AWS and Stealth Pricing

A few weeks ago Bloomberg reported on Amazon’s plans to launch a “global shipping and logistics operation.”  Following the news, I started Brad Stone’s The Everything Store: Jeff Bezos and the Age of Amazon, to gather some insights into Amazon’s past business models and how they might apply them to the realm of 3rd-party logistics.

That post is still in the works, and since I’ve been on the road the last week and a half, today I’m writing a few quick thoughts on one of my favorite excerpts from Stone’s book thus far.

In 2006 Amazon was introducing its AWS S3 and EC2 services, and its executive team was choosing a pricing strategy. One AWS executive recommended pricing EC2 instances at fifteen cents an hour, enabling Amazon to break even on the service. Bezos cut this down to ten. “Bezos wanted AWS to be a utility with discount rates, even if that meant losing money in the short term.”

This is the Amazon model. Set prices to a level that’s beneficial to the customer and delivers razor-thin (or, in the case of early AWS, negative) margins to Amazon. Through building its customer base and supplier leverage through low prices, Amazon affords a cost structure that its competitors cannot.

But there was more to the AWS pricing model than the everyday low pricing it had historically delivered to end customers. Unlike the Amazon.com store, a relatively straight-forward retail business, AWS and cloud computing represented a new frontier in 2006. Bezos knew he had a hit and priced it in such a way that the low-margins Amazon earned would discourage competitors from entering the market. Here’s Stone:

“Bezos didn’t want to repeat ‘Steve Jobs's mistake’ of pricing the iPhone in a way that was so fantastically profitable that the smartphone market became a magnet for competition… Bezos belief was borne out, and AWS’s deliberately low rates had their intended effect; Google chairman Eric Schmidt said it was at least two years before he noticed that the founders of seemingly every startup he visited told him they were building their systems atop Amazon’s servers. ‘All of the sudden, it was all Amazon’, Schmidt says. ‘It’s a significant benefit when every interesting fast-growing company starts on your platform.’”

In an industry where the majority is tirelessly seeking high-margin models, I loved reading about Bezos’s approach to winning market share: stealth pricing, or, how to make one’s business look as unappetizing as possible. Of course, it probably didn’t hurt that potential competitors (Google, Microsoft) likely doubted that the next wave of computing would come from a company that, until then, was perceived as a retailer.

“Let’s give them credit,” Schmidt says. “The book guys got computer science, they figured out the analytics, and they built something significant.”

My fan fiction Bezos riposte: “Schmidt, when did the book guys not get computer science?”