Amazon Web Services

[0] People, turns out, love the Amazon .com episode.

[1] That was so awesome.

[2] Makes me a little nervous for this one.

[3] Oh, massively.

[4] By far and away, our biggest episode ever.

[5] Is this how George Lucas felt when he was doing Empire Strikes Back?

[6] You did not just compare us to George Lucas, did you?

[7] I swear we're humble.

[8] All right, let's do this.

[9] Who got the truth?

[10] Is it you?

[11] Is it you?

[12] Is it you?

[13] Who got the truth?

[14] Welcome to Season 11, Episode 3 of Acquired, the podcast about great technology companies and the stories and playbooks behind them.

[15] I'm Ben Gilbert, and I am the co -founder and managing director of Seattle -based Pioneer Square Labs and our venture fund, PSL Ventures.

[16] And I'm David Rosenthal, and I am an angel investor based in San Francisco.

[17] Cold San Francisco here in August.

[18] And we are your hosts.

[19] All right, David, let's say you run a lemonade stand.

[20] You sell me the highest quality lemonade you can for the lowest price, $1 a cup.

[21] And when you add up all your costs, the variable ones like the lemons and the fixed ones like the table that you rented, it costs about $0 .98 .5 cents to give me that lemonade.

[22] And you're happy your turn to profit, I'm sure.

[23] But man, you are going to have to sell a lot of lemonade.

[24] So you're telling me I'm Amazon .com.

[25] in the fourth quarter of 2001, which is actually where we're going to start our story.

[26] Perhaps.

[27] But you discover something interesting.

[28] By making all this lemonade, you get really good at the stuff it takes to run a lemonade business, the perfect cups and ice and lemons, everything.

[29] And it turns out, all that stuff that you just got good at, you can sell to other businesses.

[30] And guess what?

[31] You realize further that when you sell your services to other companies, when you charge them a dollar, it only costs you 70 cents to make it.

[32] So 30 % margins instead of something like a percent and a half, you're going to have to sell a lot less of those services than you ever did on Lemonade to make the same amount of money.

[33] Well, then if you told me that, I would dig into it even further and I would realize that the existing companies that sold stands and cups and whatnot, they were actually making 70 % margins.

[34] their stands and cups.

[35] And so I would be quite happy to take 30 % margins and disrupt them and still do better than my lemonade business.

[36] Well, listeners, of course, on our last episode, we talked about Amazon's retail business.

[37] And today we are talking about Amazon Web Services, the cloud computing pioneer.

[38] And those margin percentages that I just used are the real ones for the retail business and for AWS.

[39] AWS's revenue is only about 15 % the size of Amazon's massive retail business, but their profits, or the operating income, to be specific, from AWS are in total the same, if not more than their e -commerce store.

[40] I think it's the case that every year since 2015 when they started breaking out AWS's financials, the total operating income from AWS has actually been bigger than the retail business.

[41] There may have been some quarters where it was off, but generally that trend is accurate.

[42] wild.

[43] So we're going to talk about a completely different type of business today than we talked about last time.

[44] Sort of.

[45] There's a lot of similarities and a lot more than you would sort of guess when looking at an online retailer that started as an online bookstore and a cloud computing pioneer.

[46] Well, speaking of e -commerce, we have huge news.

[47] You can finally, finally buy Acquired merch on the internet.

[48] That is available at Acquired .fm slash store or click the link in the show notes.

[49] You can grab your favorite tea, crewneck, hoodie, tank, or even a onesie, since I know a lot of you out there are like David and have little ones at home.

[50] Okay, listeners, now is a great time to thank one of our big partners here at Acquired, ServiceNow.

[51] Yes, ServiceNow is the AI platform for business transformation, helping automate processes, improve service delivery, and increase efficiency.

[52] 85 % of the Fortune 500 runs on them, and they have quickly joined the Microsoft's at the invidias as one of the most important enterprise technology vendors in the world.

[53] And just like them, ServiceNow has AI baked in everywhere in their platform.

[54] They are also a major partner of both Microsoft and Nvidia.

[55] I was at Nvidia's GTC earlier this year and Jensen brought up ServiceNow and their partnership many times throughout the keynote.

[56] So why is Service Now so important to both Nvidia and Microsoft companies we've explored deeply in the last year on the show?

[57] Well, AI in the real world is only as good as the bedrock platform it's built into.

[58] So whether you're looking for AI to supercharge developers and IT, empower and streamline customer service, or enable HR to deliver better employee experiences, service now is the platform that can make it possible.

[59] Interestingly, employees can not only get answers to their questions, but they're offered actions that they can take immediately.

[60] For example, smarter self -service for changing 401k contributions directly through AI -powered chat.

[61] or developers building apps faster with AI -powered code generation, or service agents that can use AI to notify you of a product that needs replacement before people even chat with you.

[62] With ServiceNow's platform, your business can put AI to work today.

[63] It's pretty incredible that ServiceNow built AI directly into their platform, so all the integration work to prepare for it that otherwise would have taken you years is already done.

[64] So if you want to learn more about the ServiceNow platform and how it can turbocharge the time to deploy AI for your business, go over to servicenow .com slash acquired, and when you get in touch, just tell them Ben and David sent you.

[65] Thanks, ServiceNow.

[66] After you finish this episode, come discuss it with David and I, and 13 ,000 other smart members of the Acquired community at Acquired .fm slash Slack.

[67] And if you're dying for more required in the meantime, go check out the LP show by searching Acquired LP in any podcast player.

[68] The next episode is with David's partner.

[69] in crime and kindergarten ventures, Nat Manning, talking about his company Kettle and how the business of reinsurance works.

[70] That, of course, is already live if you are a paying LP, which you can become at Acquired .fm slash LP.

[71] Now, without further ado, David, take us in.

[72] And listeners, as always, this show is not investment advice.

[73] David and I may certainly do have investments in the companies we discuss.

[74] And the show is for informational and entertainment purposes only.

[75] Well, we left off the Amazon .com episode in 2007 with the sort of Sony PlayStation -like CODA of the Kindle story and the new chapter, one might say that it seemed at the time to the outside world that Amazon was opening as a true technology company with the Kindle.

[76] I believe the quote from Eric Schmidt in the Everything store was, the book guys finally got technology.

[77] And of course, as we talked about, Jeff Bezos always got technology.

[78] This was not a shift.

[79] And in particular, this was not anything new because of everything we are going to talk about on this whole separate episode today.

[80] So to do that, we need to rewind back, as I said above, to the end of 2001, kind of early 2002, the immediate post .com bubble popping crash era.

[81] And Bezos and Amazon, as hard as it is now to remember, he was like an embattled CEO at this point.

[82] It had just gotten rid of C .O. Joe Gali, the board has brought in Coach Campbell.

[83] Amazon's fighting for its life against both eBay and Wall Street.

[84] Isn't it insane to think that the board was sort of in the place with Jeff Bezos thinking, we really need some adult supervision to be a scale CEO and help this guy out.

[85] Frigin Jeff Bezos, obviously that did not pan out, and Bezos came valiantly riding back in and ran the business for another 20 years.

[86] Another 20 years until handing the reins to somebody else who are going to spend a lot of time in just a little bit here talking about, of course, current Amazon CEO, Andy Jassy.

[87] Yep.

[88] So I don't even know what the right word.

[89] it is to use to describe AWS.

[90] I was going to say I wrote behemoth in my notes.

[91] Pioneer, inventor.

[92] I don't think there's anything you can say that captures how big and how important AWS is.

[93] It is one of the biggest and most important businesses, technologies, products of the modern world.

[94] Yep, no doubt.

[95] I don't think it's controversial to say even much, much more so than Amazon .com.

[96] Yeah.

[97] I mean, it's interesting.

[98] During the pandemic, you could argue that Amazon .com was more important because everybody needed to sort of buy goods and get them at home.

[99] But everybody also needed to be on the internet, and the internet runs on AWS.

[100] Yeah.

[101] So today, we're going to tell that story.

[102] It's funny, as we did the research.

[103] So there's no, like, Everything Store book dedicated to AWS.

[104] There are a lot of very disparate resources and stories out there.

[105] and there actually are quite a few conflicting and competing stories about what the true origin is of AWS.

[106] You might say it has a cloudy origin.

[107] See what we did there.

[108] Ew.

[109] Ew.

[110] It is true.

[111] As we were doing the research, you know, of course, David and I read both of Bradstone's excellent books.

[112] I watched the PBS Frontline documentary, which of course is a specific angle that they're trying to take on the company.

[113] You sort of read any of these Amazon analysis, pieces, they're like 95 % about the retail business.

[114] And they'll talk about things like the relationship with employees and the big New York Times piece that came out in 2015.

[115] They'll talk about the relationship with the warehouse workers or was this good for the world.

[116] And everyone indexes on that, which is important and deserves all the attention it's got.

[117] But almost none of these spend a material amount of time on AWS other than mostly an apocryphal founding story, which is not even really how it happened.

[118] So we identified, you're referring to one origin story of AWS.

[119] We identified not one, not two, not three, but four separate origin stories.

[120] And we're going to tell them all here.

[121] I think there is something important to learn about what AWS is and about Amazon and about Amazon culture in all of these.

[122] So let's start with the first, and most obviously untrue one, which is ironically also the one that the layperson believes the most.

[123] Yes, because it's tempting.

[124] I mean, it's like an, oh, like it's too convenient.

[125] Yes, and that story is the excess capacity narrative.

[126] So the way this story goes is that right around this time, 2001, 2002, 2003, Amazon .com the retail business, like all retail businesses in America, at least, is highly seasonal.

[127] They have huge spikes of traffic and demand in Q4 for the holiday shopping season.

[128] And that's when most of, maybe not most, but the largest share of any quarter revenue happens in Q4.

[129] So much so that for the first at least five years of the business, there was a rule in November and December that you could not commit new code to production.

[130] That's right.

[131] It was so, all hands on deck that no new features were allowed unless it was a red flag bug fix.

[132] Oh, and we didn't talk about this in the Amazon .com episode, but for years and years and years, the executive team and the business side of the company and the engineers, everybody would go work in the warehouses in Q4th.

[133] At our customer service.

[134] Oh, how times have changed.

[135] Can you imagine someone sitting down in Day 1 North or Doppler being told that they have to go pick and pack for a while?

[136] I think for a while they continued to do it even when it wasn't necessary just as like a culture thing, but obviously those days are gone now.

[137] So the urban legend is that because of this dynamic, Amazon had this brilliant realization around that.

[138] Again, when they're trying to achieve profitability, that they had excess technical infrastructure capacity in their IT operations during quarters one through three.

[139] So they had to build out for the peak demand of Q4, all the traffic on the website, all the transactions happening.

[140] But the rest of the year, all that capacity was just sitting there.

[141] And so they decided, let's rent out that capacity to other developers.

[142] Brilliant.

[143] Brilliant.

[144] We are going to turn a large expense line in the business into a revenue line.

[145] Magic.

[146] And of course, this falls down in two enormous places.

[147] One is, if you've ever been in, a pre -cloud technology company, you know that...

[148] It doesn't work that way.

[149] Yeah, you can't just say like, oh, cool, like the servers aren't in use right now, and there's nothing highly customized about these servers, and they're not tightly coupled to our applications in any way.

[150] So we'll just make it so that anyone can very easily just run their applications on it, and there's enough security set up correctly so that anyone can just get access to our data center and the network hardware sort of understands how to serve other tenants other than us.

[151] none of that existed and none of that was true.

[152] So there's just no way you can be like, oh yeah, other companies just started using our infrastructure, and it was pretty rip and replace.

[153] In a pre -cloud infrastructure world, you installed your software, your codebase, on your servers that you owned.

[154] The Amazon .com codebase was literally installed on a bunch of boxes that they owned.

[155] You couldn't just rent out the capacity.

[156] Until 2000, they were servers from digital, Equipment Corporation, Deck.

[157] They were Deck Alpha servers.

[158] These were unbelievably high -margin servers that you, I believe, leased from the manufacturer.

[159] It was the same business model that IBM had forever and Oracle has or had forever, where you get this highly bundled hardware software platform that you would use to run your applications.

[160] And they would make 80 % gross margins on these things.

[161] There was this massive markup.

[162] They were monolithic.

[163] And to be honest, the thing that really changed all this was Linux.

[164] When Linux came out and you could do the stuff that you used to need Unix workstations for on an open source operating system, well, then everything changed because you can go buy a whole bunch of different hardware, put Linux on it, and then write your own applications.

[165] And so this laid the groundwork for maybe infrastructure doesn't have to be as insanely expensive.

[166] And all the profit pools from all of this infrastructure don't have to be captured by, say, a deck or an Oracle or an IBM.

[167] And this would lay the groundwork for a lot of things to come, including, frankly, just saving Amazon as a company.

[168] I mean, in 2000, they almost went out of business because they were so tight on cash and they were spending so much on infrastructure that this sort of moved to the open source ecosystem and doing a massive rewrite of all of Amazon .com to run on Linux and run on these, they did this big deal with HP, run on HP servers.

[169] Right, rather than deck.

[170] That, frankly, save the company from a cost perspective during that really tight time.

[171] But that is not virtualized cloud servers.

[172] It's not what we're talking about with AWS.

[173] Here's the other reason why this excess capacity myth is a myth.

[174] How is Amazon supposed to serve their AWS customers if all of them are on excess capacity during Q4 at all?

[175] Right.

[176] Like, let's say I'm Netflix and I just took a dependency in all of my streaming is happening on AWS.

[177] Is Amazon just going to tell me I can't do it during Q4 when they need the servers?

[178] It's ridiculous.

[179] No holiday movies.

[180] Can't watch Die Hard at Christmas.

[181] So it is a very convenient narrative when someone's trying to solve the puzzle of how did this internet retailer turn into a real technology company?

[182] Oh, they had all these extra servers dispelled.

[183] So the best and final word on this that we have to put here, because it literally is from part of the horse's mouth itself comes from Werner Vogels, the at the time AWS, CTO, now CTO of all of Amazon, who wrote flat out in a Quora post in 2011, quote, the excess capacity story is a myth.

[184] It was never a matter of selling excess capacity.

[185] Actually, within two months after launch, AWS would have already burned through the excess Amazon .com capacity.

[186] Amazon Web services was always considered a business by itself with the expectation that it could even grow as big as the amazon dot com retail operation maybe maybe the other interesting thing to point out is it doesn't give amazon enough credit about their intentionality yes and strategy it short sells amazon yeah they had this extra capacity this cost center that they were using well two things one technology was never a cost center for amazon they never looked at looked at it like, oh, we have an IT department.

[187] They always thought about themselves as a technology company.

[188] So it was always thinking about, okay, in 18 months, Moore's Law is going to make it so we have twice as much compute.

[189] What crazy cool stuff can we do with that?

[190] They always looked at technology as an investment, not a cost center.

[191] And the other thing, to your point that it sells them short on, is as if this wasn't an intentional strategy.

[192] This was an incredibly intentional strategy in a brand new business school case study type laser focus on an emerging market that they had reason to believe that they could create.

[193] Okay, that's origin story number one.

[194] Origin story number two, we're going to get into this a lot more.

[195] And, you know, I didn't even really realize before diving into this, the depth of innovation of what AWS was and what Amazon was doing and led them to it is so beyond anything else that was happening at the time.

[196] This is a true fundamental innovation.

[197] So let's get into it.

[198] Remember from the Kindle Coda vignette, how it was one of those crazy stories of L. Who was responsible for the inspiration for the Kindle?

[199] And it turned out it was Tesla founder, Martin Eberhardt.

[200] Crazy.

[201] He invented the first e -reader that wasn't quite viable yet and tried to sell it to Amazon and tried to get investment from Amazon.

[202] And Amazon said, no, we'll wait till the world shifts a little bit, different technology.

[203] It's actually something we can own outright rather than funding and potentially having competitors use too.

[204] And of course, that would be a few years later and Amazon would create the Kindle internally.

[205] So there is a similar sort of figure involved in inspiring the vision for AWS.

[206] And that is Tim O 'Reilly.

[207] And for anybody of a certain age, you certainly remember the O 'Reilly programming books, the O 'Reilly conferences, and in particular for me, And they were the organization and Tim as the leader of the organization championed the whole idea of Web2 .0.

[208] For sure.

[209] I mean, I remember first reading, I think the PHP book that they put out and then when Web2