In his farewell letter to shareholders, Jeff Bezos emphasizes that you should always create more value than you consume, and then goes on to give a rough estimate of the considerable value that Amazon has created. This is a misconceived comparison. The goal to create more value than you consume resonates with the idea that you receive more money than you spend. But our goal should not be to create more value than we consume but to create more value than you capture.
Let me explain what I mean by this.
Every company is part of an ecosystem of customers, suppliers, competitors, regulators, lobbyists, interest groups, professional organizations and other stakeholders. Just like a biological organism, it can have a splendid or a miserable life in its ecosystem, or anything in between.
A business model is a conceptual model of how a company creates, delivers and captures value in its ecosystem. If the company creates more value for others than it captures, it has increased total value in the ecosystem. If it creates less value than it captures, it extracts value from its ecosystem.
Let me summarize Bezos’ estimate of how much value was created by Amazon in 2020, and then use this estimate to compare value created with value captured by Amazon in 2020.
Creating more value than you consume
The following diagram shows how he breaks down this value for 2020: Cost savings for AWS customers, time savings for Prime buyers, profit for sellers, salary and benefits for employees, and value for shareholders, adding up to $301B
Creating more value than you capture
However, we think the criterion for value addition is whether you create more value than you capture, rather than what you consume. Hence, we should include the revenues generated for Amazon. This revenue is hidden in the value created for shareholders in Figure 19.
The value created for shareholders estimated by Bezos is Amazon’s net revenue. What we are interested in is Amazon’s gross revenue. We should drop the shareholders from the diagram and add the cash flows for Amazon’s gross revenue.
Amazon’s revenue streams in this diagram add up to Amazon’s gross revenue, which we know from Amazon’s financial report over 2020: $386B.
This means that according to these estimates, Amazon is an extractor company.
The estimations of value created in this diagram are very rough, and Bezos took the smallest possible estimate of value created at several points. The estimate depends on how much cost AWS customers saved. It depends on how much time Prime customers saved, and what the value of that time is. It depends on seller profits, which Amazon estimates at somewhere between $25B and $39B. However, the estimate of the value created by Amazon should be $106B higher to turn Amazon into a value creation company.
How do they do it?
Amazon uses two techniques to extract value from its ecosystem:
- moving friction to other stakeholders and
- cross-layer subsidies.
We’ll look at these in the next two blogs.