If the choice is between a questionable business at a comfortable price or a comfortable business at a questionable price, we much prefer the latter.

Source:   Berkshire Hathaway Shareholder Letters

At Berkshire, we make no attempt to pick the few winners that will emerge from an ocean of unproven enterprises. We’re not smart enough to do that, and we know it. Instead, we try to apply Aesop’s 2,600-year-old equation to opportunities in which we have reasonable confidence as to how many birds are in the bush and when they will emerge (a formulation that my grandsons would probably update to “A girl in a convertible is worth five in the phonebook.”). Obviously, we can never precisely predict the timing of cash flows in and out of a business or their exact amount. We try, therefore, to keep our estimates conservative and to focus on industries where business surprises are unlikely to wreak havoc on owners. Even so, we make many mistakes: I’m the fellow, remember, who thought he understood the future economics of trading stamps, textiles, shoes and second-tier department stores.

Source:   Berkshire Hathaway Shareholder Letters

Every day, in countless ways, the competitive position of each of our businesses grows either weaker or stronger. If we are delighting customers, eliminating unnecessary costs and improving our products and services, we gain strength. But if we treat customers with indifference or tolerate bloat, our businesses will wither. On a daily basis, the effects of our actions are imperceptible; cumulatively, though, their consequences are enormous.

Source:   Berkshire Hathaway Shareholder Letters

When our long-term competitive position improves as a result of these almost unnoticeable actions, we describe the phenomenon as “widening the moat.” And doing that is essential if we are to have the kind of business we want a decade or two from now. We always, of course, hope to earn more money in the short-term. But when short-term and long-term conflict, widening the moat must take precedence. If a management makes bad decisions in order to hit short-term earnings targets, and consequently gets behind the eight-ball in terms of costs, customer satisfaction or brand strength, no amount of subsequent brilliance will overcome the damage that has been inflicted. Take a look at the dilemmas of managers in the auto and airline industries today as they struggle with the huge problems handed them by their predecessors. Charlie is fond of quoting Ben Franklin’s “An ounce of prevention is worth a pound of cure.” But sometimes no amount of cure will overcome the mistakes of the past.

Source:   Berkshire Hathaway Shareholder Letters

Charlie began as a lawyer, and I thought of myself as a security analyst. Sitting in those seats, we both grew skeptical about the ability of big entities of any type to function well. Size seems to make many organizations slow-thinking, resistant to change and smug. In Churchill’s words: “We shape our buildings, and afterwards our buildings shape us.” Here’s a telling fact: Of the ten non-oil companies having the largest market capitalization in 1965 – titans such as General Motors, Sears, DuPont and Eastman Kodak – only one made the 2006 list.

Source:   Berkshire Hathaway Shareholder Letters

...this criterion [of an enduring moat] eliminates the business whose success depends on having a great manager. Of course, a terrific CEO is a huge asset for any enterprise, and at Berkshire we have an abundance of these managers. Their abilities have created billions of dollars of value that would never have materialized if typical CEOs had been running their businesses. But if a business requires a superstar to produce great results, the business itself cannot be deemed great. A medical partnership led by your area’s premier brain surgeon may enjoy outsized and growing earnings, but that tells little about its future. The partnership’s moat will go when the surgeon goes. You can count, though, on the moat of the Mayo Clinic to endure, even though you can’t name its CEO.

Source:   Berkshire Hathaway Shareholder Letters

Long-term competitive advantage in a stable industry is what we seek in a business. If that comes with rapid organic growth, great. But even without organic growth, such a business is rewarding. We will simply take the lush earnings of the business and use them to buy similar businesses elsewhere. There’s no rule that you have to invest money where you’ve earned it. Indeed, it’s often a mistake to do so: Truly great businesses, earning huge returns on tangible assets, can’t for any extended period reinvest a large portion of their earnings internally at high rates of return.

Source:   Berkshire Hathaway Shareholder Letters

There aren’t many See’s [Candies] in Corporate America. Typically, companies that increase their earnings from $5 million to $82 million require, say, $400 million or so of capital investment to finance their growth. That’s because growing businesses have both working capital needs that increase in proportion to sales growth and significant requirements for fixed asset investments. A company that needs large increases in capital to engender its growth may well prove to be a satisfactory investment. There is, to follow through on our example, nothing shabby about earning $82 million pre-tax on $400 million of net tangible assets. But that equation for the owner is vastly different from the See’s situation. It’s far better to have an ever-increasing stream of earnings with virtually no major capital requirements. Ask Microsoft or Google.

Source:   Berkshire Hathaway Shareholder Letters

The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers.

Source:   Berkshire Hathaway Shareholder Letters

To sum up [the discussion on Capex and Moat], think of three types of “savings accounts.” The great one pays an extraordinarily high interest rate that will rise as the years pass. The good one pays an attractive rate of interest that will be earned also on deposits that are added. Finally, the gruesome account both pays an inadequate interest rate and requires you to keep adding money at those disappointing returns.

Source:   Berkshire Hathaway Shareholder Letters

Charlie and I avoid businesses whose futures we can’t evaluate, no matter how exciting their products may be. Just because Charlie and I can clearly see dramatic growth ahead for an industry does not mean we can judge what its profit margins and returns on capital will be as a host of competitors battle for supremacy. At Berkshire we will stick with businesses whose profit picture for decades to come seems reasonably predictable. Even then, we will make plenty of mistakes.

Source:   Berkshire Hathaway Shareholder Letters

Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns.

Source:   Poor Charlie's Almanack

The great lesson in Microeconomics is to discriminate between when technology is going to help you and when it's going to kill you.

Source:   Poor Charlie's Almanack

…having started out as Grahamites - which, by the way, worked fine - we gradually got what I would call better insights. And we realized that some company that was selling at two or three times book value could still be hell or a bargain because of the momentums implicit in its position, sometimes combined with an unusual management skill plainly present in some individual or other, or some system or other.

Source:   Poor Charlie's Almanack

…averaged out, betting on the quality of a business is better than betting on the quality of management. In other words, if you have to choose one, bet on the business momentum, not the brilliance of the manager.

Source:   Poor Charlie's Almanack

...companies which decade by decade have consistently shown spectacular growth might be divided into two groups. For lack of better terms I will call one group those that happen to be both “fortunate and able” and the other group those that are “fortunate because they are able.” A high order of management ability is a must for both groups. No company grows for a long period of years just because it is lucky. It must have and continue to keep a high order of business skill, otherwise it will not be able to capitalize on its good fortune and to defend its competitive position from the inroads of others.

Source:   Common Stocks and Uncommon Profits

The investor usually obtains the best results in companies whose engineering or research is to a considerable extent devoted to products having some business relationship to those already within the scope of company activities. This does not mean that a desirable company may not have a number of divisions, some of which have product lines quite different from others. It does mean that a company with research centered around each of these divisions, like a cluster of trees each growing additional branches from its own trunk, will usually do much better than a company working on a number of unrelated new products which, if successful,will land it in several new industries unrelated to its existing business.

Source:   Common Stocks and Uncommon Profits

Fisher's Research Questions: POINT 5. Does the company have a worthwhile profit margin? POINT 6. What is the company doing to maintain or improve profit margins?

Source:   Common Stocks and Uncommon Profits

Fisher's Research Questions: POINT 12. Does the company have a short-range or long-range outlook in regard to profits?

Source:   Common Stocks and Uncommon Profits

Many companies seem to have an irresistible urge to show the greatest possible profits at the end of each accounting period— to bring every possible cent down to the bottom line. This a true growth-oriented company can never do. Its focus must be on earning sufficient current profits to finance the costs of expanding the business.

Source:   Common Stocks and Uncommon Profits

Fisher's Research Questions: “What can the particular company do that others would not be able to do about as well?”

Source:   Common Stocks and Uncommon Profits

[Buffett] defines a franchise as a company providing a product or service that is (1) needed or desired, (2) has no close substitute, and (3) is not regulated. These traits allow the company to hold its prices, and occasionally raise them, without the fear of losing market share or unit volume. This pricing flexibility is one of the defining characteristics of a great business; it allows the company to earn above-average returns on capital.

Source:   The Warren Buffett Way

If we make mistakes, [Buffett] points out, it is either because of (1) the price we paid, (2) the management we joined, or (3) the future economics of the business. Miscalculations in the third instance are, he notes, the most common.

Source:   The Warren Buffett Way

“If my universe of business possibilities was limited, say, to private companies in Omaha, I would, first, try to assess the long-term economic characteristics of each business,” says Buffett. “Second, assess the quality of the people in charge of running it; and third, try to buy into a few of the best operations at a sensible price. I certainly would not wish to own an equal part of every business in town. Why, then, should Berkshire take a different tack when dealing with the larger universe of public companies? And since finding great businesses and outstanding managers is so difficult, why should we discard proven products? Our motto is: If at first you do succeed, quit trying.”

Source:   The Warren Buffett Way

Innovation is not sustainable, merely renewable.

Source:   Renewable Competitive Advantage

You seek and gain advantage. Value flows for a time. But then that advantage is lost and must be renewed again. Even managers in the most powerful companies find that success is temporary. Obsolescence is inevitable. Nothing lasts forever.

Source:   Renewable Competitive Advantage

Renewal advantage is not based on endowments, handed down from outside, over which you have little control. Neither is it based on luck, outcomes you did not create, don’t control, or do not understand. Renewal is not a crapshoot. Nor is it a game of narrow-mindedly extending past behavior forward. For successful companies – the management of guided obsolescence through economic time – matters a lot.

Source:   Renewable Competitive Advantage

Convergence thinking encourages – actually forces – us to move away from implicit notions that advantage is sustainable unless it is lost, and toward the transforming assumption that advantage will be lost unless it is renewed. Once managers become comfortable with the idea, that through convergence, all advantage in temporary, they ask the questions of themselves and their companies that take on a greater responsibility for creating the future. By making the reality of convergence central at the onset, leadership becomes focused on reformation and rebirth.

Source:   Renewable Competitive Advantage

Investors operate by the same laws as do managers. For investors, the laws of convergence, alignment, and renewal show up through a concern for the speed and duration of cash flows. In this way, the question for investors is the same as for managers: “Where is the business in economic time?” And, “Where is the business heading in economic time?” Several techniques can align managers with investors in crafting strategy.

Source:   Renewable Competitive Advantage

In terms of theory, slow-cycle markets are a grouping of different types of mostly “natural” monopolistic advantages. Standard-cycle markets map most closely onto oligopolistic rivalry, or “life with the four-hundred-pound gorillas”. Fast-cycle markets can be thought of as most like Schrumpeterian competition, “the chase after the innovator”. So in this sense economic time is a simple organizing device with which to compare a range of possible renewal opportunities and to know whether they are changing.

Source:   Renewable Competitive Advantage

The growth engine of every company has distinguishing competitive mechanics, its own dynamic signature that gives clues as to how value for it is created, destroyed, and potentially renewed. The reality is that customers don’t come first – neither do companies. Each gains its meaning from its relationship with the other. Through Economic Time we see the dynamic forces rooted in these processes of value creation: how managers perceive environmental threats, learn and meet customer needs, and react to one another.

Source:   Renewable Competitive Advantage

Slow Cycle Economic Time: The key to renewal [of competitive advantage] lies in gaining advantage that is proprietary, slowly changing, and essential to the functioning of a market. As a unique point of supply and demand, slow cycle renewal efforts more or less automatically resist competitors’ attempts to duplicate them. Product advantage is secured within the company and confined to it. Competitors cannot effectively gain a foothold with the company’s customers, even where they find the company’s advantage attractive.

Source:   Renewable Competitive Advantage

Standard-Cycle Economic Time: Companies in this second renewal class are found midway on the spectrum of Economic Time. They are typically mass-market companies, market-share oriented, and process focused. What distinguishes their success is their ability to replicate the same usage experience for customers with no surprises. Standard-cycle management styles are a descendant of traditional business thinking.

Source:   Renewable Competitive Advantage

Standard-cycle companies are oriented toward serving large numbers of customers in competitive markets. Demand patterns are repetitive and relatively stable. Still, economic time moves faster for these companies because their capabilities are less specialized. Competitors have greater ability and incentive to duplicate them, improve upon them, or render them obsolete. In this way their isolating mechanisms as less powerful than those in slower-cycle time.

Source:   Renewable Competitive Advantage

We came to describe the management style needed to renew standard-cycle companies as one Scale Orchestration.

Source:   Renewable Competitive Advantage

[Fast-cycle markets]: With the forces of value creation and destruction operating at high speed, the pursuit of advantage takes place in its fastest, most unrestrained form. This is why managers find their journey in the fastest cycle markets to be marked by a continuous gale of creative destruction, as the economist Joseph Schumpeter emphasized.

Source:   Renewable Competitive Advantage

In terms of theory, slow-cycle markets are a grouping of different types of mostly “natural” monopolistic advantages. Standard-cycle markets map most closely onto oligopolistic rivalry, or “life with the four-hundred-pound gorillas”. Fast-cycle markets can be thought of as most like Schrumpeterian competition, “the chase after the innovator”. So in this sense economic time is a simple organizing device with which to compare a range of possible renewal opportunities and to know whether they are changing.

Source:   Renewable Competitive Advantage

…over the past twenty-five years managers have operated by a difference way of thinking: the idea that advantage, once achieved, is inherently sustainable. As success is gained, advantage is long-lived unless managers make mistakes. We refer to this collection of ideas as the traditional view of business. Many of us were taught that the drivers of success have more of less the same mechanics; achieve and maintain market share through economies of scale. Extended rivalry, as it is termed, has indeed played an essential role in business. Examples include the rivalry between General Motors and Ford in the 1970s, or Coke and Pepsi in the 1980s, to name but two.

Source:   Renewable Competitive Advantage

Traditional thinking reflects insufficient attention to what Joseph Schrumpeter emphasized and what today’s business leaders know. Change is central to economic progress. The progression of species, their life, death, and renewal, gives meaning to their existence. The old must be cleared away to create opportunities for the next generation. The evolutionary ecology of business, the competitive, dynamic interdependence of your organization and your customers, can be difficult to account for in traditional thinking.

Source:   Renewable Competitive Advantage

A step in preserving the best of the past while moving toward the future is to think in terms of the laws of competitive evolution. In our studies of economic time we came to see the three laws at work. We termed them convergence, alignment, and renewal.

Source:   Renewable Competitive Advantage

You can slow down convergence through isolating mechanisms but you cannot stop it. Convergence formalizes the idea of economic time that nothing lasts forever.

Source:   Renewable Competitive Advantage

The second law of [competitive evolution] is the principle of alignment. This is the idea that the capabilities of your company and the needs of your customers are dependent on one another. Companies and customers each gain meaning from the requests placed on them by the other. Your company and your customers need one another, are defined by one another, and exist for one another.

Source:   Renewable Competitive Advantage

Ask yourself: Do you think of your advantage as merely sustainable-or as dynamically renewable?

Source:   Renewable Competitive Advantage

Traditionally there have been two primary ways to position products in markets dominated by economies of scale: through cost leadership or through differentiation. As Michael Porter has shown, cost leaders win through the ability to sell at lower prices, while differentiated producers gain from selling higher-priced products that customers perceive have additional value. It can be difficult to excel at cost leadership and differentiation at the same time where two efforts require opposing types of investments. Yet in the dynamic sense, many of the benefits of scale orchestration come when cost leadership and differentiation are combined, a process that we see as differentiated cost leadership.

Source:   Renewable Competitive Advantage

It is straightforward to imagine that lowering the cost or raising the price of products is good. What is more useful is to know how some combinations of these two investments will generate greater profits than others.

Source:   Renewable Competitive Advantage

Related to differentiated cost leadership is what can be thought of as renewable scale, the amount of volume that a market segment will absorb any combination of price and cost. To estimate renewable scale, compare the actual volume likely to be sold in a market with the minimum volume necessary to break even. Where market demand is sufficient to satisfy the investment needs of only one company, that segment of the differentiated cost leadership map will be focused.

Source:   Renewable Competitive Advantage

When markets are focused, renewable scale is too low to make it profitable for large companies to enter and compete for the business in that segment. Thus convergence does not occur. Still scale is high enough for a smaller, focused company to survive.

Source:   Renewable Competitive Advantage

Managing standard-cycle companies is a task analogous to commanding large battleships. It takes a long time to gain momentum and direction. Once established, momentum continues in the same direction unless altered through strong leadership or the actions of competitors. Changes in direction that are desired two or three years from now should be carefully thought through and initiated early on.

Source:   Renewable Competitive Advantage

[In Fast-Cycle markets] Value is idea-driven. Profit cycles are short. There is little that slows down the copying process or retards the fast commercialization of attractive alternatives. Complimentary assets are weak. Isolating mechanisms like scale orchestration, as well as geography, patents, and close customer relationships are rare. Fast-cycle markets and the products sold in them are based on freestanding, portable ideas. Value is high upon introduction but erodes quickly as ideas become commonplace.

Source:   Renewable Competitive Advantage

To borrow a phrase from a Hollywood movie: in fast-cycle markets there are two kinds of companies – The Quick and The Dead.

Source:   Renewable Competitive Advantage

Worldwide, wealthy, educated customers are predisposed to try out new products with little delay. Global capitalism generates ever-rising amounts of capital for investment. Technology can be employed to build or to copy any number of configurations of products, quickly and efficiently. Global communications have transformed international markets into an electronic village where distance no longer matters. Imagine a marketplace where thousands of idea-driven, well-financed companies have quick access to millions of customers who, as they say, “have so much money that they don’t know what to do with it”. These are the building blocks of fast-cycle markets.

Source:   Renewable Competitive Advantage

Fast-cycle products generally share the following characteristics: a) They are freestanding and idea-based. b) They can be copied or improved upon quickly. c) They experience supernormal productivity gains. d) They see economies of scale for a brief period only. e) they originate from uncontrolled innovation. f) They are culturally neutral and innately global, with few physical, regulatory, or geographic barriers.

Source:   Renewable Competitive Advantage

Fast-Cycle markets are unencumbered. Products are idea-driven, technology-or-information-based, valued in their purest forms , unconnected to isolating mechanisms. Knowledge-based advantage is slippery, easily dispersed and copied. Momentum is low, but velocity – the speed at which revenues rise and fall – is high. Thus, fast-cycle innovators can be pushed off their renewal pathways by fast followers in little time.

Source:   Renewable Competitive Advantage

As prices fall, they open up unfamiliar markets with new competitors. Alignment between the company and its customers changes. The focus of competition passes from early adopters, who are predisposed to pay high prices, to fast followers who are price sensitive, and finally late adopters who see the product as a low-priced commodity.

Source:   Renewable Competitive Advantage

The goal of brand awareness in fast-cycle markets in not to encourage repeat business; the goals is to expand the amount of product that can be sold before price erosion sets in. Brand awareness, rather than creating a defensible barrier to entry, sets the stage for competitive entry.

Source:   Renewable Competitive Advantage

Successful fast-cycle companies sustain renewal by adopting, even embracing, creative destruction as their central, ongoing way of doing business. Fast-cycle companies commercialize ideas, transfer resources to ever-newer products, and eat their children faster than their competitors do. It’s that simple and that difficult. Successful fast-cycle companies are high powered engines of creative destruction.

Source:   Renewable Competitive Advantage

Slow-cycle advantages are highly attractive from a strategic standpoint. Products and services operating in slow-cycle markets are shielded from traditional competitive pressures: a) They enjoy stable pricing b) they face few cost-reduction demands c) They experience long-lived profit cycles and d) they survive late delivery, poor quality, and even catastrophic failures.

Source:   Renewable Competitive Advantage

Slow-cycle products naturally dominate their markets. They define their market. They own their market. They are their market. A slow-cycle company operates within a strategic group of one: itself. Market ownership is localized to a factor of the market that the company owns exclusively…Is this monopolistic competition? Of course it is. But these monopolistic advantages can be created legally. As we will see, there can be a complex interpretation of monopoly power in slow-cycle markets. But by and large, slow-cycle advantages are earned the old-fashioned way: through hard work, smart decisions, careful investment, and foresight into new market opportunities.

Source:   Renewable Competitive Advantage

[Types of monopolies that characterize a slow-cycle market]: a) The human capital monopoly b) The bilateral monopoly c) Location, brand, or standards ownership d) patents and copyrights.

Source:   Renewable Competitive Advantage

In standard-cycle markets customers see a final product, a car for example, but not the automobile assembly line. In these slow-cycle markets the unit of production is the relationship with the customer. Thus, the traditional distinction between product and process, and the ability to conquer each, breaks down. Tightly coupled product/process relationships create strong isolating mechanisms, raising barriers to would-be competitors.

Source:   Renewable Competitive Advantage

Winner-take-all markets can experience a form of dynamic lock-in that we term tipping. Tipping is the tendency of a slow-cycle market to tilt all the way towards the adoption of a single product or service. Another expression of the winner-take-all nature of these markets, tipping is encouraged when a market is aided by the emergence of a common factor, such as gate control in airlines or common computer operating system. When tipping occurs, a competitor either wins the bulk of the customers or loses them to the winning company. Tipping, or tilting as it is called by economic theorist Brian Arthur, is an important new branch of economics based on the idea of continually increasing returns.

Source:   Renewable Competitive Advantage

If you continuously evolve your product designs along with changing customer needs and continuously improve your processes, and drive continuous learning throughout your organization – and orchestrate these activities among one another – then you can achieve economies of scale.

Source:   Renewable Competitive Advantage

With a focus on flawless execution, how much opportunity is there in scale orchestra for innovation? Let’s return to our physical metaphor. In a real symphony orchestra, new music is carefully chosen and coordinated with the overall repertoire. New Performers are introduced selectively.

Source:   Renewable Competitive Advantage

Convergence is continually at work on standard-cycle companies. Profits fall when any combination of poorly thought out, poorly executed investments or superior competitor moves forces products [to be neither a cost leader nor a product differentiator]. We think of this as competitive Hell, where your rate of return falls below your cost of capital. One manager remarked that this region is more like Purgatory, where you may have another chance to work out your sins before the Final Judgement.

Source:   Renewable Competitive Advantage

Convergence: [About] thirty percent of typical company’s value is set by where its products are located on the convergence curve. For a multiproduct company, the aggregate location of all of its products on the convergence curve shows up as total current profits. Significant also is the speed at which a company’s markets are becoming more competitive. This shows up as the rate of movement of products along the convergence curve toward zero profits. While the rate of movement along the convergence curve will not affect current profits, rate of movement affects sustainability of profits.

Source:   Renewable Competitive Advantage

Renewal: [About] Seventy percent of a company’s value is determined by efforts in place to refresh ageing products. The company’s price/earnings ratio is a measure of this: the degree to which current earnings are multiplied by the expectations that earnings can be sustained and improved.

Source:   Renewable Competitive Advantage

In the long term, the process of building new relationships with new customers can take years. Part of the reason is that customers may not know what they want until a company supplies it and starts the parallel customer/company learning experience learning experience discussed earlier. In this way, companies create demand.

Source:   Renewable Competitive Advantage

Where your isolating mechanisms are weak, economic time moves fast, so strategies can be imitated quickly. This is another reason why strategy in fast-cycle markets needs to be quick and adaptive. Where isolating power is strong, and economic time moves slowly, strategies will be more difficult to imitate. In this way the speed at which a strategy can be copied mirrors underlying capabilities and the economic cycle time of a market. Or put simply: think about the half-life of your strategy. It’s part of the calculus of economic time.

Source:   Renewable Competitive Advantage

…in determining the extent to which a capability is renewable, it can be helpful to distinguish how capabilities arise. Generally, capabilities can arise from any of the three sources: skills (hard work and investments), endowments (something that is handed to you), or good fortune (luck). While each of these sources can be a source of renewal, the leverage associated with each and renewal opportunities that they present for managers are different.

Source:   Renewable Competitive Advantage

The length of an organization’s renewal cycle, the amount of time required to recapitalize itself, is influenced by where the organization operates in economic time. This is because economic time provides a guide to the amount of time over which the market alignment is likely to remain viable. To the degree that a company’s environment is changing, or is transforming in economic time, the renewal cycle must keep pace. When an organization’s renewal cycle falls behind the speed of realignment, the rate of capitalization of the company will fall. This is just another way of saying that the company’s capabilities are ageing faster than they need to be renewed.

Source:   Renewable Competitive Advantage

The relative predictability of cash flows of a slow-cycle company should be attractive to creditors. Management can use predictability to bolster arguments for proposing low-risk payout schedules for creditors. A lower level of debt for the company may be possible, in service of relatively high-confidence forecasts of sources of cash flows.

Source:   Renewable Competitive Advantage

A question we hear from managers working across economic time is: “Which economic time zone is better?” Long product cycles, while they appear attractive, are not necessarily better than short product cycles in this regard. This is because the total amount of cash flows and the speed at which they are received represent a tradeoff between the stability associated with longer profit cycles and the speed of payback associated with longer profit cycles. Thus economic time cycles create opportunities – but the speed and means by which cash flows from different economic time cycles create value are highly differentiating.

Source:   Renewable Competitive Advantage

In slow-cycle settings, cash flows can behave like annuities. Slow-cycle company products have stable, relatively certain payback periods. Then, as products are positioned further up in economic time, the velocity and uncertainty of cash flows associated with them increase. Similarly, investments in R&D, manufacturing, inventory, and marketing depreciate faster. The expected return from projects becomes less certain.

Source:   Renewable Competitive Advantage

What is the historical relationship of your products to volume? How is competitive advantage strengthened by scale, or made stronger by an ever-increasing volume of product produced within the same fixed cost structure? As technological change becomes more rapid, fixed-cost investments age faster economically. The result is that the amount of time over which scale economies can be sustained is shortened. This reduces the importance of scale economies in the industry overall.

Source:   Renewable Competitive Advantage

A productivity measurement related to scale economies is the expected per-unit cost reduction to be had by doubling volume. Shifts in technology can upset historical experience curve relationships, causing productivity gains to increase. Often this increase is passed along to customers in the form of lower prices and faster product introductions. Thus it can be helpful to monitor an industry’s price dynamics for clues to changes in the productivity of competitors. More generally, as productivity gains increase, economic time moves faster, as seen in the semiconductor industry.

Source:   Renewable Competitive Advantage

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.

Source:   Amazon Shareholder Letters

Industry growth and new customer adoption will be driven over the coming years by relentless improvements in the customer experience of online shopping. These improvements in customer experience will be driven by innovations made possible by dramatic increases in available bandwidth, disk space, and processing power, all of which are getting cheap fast. Price performance of processing power is doubling about every 18 months (Moore’s Law), price performance of disk space is doubling about every 12 months, and price performance of bandwidth is doubling about every 9 months. Given that last doubling rate, Amazon.com will be able to use 60 times as much bandwidth per customer 5 years from now while holding our bandwidth cost per customer constant. Similarly, price performance improvements in disk space and processing power will allow us to, for example, do ever more and better real-time personalization of our Web site.

Source:   Amazon Shareholder Letters

One of our most exciting peculiarities is poorly understood. People see that we’re determined to offer both world-leading customer experience and the lowest possible prices, but to some this dual goal seems paradoxical if not downright quixotic. Traditional stores face a time-tested tradeoff between offering high-touch customer experience on the one hand and the lowest possible prices on the other. How can Amazon.com be trying to do both? The answer is that we transform much of customer experience—such as unmatched selection, extensive product information, personalized recommendations, and other new software features—into largely a fixed expense. With customer experience costs largely fixed (more like a publishing model than a retailing model), our costs as a percentage of sales can shrink rapidly as we grow our business. Moreover, customer experience costs that remain variable—such as the variable portion of fulfillment costs—improve in our model as we reduce defects. Eliminating defects improves costs and leads to better customer experience.

Source:   Amazon Shareholder Letters

In this turbulent global economy [2008-09], our fundamental approach remains the same. Stay heads down, focused on the long term and obsessed over customers. Long-term thinking levers our existing abilities and lets us do new things we couldn’t otherwise contemplate. It supports the failure and iteration required for invention, and it frees us to pioneer in unexplored spaces. Seek instant gratification – or the elusive promise of it – and chances are you’ll find a crowd there ahead of you. Long-term orientation interacts well with customer obsession. If we can identify a customer need and if we can further develop conviction that that need is meaningful and durable, our approach permits us to work patiently for multiple years to deliver a solution. “Working backwards” from customer needs can be contrasted with a “skills-forward” approach where existing skills and competencies are used to drive business opportunities. The skills-forward approach says, “We are really good at X. What else can we do with X?” That’s a useful and rewarding business approach. However, if used exclusively, the company employing it will never be driven to develop fresh skills. Eventually the existing skills will become outmoded. Working backwards from customer needs often demands that we acquire new competencies and exercise new muscles, never mind how uncomfortable and awkward-feeling those first steps might be.

Source:   Amazon Shareholder Letters

A review of our current goals reveals some interesting statistics: 1) 360 of the 452 goals will have a direct impact on customer experience. 2) The word revenue is used eight times and free cash flow is used only four times. 3)  In the 452 goals, the terms net income, gross profit or margin, and operating profit are not used once. Taken as a whole, the set of goals is indicative of our fundamental approach. Start with customers, and work backwards. Listen to customers, but don’t just listen to customers – also invent on their behalf. We can’t assure you that we’ll meet all of this year’s goals. We haven’t in past years. However, we can assure you that we’ll continue to obsess over customers. We have strong conviction that that approach – in the long term – is every bit as good for owners as it is for customers.

Source:   Amazon Shareholder Letters

State management is the heart of any system that needs to grow to very large size. Many years ago, Amazon’s requirements reached a point where many of our systems could no longer be served by any commercial solution: our key data services store many petabytes of data and handle millions of requests per second. To meet these demanding and unusual requirements, we’ve developed several alternative, purpose-built persistence solutions, including our own key value store and single table store. To do so, we’ve leaned heavily on the core principles from the distributed systems and database research communities and invented from there. The storage systems we’ve pioneered demonstrate extreme scalability while maintaining tight control over performance, availability, and cost. To achieve their ultra-scale properties these systems take a novel approach to data update management: by relaxing the synchronization requirements of updates that need to be disseminated to large numbers of replicas, these systems are able to survive under the harshest performance and availability conditions. These implementations are based on the concept of eventual consistency. The advances in data management developed by Amazon engineers have been the starting point for the architectures underneath the cloud storage and data management services offered by Amazon Web Services (AWS). For example, our Simple Storage Service, Elastic Block Store, and SimpleDB all derive their basic architecture from unique Amazon technologies.

Source:   Amazon Shareholder Letters

We live in an era of extraordinary increases in available bandwidth, disk space, and processing power, all of which continue to get cheap fast. We have on our team some of the most sophisticated technologists in the world – helping to solve challenges that are right on the edge of what’s possible today. As I’ve discussed many times before, we have unshakeable conviction that the long-term interests of shareowners are perfectly aligned with the interests of customers.

Source:   Amazon Shareholder Letters

Invention comes in many forms and at many scales. The most radical and transformative of inventions are often those that empower others to unleash their creativity – to pursue their dreams. That’s a big part of what’s going on with Amazon Web Services, Fulfillment by Amazon, and Kindle Direct Publishing. With AWS, FBA, and KDP, we are creating powerful self-service platforms that allow thousands of people to boldly experiment and accomplish things that would otherwise be impossible or impractical. These innovative, large-scale platforms are  not zero-sum – they create win-win situations and create significant value for developers, entrepreneurs, customers, authors, and readers

Source:   Amazon Shareholder Letters

A dreamy business offering has at least four characteristics. Customers love it, it can grow to very large size, it has strong returns on capital, and it’s durable in time – with the potential to endure for decades. When you find one of these, don’t just swipe right, get married. Well, I’m pleased to report that Amazon hasn’t been monogamous in this regard. After two decades of risk taking and teamwork, and with generous helpings of good fortune all along the way, we are now happily wed to what I believe are three such life partners: Marketplace, Prime, and AWS. Each of these offerings was a bold bet at first, and sensible people worried (often!) that they could not work. But at this point, it’s become pretty clear how special they are and how lucky we are to have them. It’s also clear that there are no sinecures in business. We know it’s our job to always nourish and fortify them.

Source:   Amazon Shareholder Letters

“Jeff, what does Day 2 look like?” That’s a question I just got at our most recent all-hands meeting. I’ve been reminding people that it’s Day 1 for a couple of decades. I work in an Amazon building named Day 1, and when I moved buildings, I took the name with me. I spend time thinking about this topic. “Day 2 is stasis. Followed by irrelevance. Followed by excruciating, painful decline. Followed by death. And that is why it is always Day 1.” To be sure, this kind of decline would happen in extreme slow motion. An established company might harvest Day 2 for decades, but the final result would still come. I’m interested in the question, how do you fend off Day 2? What are the techniques and tactics? How do you keep the vitality of Day 1, even inside a large organization? Such a question can’t have a simple answer. There will be many elements, multiple paths, and many traps. I don’t know the whole answer, but I may know bits of it. Here’s a starter pack of essentials for Day 1 defense: customer obsession, a skeptical view of proxies, the eager adoption of external trends, and high-velocity decision making.

Source:   Amazon Shareholder Letters

As companies get larger and more complex, there’s a tendency to manage to proxies. This comes in many shapes and sizes, and it’s dangerous, subtle, and very Day 2. A common example is process as proxy. Good process serves you so you can serve customers. But if you’re not watchful, the process can become the thing. This can happen very easily in large organizations. The process becomes the proxy for the result you want. You stop looking at outcomes and just make sure you’re doing the process right. Gulp. It’s not that rare to hear a junior leader defend a bad outcome with something like, “Well, we followed the process.” A more experienced leader will use it as an opportunity to investigate and improve the process. The process is not the thing. It’s always worth asking, do we own the process or does the process own us? In a Day 2 company, you might find it’s the second.

Source:   Amazon Shareholder Letters

The most direct consequence of more rapid business evolution is that the time an average company can sustain a competitive advantage—that is, generate an economic return in excess of its cost of capital—is shorter than it was in the past. This trend has potentially important implications for investors in areas such as valuation, portfolio turnover, and diversification.

Source:   More Than You Know