"We need a department like this as well!" - Peter

Excerpts from "The Everything Store: Jeff Bezos and the age of Amazon" by Brad Stone

Chapter 10 - Expedient Convictions

There is a clandestine group inside Amazon with a name seemingly drawn from a James Bond film: Competitive Intelligence. The group, which since 2007 has operated within the finance department under longtime executives Tim Stone and Jason Warnick, buys large volumes of products from competitors and measures the quality and speed of their services. Its mandate is to investigate whether any rival is doing a better job than Amazon and then present the data to a committee that usually includes Bezos, Jeff Wilke, and Diego Piacentini, who ensure that the company addresses any emerging threat and catches up quickly.

In the late 2000s, Competitive Intelligence began tracking a rival with a difficult to pronounce name and a strong rapport with female shoppers. Quidsi (quid si is Latin for “what if”) was a New Jersey company known for its website Diapers.com. Grammar-school friends Marc Lore and Vinit Bharara founded the startup in 2005 to allow sleep-deprived caregivers to painlessly schedule recurring shipments of vital supplies. By 2008, the company had expanded into selling all of the necessary survival gear for new parents, including baby wipes, infant formula, clothes, and strollers.

Dragging screaming children to the store is a well-known parental hassle, but Amazon didn’t start selling diapers until a year after Diapers.com, and neither Walmart.com nor Target.com was investing significantly in the category. Back when the dark clouds of the dot-com bust still hung over the e-commerce industry, retailers felt that they wouldn’t make any money shipping big, bulky, low-margin products like jumbo packs of Huggies Snug and Dry to people’s front doors.

Lore and Bharara made it work by customizing their distribution system for baby gear. Quidsi’s fulfillment centers, designed by former Boeing operations manager Scott Hilton, used software to match every order with the smallest possible shipping box (there were twenty-three sizes available), minimizing excess weight and thus reducing the per-order shipping cost. (Amazon, which had to match box sizes to a much larger selection of products, was not as adept at this.) Quidsi selected warehouses outside major population centers to take advantage of inexpensive ground-shipping rates and was able to promise free overnight shipping in two-thirds of the country. The Quidsi founders studied Amazon closely and idolized Jeff Bezos, referring to him in private conversation as “sensei.”9

Moms got hooked on the seemingly magical appearance of diapers on their doorsteps and enthusiastically told friends about Diapers.com. Several venture-capital firms, including Accel Partners, a backer of Facebook, bought into the possibility that Lore and Bharara had identified a weakness in Amazon’s armor, and they pumped over $50 million into the company. Around this time, Jeff Bezos and his business-development team, as well as Amazon’s counterparts at Walmart, started to pay attention.

Executives and official representatives from Amazon, Quidsi, and Walmart have all declined to discuss the ensuing scuffle in detail. Jeff Blackburn, Amazon’s mergers and acquisitions chief, said Quidsi was similar to Zappos, a “stubbornly independent company building an extremely flexible franchise.” He also said that everything Amazon subsequently did in the diapers market was planned beforehand and was unrelated to competing with Quidsi.

The story that follows has been pieced together from the recollections of insiders at all three companies. They spoke anonymously and with a significant amount of trepidation, given the strength of Amazon’s and Walmart’s strict nondisclosure agreements and the possibility of legal consequences for them for speaking publically about it.

In 2009, Blackburn ominously informed the Quidsi cofounders over an introductory lunch that the e-commerce giant was getting ready to invest in the category and that the startup should think seriously about selling to Amazon. Lore and Bharara replied that they wanted to remain private and build an independent company. Blackburn told the Quidsi founders that they should call him if they ever reconsidered.

Soon after, Quidsi noticed Amazon dropping prices up to 30 percent on diapers and other baby products. As an experiment, Quidsi execs manipulated their prices and then watched as Amazon’s website changed its prices accordingly. Amazon’s famous pricing bots were lasered in on Diapers.com.

Quidsi fared well under Amazon’s assault, at least at first. It didn’t try to match Amazon’s low prices but capitalized on the strength of its brand and continued to reap the benefits of strong word of mouth. It also used its trusting relationship with customers and its expertise in fulfillment to open two new websites, Soap.com for home goods and BeautyBar.com for makeup. But after a while, the heated competition began to take a toll on the company. Quidsi had grown from nothing to $300 million in annual sales in just a few years, but with Amazon focusing on the category, revenue growth started to slow. Investors were reluctant to furnish Quidsi with additional capital, and the company was not yet mature enough for an IPO. For the first time, Lore and Bharara had to think about selling.

At around this point, Walmart was looking for ways to make up the ground they’d lost to Amazon, and the retailer was shaking up its online division. Walmart vice chairman Eduardo Castro-Wright took over Walmart.com, and one of his first calls was to Marc Lore at Diapers.com to initiate acquisition talks. Lore said that Quidsi wanted a chance to get “Zappos money”—$900 million, which included bonuses spread out over many years tied to performance goals. Walmart agreed in principle and started due diligence. Mike Duke, Walmart’s CEO, even visited a Diapers.com fulfillment center in New Jersey. However, the subsequent formal offer from Bentonville was well under the requested amount.

So Lore picked up the phone and called Amazon. On September 14, 2010, Lore and Bharara traveled to Seattle to pitch Jeff Bezos on acquiring Quidsi. While they were in that early-morning meeting with Bezos, Amazon sent out a press release introducing a new service called Amazon Mom. It was a sweet deal for new parents: they could get up to a year’s worth of free two-day Prime shipping (a program that usually cost $79 to join), and there was a wealth of other perks available, including an additional 30 percent off the already-discounted diapers, if they signed up for regular monthly deliveries of diapers as part of a service called Subscribe and Save. Back in New Jersey, Quidsi employees desperately tried to call their founders to discuss a public response to Amazon Mom. It was no accident that they couldn’t reach them. They were sitting blithely unaware in a meeting in Amazon’s own offices.

Quidsi could now taste its own blood. That month, Diapers.com listed a case of Pampers at forty-five dollars; Amazon priced it at thirty-nine dollars, and Amazon Mom customers with Subscribe and Save could get a case for less than thirty dollars.10 At one point, Quidsi executives took what they knew about shipping rates, factored in Procter and Gamble’s wholesale prices, and calculated that Amazon was on track to lose $100 million over three months in the diapers category alone.

Inside Amazon, Bezos had rationalized these moves as being in the company’s long-term interest of delighting its customers and building its consumables business. He told business-development vice president Peter Krawiec not to spend over a certain amount to buy Quidsi but to make sure that Amazon did not, under any circumstances, lose the deal to Walmart.

As a result of Bezos’s meeting with Lore and Bharara, Amazon now had an exclusive three-week period to study Quidsi’s financial results and come up with a proposal. At the end of that period, Krawiec offered Quidsi $540 million and said that this was a “stretch price.” Knowing that Walmart hovered on the sidelines, he gave Quidsi a window of forty-eight hours to respond and made it clear that if the founders didn’t take the offer, the heightened competition would continue.

Walmart should have had a natural advantage in this fight. Jim Breyer, the managing partner at one of Quidsi’s venture-capital backers, Accel, was also on the Walmart board of directors. But Walmart was caught flat-footed. By the time Walmart upped its offer to $600 million, Quidsi had tentatively accepted the Amazon term sheet. Mike Duke called and left messages for several Quidsi board members, imploring them not to sell to Amazon. Those messages were then transcribed and sent to Seattle, since Amazon had stipulated in the preliminary term sheet that Quidsi was required to turn over information about any subsequent offers.

When Amazon executives learned of Walmart’s counterbid, they ratcheted up the pressure even further, threatening the Quidsi founders that “sensei,” being such a furious competitor, would drive diaper prices to zero if they went with Walmart. The Quidsi board convened to discuss the Amazon proposal and the possibility of letting it expire and then resuming negotiations with Walmart. But by then, Bezos’s Khrushchev-like willingness to take the e-commerce equivalent of the thermonuclear option in the diaper price war made Quidsi worried that it would be exposed and vulnerable if something went wrong during the consummation of a shotgun marriage to Walmart. So the Quidsi executives stuck with Amazon, largely out of fear. The deal was announced on November 8, 2010.

The money-losing Amazon Mom program was obviously introduced to help dead-end Diapers.com and force a sale, and if anyone at the time had doubts about that, those doubts were quickly dispelled by Amazon’s subsequent actions.

A month after it announced the acquisition of Quidsi, Amazon closed the program to new members. But by then the Federal Trade Commission was reviewing the deal, and a few weeks after it closed the program, Amazon reversed course and reopened it, though with much smaller discounts.

The Federal Trade Commission scrutinized the acquisition for four and a half months, going beyond the standard review to the second-request phase, where companies must provide more information about a transaction. The deal raised a host of red flags, according to an FTC official familiar with the review. A significant head-to-head competition and the subsequent merger had led to the demise of a major player in the category. But the deal was eventually approved, in part because it did not result in a monopoly. There was a plethora of other companies, like Costco and Target, that sold diapers both online and offline.

Bezos had won again, neutralizing an incipient competitor and filling another set of shelves in his everything store. Like Zappos, Quidsi was permitted to operate independently within Amazon (from New Jersey), and soon it expanded into pet supplies with Wag.com and toys with Yoyo.com. Walmart had missed the chance to acquire a talented team of entrepreneurs who had gone toe to toe with Amazon in a key product category. And insiders were once again left with their mouths agape, marveling at how Bezos had ruthlessly engineered another acquisition by driving his target off a cliff. Says one observer who had a seat close to the battle, “They have an absolute willingness to torch the landscape around them to emerge the winner.”