, HP Inc, and Dell no longer have a promising future. In China, Alibaba and JD.com stand out as the equivalent of Amazon, with Alibaba Cloud showing vast potential.

'Projects that generate only short-term profits are not important, no matter how much money they make now. What matters are projects that can produce long-term cash flow, even if they lose money at present.' Under this long-term thinking, company valuations are no longer based solely on profits but can also be calculated using free cash flow × multiples. This provides the theoretical basis for unicorns to go public on the A-share market. The number of long-term investors in the A-share market will increase, and the valuation of high-investment, slow-return but strong cash-flow projects should improve.

'To identify long-term investment opportunities, one must clearly answer the question: What will remain unchanged over the next decade? For example, the essence of the retail industry—offering unlimited choices, the lowest prices, and fast delivery—will not change in ten years. Based on this understanding, can we conclude that SF Holding and JD Logistics have a brighter future?'

If we view banks and securities firms as alternative retailers (where financial products are immediately delivered without logistics), then Ant Financial, WeBank, JD Finance, Lufax, and East Money will significantly disrupt traditional banking and securities industries.

Bezos is an extraordinary individual—a persistent, non-continuous, and innovative entrepreneur.

• He revolutionized the bookstore industry.

Before Amazon entered the bookstore business, Barnes & Noble was the largest bookstore in the United States, holding an 8-12% market share.

Back when Amazon had only tens of millions of dollars in revenue, Barnes & Noble raised two billion dollars to establish its online bookstore, complete with its own channels, warehouses, and distribution network.

However, even in such a situation, it was ultimately disrupted by Amazon.

• It disrupted the supermarket industry.

After completing the disruption of the book category, Amazon began to enter retail, with its rival becoming Walmart, the king of retailers.

The Walton family has long been the richest in the world and was considered invincible. However, now this battle has concluded, with Amazon’s market value surpassing the combined market values of the top 10 U.S. retailers.

• It disrupted the computing power market.

Traditionally, computing power was provided by companies like IBM and HP Inc. However, to everyone's surprise, Amazon, an e-commerce company without a technical background, entered the cloud computing industry.

Currently, the combined market capitalization of renowned traditional computing giants such as Oracle, IBM, SAP, HP Inc, and Dell is still less than that of Amazon.

In March 2017, Bezos surpassed Buffett to become the second richest person in the world; on July 27, 2017, his net worth reached $90.2 billion, making him the world's richest person on that day; on October 28, 2017, his net worth increased to $93.8 billion, reclaiming the title of the world’s richest person.

Why has Amazon's Bezos been able to disrupt industries repeatedly?

Moreover, not for one year but for twenty years, and not just one thing but numerous achievements. Why?

What unique ways of thinking does he possess?

Today, I will systematically explain it to you.

01. The Three Pillar Assumptions: The Core of Bezos' Thinking - Non-Consensus

Peter Thiel once said in his book 'Zero to One':

Whenever I interview a candidate, I always ask one question: What important truth do you believe that most people would disagree with you on? A good answer follows this pattern: Most people believe X, but the truth is the opposite of X.

Similarly, Bezos also expressed a view following a similar approach:

I believe that if you want to innovate, you must be willing to be misunderstood for long periods of time. You must adopt a non-consensus but correct viewpoint in order to outperform your competitors.

This is also the core of my analysis of Bezos' thinking today: non-consensus.

On what important issues does Bezos hold different views from others? I have selected three pillar assumptions. (Extension: What defines boundaries? It is your foundational assumptions about a system that define its boundaries. When you break through these assumptions, the boundaries they define are also broken. We call this the shift of base points.)

02. Free Cash Flow, Circle of Competence: Long-Term Thinking

Which is more important, cash or profit?

Let’s first look at a phenomenon: both Amazon and Alibaba have reached a market capitalization of 500 billion US dollars. In the third quarter of 2017,$Alibaba (BABA.US)$Alibaba's profit was 2.6 billion US dollars, while Amazon's profit was only 256 million US dollars.

However, in the capital market, Amazon's PE ratio (note: the mainstream valuation model for companies is the PE ratio, which is the company’s market value divided by its earnings per share) reached 296 times. In other words, the capital market has already given Amazon all the money it will earn 300 years from now.

Is Bezos a fraud? Did he inflate his market value to 500 billion US dollars just by telling stories?

No.

This is because most people use the valuation model of profit × multiples, but since 1997, Bezos has adopted a different valuation model:

A company’s value equals the total discounted value of the free cash flow that the company can generate over its lifecycle (long term).

Very few people use this valuation method. I found that Buffett also believes in this approach.

The majority of people focus on profits, but Bezos emphasizes free cash flow.

Bezos stated that a company’s valuation is not calculated based on profit but rather on free cash flow × multiples.

Why free cash flow?

What is free cash flow? It refers to the money a company can freely allocate after meeting operating costs and maintenance capital expenditures.

Bezos believed that the net profit figures on financial statements are not the core capability of a company. The core capability of a company lies in its free cash flow — the amount of money available to invest in the future, which is the most critical metric determining a company's value.

Amazon is a quintessential example:

When profits and free cash flow are at odds, Amazon completely disregards the net profit shown on financial statements, choosing instead to reinvest it into the future, such as in major infrastructure projects like Prime, FBA, warehousing and logistics, and AWS cloud services. This ultimately allowed Amazon to decisively outpace its second-largest competitor and establish long-term market dominance.

From 2010 to 2013, Amazon’s annual capital investment in its cloud computing business grew from $150 million to $1.5 billion, with an annual compound growth rate exceeding 200%.

Among our 452 goals, terms like 'net income,' 'gross profit,' and 'operating profit' never appeared once.

— Jeff Bezos, 2009 Letter to Shareholders

Bezos believed that competitors’ obsession with profit margins presented an opportunity for Amazon. These companies would be constrained by their focus on profitability, making competition against them akin to 'cutting through butter with a hot knife.'

Although Amazon’s net profit remained around zero for 18 years prior to 2014, its operating cash flow had consistently been very healthy.

In the history of American business, the first person to declare that he did not focus on profits but only on cash flow was John Malone, the American telecom tycoon. Bezos was the first entrepreneur to apply this strategy to e-commerce.

Coincidentally, Netflix, which has had the highest investment return rate over the past decade, also adheres to the same philosophy.

The founder of Netflix stated that the more cash a company has on its books, the less innovative drive it demonstrates.

The game rules of Wall Street emphasize short-term profits, with quarterly reports issued to shareholders every three months. What is frightening is that both revenue and profit must increase each quarter. Even more daunting is that the growth rate must exceed the level analysts expect.

However, Netflix and Amazon have broken the established rules by adopting a long-term mindset, sacrificing short-term profits for growth.

This is Bezos’ distinctive business philosophy:

All projects that can only generate short-term profits are unimportant, no matter how much money they make now.

Projects capable of generating long-term cash flow are important, no matter how much they lose now!

Bezos' Circle of Competence — Long-Term Thinking

What kind of thinking does prioritizing long-term cash flow over short-term profits reflect?

This is Bezos's circle of competence (the boundary of core capabilities): the strategic ability driven by long-term thinking.

He opposes the competitor-centric approach, stating:

Don't worry about what competitors are doing; they don't pay you.

Indeed, if Bezos had been focusing on eBay all the time, he would not have created AWS cloud services;

If Bezos had been preoccupied with Walmart, he would not have developed the Echo smart speaker.

Choose your competitors carefully because eventually, you may end up looking very similar to them.

He rejects the stock market-centric perspective, saying: If the stock rises 30% this month, it doesn’t mean you’ve become 30% smarter; if the stock drops 30% this month, it also doesn’t mean you’ve become 30% dumber.

Why must one adhere to long-term thinking? Bezos's viewpoint is as follows:

If every action you take focuses on a three-year horizon, you will face many competitors; however, if your vision extends to seven years, then there will be very few who can compete with you, as few companies are willing to plan that far ahead.

— Jeff Bezos (2011)

03. Customer obsession, methodology: Working backwards

Three things in retail

Bezos said:

I am often asked one question: 'What changes will happen in the next ten years?' However, I am rarely asked: 'What will remain unchanged in the next ten years?'

I think the second question is more important than the first because you need to build your strategy on things that are constant.

Devoting all resources to what remains constant is such an exciting principle.

So, what is that constant thing Bezos referred to?

In the ever-changing retail industry, there are three very ordinary things:

First, unlimited selection.

Second, the lowest price.

Third, fast delivery.

Bezos said that even ten years from now, no customer will jump out and say, 'Hey, Bezos, I love you, I love Amazon, but I just hope your prices are a bit higher and your delivery is slower.'

Moreover, Bezos believes that there are two kinds of companies in the world: one tries to persuade customers to pay a high profit margin, while the other works hard to lower prices and pass on profits to consumers.

I think both types of companies can be very successful, but we firmly choose to be the latter.

How did he do it? Brad Stone described it in 'The Everything Store' as follows:

Amazon Web Services (AWS), in the long absence of competitors, proactively cut prices 51 times. Bezos said he didn't want to repeat 'Steve Jobs' mistake'

- pricing the iPhone too high, thereby making smartphones an attractive target for large-scale competition.

Customer obsession

What is at the core of the three ordinary things mentioned above? Customer experience.

The most customer-centric company in the world, this is Amazon's culture.

Almost every company claims this, but only Bezos elevated this principle to a level stricter than religious belief and truly implemented it.

Case Study: Amazon Prime

In 2005, a mid-level employee at Amazon proposed the idea of Prime, a service offering two-day delivery for an annual fee of $99. At that time, from Wall Street to senior executives, everyone thought this was insane. Bezos overruled objections and persisted with the project.

The strongest opposition came from his CFO, who was highly combative and a close ally of Bezos. However, on this project, the CFO argued that free shipping was not innovative and would once again damage the company’s balance sheet. During one meeting, he even suggested demoting the person who made the suggestion.

Currently, Prime has over 90 million global subscribers. With an annual fee of $99 per member, this generates nearly $9 billion in revenue. However, the project is still operating at a loss, as Amazon's investment in Prime benefits far exceeds this figure.

In hindsight, the $99 annual fee incentivized members to fully utilize the value of Prime, leading to more orders. A large number of customers became loyal supporters of Amazon due to this service.

This is considered one of the most cost-effective deals in Amazon’s history.

What methods did Bezos use to implement the principle of customer obsession?

Generally speaking, there are two types of innovation drivers:

The first type is skill-driven.

The second approach is the reverse working method.

The representative of skill-oriented approach is Apple. Steve Jobs said, 'I have the ability, I am highly competent, I possess an aesthetic sense, and people are willing to buy what I create.'

But Bezos said, 'I don't have the ability that Jobs had. It's not because I have some special ability that compels consumers to buy, but rather, I must start from the perspective of the consumer. What do consumers need? In other words, I create what consumers need.'

So, what capability does this cultivate?

It is essential to start from consumer demand and touch upon what consumers need. This is the reverse working method.

04, Day one, First Principles: Anti-Entropy Growth

Which is more important, Day one or Day two?

Bezos coined two terms: Day one and Day two.

Day one: The state of starting a business.

Day two: The state of having achieved success and recognition.

Which is more important, Day One or Day Two?

If everyone is honest, they would surely think it is Day Two. Of course, we do things to achieve success. When I start a business, I dream of the day we ring the bell.

But Bezos is peculiar. He says that your endpoint is not important at all; what matters is your starting point.

A company with a Day One mindset is one that is just beginning to unleash its potential; a company with a Day Two mindset is stagnant, becoming increasingly irrelevant in the market, and will gradually decline and perish. Therefore, a company must always remain in a Day One state.

— Jeff Bezos

To remind himself, Bezos named the main office building Day One. Every day when I step into this building, I see that this is my first day, and this is Amazon's first day. (WeChat Official Account: qlhclub)

The entire company does not have luxurious decorations; the desks are made from door panels or designed to look like them.

In fact, what is the essence behind Day One and Day Two?

Day One: The innovator's dilemma (inflection point).

Day Two: Established companies on the verge of entering the innovator's dilemma (limit point).

Your limit point is your stall point.

Almost everyone aspires to reach the pinnacle of life, but Bezos believes that the day you reach the peak is the day your misfortune begins. Therefore, I must always stay here.

How to maintain the vitality of Day One?

The next question is, how to maintain the vitality of Day One, especially within a large organization? What is the key leverage point?

In fact, the trend from Day One to Day Two is irreversible, just like time. What are the forces behind this?

The law of entropy increase states that any closed system continuously consumes energy and releases energy that cannot be recovered. 'Entropy' refers to the energy that is constantly being depleted and can no longer perform work.

Moreover, the trend of increasing entropy is irreversible. The progression from order to disorder is also irreversible.

In this regard, Wang Dongyue stated that any organization, over time, will inevitably become dispersed, bureaucratized, and ineffective, eventually leading to its demise. The primary force behind this is organizational entropy increase.

Similarly, Drucker believed that management has only one task: how to combat entropy increase. In this process, corporate vitality can be enhanced rather than silently heading toward death.

On this point, Bezos explicitly stated in his 1998 letter to shareholders: We must resist entropy increase, but most researchers overlooked this statement.

In fact, anti-entropy thinking is the first principle Bezos applies to manage this vast organization.

How exactly is it done? There are three key approaches:

① Resist formalism.

As companies grow larger, the most common manifestation is formalism, where you stop focusing on results and instead ensure that processes are followed correctly.

However, Amazon is a large company that particularly detests processes. In fact, a hallmark of a company falling into a "Day Two" state is when processes restrict your operations.

② Small teams

Amazon has 240,000 employees, but most teams are very small, the most famous being the "two-pizza team." Brad Stone wrote in "The Everything Store":

The entire company was to be reorganized according to the "two-pizza team" model. Employees were to form independent teams of no more than 10 people — especially during night shifts, where the team size could be small enough that two pizzas would suffice for a meal.

③ Open systems

Bezos has a powerful tool against entropy:

Amazon transformed its internal functional operations into external service-oriented businesses.

When a particular service is externalized, it will face real competition and must understand customer needs because Amazon is only one of its early users. Eventually, it evolved into a situation like AWS, serving entirely external clients.

In its early stages, AWS was designed to avoid technological bureaucracy for internal use, but later it became fully commercialized as an external service, with usage even surpassing internal consumption.

Case Study: Third-Party Seller Platform (Marketplace)

Initially, Amazon only sold its own products, but later it opened up to third parties. Moreover, Bezos made price comparison tools available to all consumers.

This business model clearly undermined Amazon’s interests and faced opposition from many quarters. For example, if you wanted to buy a book, you might find the cheapest option was a used book, which would upset the bookseller; or if others sold items cheaper than Amazon itself, the business unit head would be unhappy. (WeChat Official Account ID: qlhclub)

Bezos said, 'So what? I want to use external pressure to ensure my prices are the lowest in the market.'

Summary.

Finally, let us reiterate how to properly learn from Bezos.

We cannot replicate his entrepreneurial story because that era has passed, but his way of thinking can expand our horizons. Have you grasped this essence?

Munger once said, there is an old adage in the business world:

Find a simple, fundamental principle.

Act very strictly in accordance with this principle.

It is hoped that today, you will find it and carry it through your entire life.

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Editor/Rice