Sinegal explained the Costco model to Bezos: it was all about customer loyalty. There are some four thousand products in the average Costco warehouse, including limited-quantity seasonal or trendy products called treasure-hunt items that are spread out around the building. Though the selection of products in individual categories is limited, there are copious quantities of everything there—and it is all dirt cheap. Costco buys in bulk and marks up everything at a standard,
across-the-board 14 percent, even when it could charge more. It doesn’t advertise at all, and earns most of its gross profit from the annual membership fees. “The membership fee is a onetime pain, but it’s reinforced every time customers walk in and see forty-seven-inch televisions that are two hundred dollars less than anyplace else,” Sinegal said. “It reinforces the value of the concept. Customers know they will find really cheap stuff at Costco.”
Costco’s low prices generated heavy sales volume, and the company then used its significant size to demand the best possible deals from suppliers and raise its per-unit gross profit dollars. Its vendors hadn’t been happy about being squeezed but they eventually came around. “You can fill Safeco Field with the people that don’t want to sell to us,” Sinegal said. “But over a period of time, we generate enough business and prove we are a good customer and pay our bills and keep our promises. Then they say, ‘Why the hell am I not doing business with these guys. I gotta be stupid. They are a great form of distribution.’
“My approach has always been that value trumps everything,” Sinegal continued. “The reason people are prepared to come to our strange places to shop is that we have value. We deliver on that value constantly. There are no annuities in this business.”
The Monday after the meeting with Sinegal, Bezos opened an S Team meeting by saying he was determined to make a change. The company’s pricing strategy, he said, according to several executives who were there, was incoherent. Amazon preached low prices but in some cases its prices were higher than competitors’. Like Walmart and Costco, Bezos said, Amazon should have “everyday low prices.” The company should look at other large retailers and match their lowest prices, all the time. If Amazon could stay competitive on price, it could win the day on unlimited selection and on the convenience.
That July, as a result of the Sinegal meeting, Amazon announced it was cutting prices of books, music, and videos by 20 to 30 percent. “There are two kinds of retailers: there are those folks who work to figure how to charge more, and there are companies that work to figure how to charge less, and we are going to be the second, full-stop,” he said in that month’s quarterly conference call with analysts, coining a new Jeffism to be repeated over and over ad nauseam for years.
Drawing on Collins’s concept of a flywheel, or self-reinforcing loop, Bezos and his lieutenants sketched their own virtuous cycle, which they believed powered their business. It went something like this: Lower prices led to more customer visits. More customers increased the volume of sales and attracted more commission-paying third-party sellers to the site. That allowed Amazon to get more out of fixed costs like the fulfillment centers and the servers needed to run the website. This greater efficiency then enabled it to lower prices further. Feed any part of this flywheel, they reasoned, and it should accelerate the loop. Amazon executives were elated; according to several members of the S Team at the time, they felt that, after five years, they finally understood their own business. But when Warren Jenson asked Bezos if he should put the flywheel in his presentations to analysts, Bezos asked him not to. For now, he considered it the secret sauce.
The Everything Store: Jeff Bezos and the Age of Amazon by Brad Stone