what-is-entrepreneurship

Jeff Bezos Teaches You When Judgment Is Better Than Math And Data

Back in 2005, Amazon.com had already become a massive success. A website, turned into a bookstore with a wide selection of books, had started in July 1994.

By 1995 it had sold already half a million worth of inventory. Its growth was exponential and by 1997 sales skyrocketed at over a hundred forty-seven million dollars!

The escalation continued, and by 2005, Amazon.com had evolved in a store offering a wide range of products, from books to music.

Amazon had started from a niche, which had dominated and quickly expanded. Indeed, in 2005 the company had sold almost eight billion and a half worth of goods!

To indeed get Amazon’s growth, let’s visualize it:

is-amazon-profitable
Amazon was profitable in 2021. The company generated over $33 billion in net income, primarily driven by the Amazon AWS business, which contributed to over 55% of its operating margins and other profitable parts like Amazon Prime and Ads. The Amazon e-commerce platform runs at tight operating margins since it’s built for scale.

A company that had started as a bookstore, challenging existing giants (like Barnes & Noble) had become a recognized brand not only in the US but also in Europe. 

Why not stop there? Yet in 2005, Amazon kept making hard choices. For instance, the company launched a program called Amazon Prime.

Why Amazon Prime was a controversial judgment call rather than a quantitative analysis

As Jeff Bezos recounted back in 2006, “many of the important decisions we make at Amazon.com can be made with data. There is a right answer or a wrong answer, a better answer or a worse answer, and math tells us which is which. These are our favorite kinds of decisions.”

Indeed, Amazon had always been more of a tech and software company than a retail store. If all Amazon had turned the retail store business model upside down.

Where retail stores would focus either on lowering prices or customer experience. Amazon is obsessed with both.

Amazon turned to quantitative analysis each time it had to make critical operating decisions related to the business.

For instance, as pointed out back in 2006, when it came to deciding whether to open up a new fulfillment center Amazon used historical data to estimate seasonal peaks and to model alternatives for new capacity.

It also looked at the shapes, and dimensions of products to optimize their fulfillment capacity. Or computed and shortened with maximum precision, the outbound transportation costs, based on the proximity of customers.

In short, in making decisions, Amazon is more of a lab made of scientists relying on data and math than a company relying on human judgment.

However, as Jeff Bezos admitted back then, there were certain kinds of decisions that cannot be modeled and made through math and data.

Nonetheless, massive growth, for instance, in 2005 Amazon launched Amazon Prime. And there was no way to assess quantitatively, whether that initiative would have been successful.

Fast forward to 2021, Amazon Prime has become a key ingredient in Amazon’s business model mix. 

amazon-business-model
Amazon has a diversified business model. In 2021 Amazon posted over $469 billion in revenues and over $33 billion in net profits. Online stores contributed to over 47% of Amazon revenues, Third-party Seller Services,  Amazon AWS, Subscription Services, Advertising revenues, and Physical Stores.

Amazon Prime is a key ingredient to the overall Amazon success.

With Prime, Amazon can hook customers to purchase more things in the online store. While they also pay a subscription fee that makes Amazon revenues more predictable and at higher margins, compared to the online store.

Short-term, operating decisions, based on quantitative analyses, and long-term, strategic decisions based on opinion and judgment

Indeed, opinion and judgment, in that case, mattered way more. As Jeff Bezos recounted in 2006:

As our shareholders know, we have made a decision to continuously and significantly lower prices for customers year after year as our efficiency and scale make it possible. This is an example of a very important decision that cannot be made in a math-based way. In fact, when we lower prices, we go against the math that we can do, which always says that the smart move is to raise prices. We have significant data related to price elasticity. With fair accuracy, we can predict that a price reduction of a certain percentage will result in an increase in units sold of a certain percentage. With rare exceptions, the volume increase in the short term is never enough to pay for the price decrease. However, our quantitative understanding of elasticity is short-term. We can estimate what a price reduction will do this week and this quarter. But we cannot numerically estimate the effect that consistently lowering prices will have on our business over five years or ten years or more. Our judgment is that relentlessly returning efficiency improvements and scale economies to customers in the form of lower prices creates a virtuous cycle that leads over the long term to a much larger dollar amount of free cash flow, and thereby to a much more valuable Amazon.com. We’ve made similar judgments around Free Super Saver Shipping and Amazon Prime, both of which are expensive in the short term and—we believe—important and valuable in the long term.

In particular, Jeff Bezos cited a paper called “The Structure of ‘Unstructured’ Decision Processes” published in 1976 by Henry Mintzberg, Duru Raisinghani, and Andre Theoret.

More, in particular, the paper highlighted how, when an institution made decisions, primarily based on data and math, that made them take efficient operating decisions.

Yet, as long-term, strategic, and “unstructured” (based on processes that have not been encountered in quite the same form and for which no predetermined and explicit set of ordered responses in the organization) decisions, might not rely on the quantitative understanding, will get underestimated.

That happens, because decisions that can be taken on a quantitative basis can be measured, thus institutions but also companies and managers in the field focus too much on measurable analyses.

Yet while those decisions might be good for the short-term. They might prevent an organization to focus on long-term, hard and strategic decisions.

Amazon, is a company that relied over and over again on quantitative analysis of things that could be measured, optimized, and maximized.

Also relied a lot on judgment, opinion, and human decision-making when it came to long-term, strategic decisions, that could not be based on previous experience or scenarios, but needed to be tackled.

This point is very important. In a world of management that focuses more and more on the quantifiable, and measurable. Getting data-driven might mean losing the strategic focus.

How did Jeff Bezos as manager and executive and Amazon as a company handle it?

You just need a simple framework, made of a few core principles for your strategic decisions, and you need to stick to them!

amazon-leadership-principles

Amazon fundamental principles that drove and drive the company are:

  • Customer Obsession
  • Ownership
  • Invent and Simplify
  • Are Right, A Lot
  • Learn and Be Curious
  • Hire and Develop the Best
  • Insist on the Highest Standards
  • Think Big
  • Bias for Action
  • Frugality
  • Earn Trust
  • Dive Deep
  • Have Backbone; Disagree and Commit
  • Deliver Results

Amazon laid out the foundation of its decision-making process, based on a few key principles, defined in 1997, in the first Shareholders letter:

  • We will continue to focus relentlessly on our customers.
customer-obsession
Customer obsession goes beyond quantitative and qualitative data about customers, and it moves around customers’ feedback to gather valuable insights. Those insights start by the entrepreneur’s wandering process, driven by hunch, gut, intuition, curiosity, and a builder mindset. The product discovery moves around a building, reworking, experimenting, and iterating loop.
  • We will continue to make investment decisions in light of long-term market leadership considerations rather than short-term profitability considerations or short-term Wall Street reactions.
  • We will continue to measure our programs and the effectiveness of our investments analytically, to jettison those that do not provide acceptable returns and to step up our investment in those that work best. We will continue to learn from both our successes and our failures.
  • We will make bold rather than timid investment decisions where we see a sufficient probability of gaining market leadership advantages. Some of these investments will pay off, others will not, and we will have learned another valuable lesson in either case.

Those bold decisions that made Amazon the company we know today were not based on quantitative analyses but rather on controversial human judgment.

The compass for Amazon was based on customer focus, long-term game, launching programs fast and killing them even faster, invest massively in areas where the company sees a sufficient probability of gaining market leadership

Key takeaway

Where managers and practitioners get bogged down by complex and quantitative analysis to make short-term decisions.

In reality, companies like Amazon did rely on those quantitative analyses to make short-term decisions to maximize their fulfillment centers, the shapes of their products, the shipping time, and so on.

However, a whole new set of strategic and unstructured decisions that could not rely on math and data (like the launch of Amazon Prime) were made based on human judgment.

To make these decisions, Amazon defined since the onset a clear framework, based on a few guiding principles.

If you want to make an impact on your organization you need to have that framework ready each time math and data can’t help you out!

Read Next: Amazon Business Model

Connected to Amazon Business Model

Amazon Business Model

amazon-business-model
Amazon has a diversified business model. In 2021 Amazon posted over $469 billion in revenues and over $33 billion in net profits. Online stores contributed to over 47% of Amazon revenues, Third-party Seller Services,  Amazon AWS, Subscription Services, Advertising revenues, and Physical Stores.

Amazon Mission Statement

amazon-vision-statement-mission-statement (1)
Amazon’s mission statement is to “serve consumers through online and physical stores and focus on selection, price, and convenience.” Amazon’s vision statement is “to be Earth’s most customer-centric company, where customers can find and discover anything they might want to buy online, and endeavors to offer its customers the lowest possible prices.” 

Customer Obsession

customer-obsession
In the Amazon Shareholders’ Letter for 2018, Jeff Bezos analyzed the Amazon business model, and it also focused on a few key lessons that Amazon as a company has learned over the years. These lessons are fundamental for any entrepreneur, of small or large organization to understand the pitfalls to avoid to run a successful company!

Amazon Revenues

amazon-revenue-model
Amazon has a business model with many moving parts. With the e-commerce platform which generated over $222 billion in 2021, followed by third-party stores services which generated over $103 billion, Amazon AWS, which generated over $62 billion, Amazon advertising which generated over $31 billion and Amazon Prime which also generated over $31 billion, and physical stores which generated over $17 billion.

Amazon Cash Conversion

cash-conversion-cycle-amazon

Working Backwards

working-backwards
The Amazon Working Backwards Method is a product development methodology that advocates building a product based on customer needs. The Amazon Working Backwards Method gained traction after notable Amazon employee Ian McAllister shared the company’s product development approach on Quora. McAllister noted that the method seeks “to work backwards from the customer, rather than starting with an idea for a product and trying to bolt customers onto it.”

Amazon Flywheel

amazon-flywheel
The Amazon Flywheel or Amazon Virtuous Cycle is a strategy that leverages on customer experience to drive traffic to the platform and third-party sellers. That improves the selections of goods, and Amazon further improves its cost structure so it can decrease prices which spins the flywheel.

Jeff Bezos Day One

jeff-bezos-day-1
In the letter to shareholders in 2016, Jeff Bezos addressed a topic he had been thinking quite profoundly in the last decades as he led Amazon: Day 1. As Jeff Bezos put it “Day 2 is stasis. Followed by irrelevance. Followed by excruciating, painful decline. Followed by death. And that is why it is always Day 1.”

Leave a Reply

Scroll to Top
FourWeekMBA