Death of a Flywheel

Amazon and Berkshire Hathaway are in the midst of an identical, potentially fatal crisis: They are simply too successful. 

Buying Amazon stock is a bet on overworked managers screaming at their employees about customer obsession. Buying Berkshire Hathaway stock is a bet on an old geezer who likes peanut brittle. It is new America, one of silicon and servers, versus old America, a nation of steel and Coke syrup. 

The two companies pursue wholly different capital allocation strategies. Amazon is constantly running hundreds of experiments at once. Berkshire mostly does highly concentrated buyouts or public equity purchases.  

Amazon is the 5th most valuable company in the world at $1.069T valuation, and Berkshire Hathaway is the 6th most valuable at $717B. They are also revenue giants, with Amazon pulling in $513B and Berkshire doing $234B in 2022. At this valuation and revenue size, there are very, very few opportunities available to meaningfully grow the business. 

While it’s a wonderful problem to have, it is a crisis nonetheless. Amazon has flailed into all sorts of large capital expenditures from movie studios (an $8.5B purchase of MGM) to internet satellites ($10B in expected capital spend) to healthcare (a $3.9B purchase of OneMedical). Berkshire Hathaway’s big move this year was getting majority ownership in a gas station chain ($11B, Pilot). 

While the scale is unprecedented, this is something all companies face at some point in their existence. I call it the scaled out problem: growth plateaus for a particular business line as the marginal cost to acquire additional customers outstrips their lifetime value. Companies have to diversify their markets and/or product mix. If they don’t, they embrace a slow death by decay. 

This conundrum can manifest on the scale of yeeting $10B dollars into satellites, or it can be as simple as a local diner adding a new menu item. However, by examining this problem in its most scaled, most extreme version (i.e., Amazon and Berkshire Hathaway), there are truths about investing and operating to be teased out that apply to everyone. 

I think 99% of strategy advice is terrible. Having founders follow the latest Harvard Business School theory is like telling someone with a bipolar disorder to heal themselves by reading fortune cookies. Sure, there is nice stuff contained therein, but it is so generic that it is essentially useless. Every person and every business is unique—decisions have to be made in context. The goal for today is to help founders and investors make more informed choices, not give a recipe for success. 

Amazon’s flywheel(s)

Amazon’s flywheel is this: The bigger Amazon gets, the more consumers and suppliers they have, which means they can get ever lower prices and ever better selection. 

Amazon’s target market is all consumer retail spending, a $8T+ annual category in the U.S. alone. While it started with books, the vision was always to be “the everything store.” The initial expansion was incredibly simple. They went from books to other forms of media to kid’s toys—products that were pretty similar to one another. At the beating heart of this is Amazon’s flywheel: 

However, as it expanded to more and more categories, Amazon found that not all consumer packaged goods are created equal. I had a conversation with a strategy lead at Walmart about e-commerce category expansion eight years ago, and he spent an hour complaining about “toilet paper and its shitty economics.” TP is bulky, consumers are sensitive about the price, and they are relatively cheap. Getting the last mile delivery profitable was near impossible for Walmart at the time. There are dozens, if not hundreds, of problems like this in the path to becoming the everything store: goods that at first glance look good, but end up being far less profitable then the initial customer/product fit of something such as books. Expansion means additional dollars of revenue become harder and harder to acquire. 

Think of it this way: A company is powered by a flywheel, but the longer that flywheel spins, the less efficient the motion. Eventually the sand gets in the gears, and each additional unit of speed is harder to gain, and you have to add new flywheels to get the machine moving again.