Maybe Zappos wasn’t the amazing shiny business bundle of joy it was made out to be?
I’ve always found Zappos’ exuberant approach to customer service and employee perks somewhat peculiar. Masterminded by its CEO, Tony Hsieh, I’ve seen him speak several times on the subject and read countless stories in the media and blogosphere on how amazing it all is.
Don’t get me wrong, it’s great that you can call them up and order a pizza and every employee gets to decorate their cubes.
But I’ve never been convinced it really converts into increased profits in a mainstream, volume-orientated, retail vertical selling commodity products like shoes.
As much as I want to believe in it all, we’ve never seen the hard numbers on sales because Zappos has always remained a private company. Yes, they revealed they did $1bn in sales in 2008 but that doesn’t mean anything – that could be against $1.2bn in costs at which point they’d be operating at a loss. And I don’t see the point of cheerleading an established company that has never turned a profit.
So it was interesting to read a somewhat bitter-sounding Tony Hsieh reveal some insight to Inc. Magainze on the operations of his company and why he sold to Amazon.
The two juicy nuggets I found interesting:
1) Even with $1bn in sales, Zappos was trading on a $100m line of credit
By 2008 we were doing more than $1 billion in gross merchandise sales annually
…
At the time, Zappos relied on a revolving line of credit of $100 million to buy inventory. But our lending agreements required us to hit projected revenue and profitability targets each month. If we missed our numbers even by a small amount, the banks had the right to walk away from the loans, creating a possible cash-flow crisis that might theoretically bankrupt us. In early 2009, there weren’t a lot of banks eager to give out $100 million to a business in our situation.
In other words it doesn’t appear Zappos was even making $100m/year profit on that $1bn/year in sales (a rather poor 10%) – if it was, presumably it would pay off the debt that was leaving it in such a precarious position. Given that Zappos has never competed with other retailers on price, and thus been able to maintain healthy margins, one has to wonder whether all that amazing customer service and employee benefits have been proven overly expensive?
2) Zappos’ Board had no confidence in his corporate culture methodology and just wanted to exit
Although I’d [Tony Hsieh] financed much of Zappos myself during its early days, we’d eventually raised tens of millions of dollars from outside investors, including $48 million from Sequoia Capital, a Silicon Valley venture capital firm. As with all VCs, Sequoia expected a substantial return on its investment — most likely through an IPO. It might have been happy to wait a few more years if the economy had been thriving, but the recession and the credit crisis had put Zappos — and our investors — in a very precarious position.
…
Some board members had always viewed our company culture as a pet project — “Tony’s social experiments,” they called it. I disagreed. I believe that getting the culture right is the most important thing a company can do. But the board took the conventional view — namely, that a business should focus on profitability first and then use the profits to do nice things for its employees. The board’s attitude was that my “social experiments” might make for good PR but that they didn’t move the overall business forward. The board wanted me, or whoever was CEO, to spend less time on worrying about employee happiness and more time selling shoes.
Despite controlling the common stock, Tony was at risk of being ousted as CEO at any time and replaced with someone more traditional. In other words it appears he sold out to Amazon not because it was a match made in heaven but really just to eject the board and keep his position safe. And Jeff Bezos had the check waiting.
Conclusions
I don’t have any firm conclusions right now as I’m still digesting the rest of the article (an excerpt from his book) but it’s pretty frank and telling. I’m actually very surprised Tony has given such a revealing account given he is still the CEO.
But I do think this indicates a friction between the much lauded Zappos corporate culture and the realities of establishing a profitable business – specifically that Zappos failed to prove it.
While everyone working at Zappos was able to pick up a solid pay check while working in nice conditions and customers could call up the helpline and talk about whatever they wanted, it appears that Zappos hasn’t become the business success many have drunk the kool-aid over.
Gary Vaynerchuck has proved with figures that this careing approach with wine works maybe it is down the the niche where this approach works..
@Richard I’m about to go to bed, it’s 3am, but two thoughts:
1) Wine is not really a commodity vertical like shoes are.
2) I’m suspicious of Gary V’s business story. Gary and his family already had a very profitable wine import/export business netting them $millions before they even started using the Internet.
It’s hard to gauge to what extent Gary V has been able to profit from the Interent vs him just using it for his own personal PR drive.
Funnily enough, earlier this evening I was reading Philip Greenspun’s tale of ArsDigita (http://waxy.org/random/arsdigita/) and Michael Yoon’s follow-up (http://michael.yoon.org/arsdigita)
Who’d be a VC, eh? You never get the love.
[...] here: Maybe Zappos wasn't the amazing shiny business bundle of joy it … // Tags: ceo, customer-service, exuberant-approach, hsieh, perks-somewhat, seen-him, [...]
[...] Maybe Zappos wasn’t the amazing shiny business bundle of joy it was made out to be? (benmetcalfe.com) [...]
One not-so-hidden secret is that the return rate is upwards of 50% making the true net sales more in the $500-600 million range.
On one hand, the Zappos culture is important since, after all, it is competing with the far more delightful show buying experience offered by a physical store.
But as I think we are finding out, the profits are not there…and may never be.
[...] Salmon at Reuters concludes Sequoia ‘forced’ Zappos to sell, while Ben Metcalfe raises some questions about Zappos’ way of treating customers and employees, saying this approach appears to not [...]
[...] Salmon at Reuters concludes Sequoia ‘forced’ Zappos to sell, while Ben Metcalfe raises some questions about Zappos’ way of treating customers and employees, saying this approach appears to not [...]
It is completely normal for retail businesses to float their inventory on credit.
Nice post. I disagree with your conclusion though, I think Zappos succeeded in a fundamentally terrible business because of its culture.
If you take away Zappos’s culture and customer service, you are essentially left with a terrible retail format. The fact that they were able to succeed at all selling shoes on the internet is amazing. Their growth was fueled by earned media that arose from their culture and service as well as (I’m assuming) some productivity advantages gleaned from Tony’s focus. Its not surprising that financially they were marginal and under pressure during a severe economic downturn. Its also not surprising that their Sequoia-backed BOD and their creditors didn’t buy in – they are trained to follow cookie cutter rules of thumb.
If someone came to you and said I want you to invest in a company that sells shoes on the internet with a liberal return policy you would tell them they are crazy. Zappos’ only competitive advantage was their culture – it was the only reason they built the business to where Sequoia would have put $50M in, and Tony was right to be focused on it. When you take money from VCs, you are usually forced to exit – that is the game.
The takeaway is that culture cant turn a dog business into a star, but it can provide a competitive advantage that allows you to grow and survive in a tough business climate.
comment deleted by Ben Metcalfe. Anonymous comments that contain personal attacks and serious accusations about the subject of this post will not be published. You are welcome to submit the comment again with verifiable attribution (your email address at the very least) if you would like this comment to appear.
Ben, it’s pretty normal for a growing retail business to use a line of credit to finance their inventory. If you think about it, in particular if they are growing rapidly, they need to acquire more and more inventory to meet the next quarter’s increasing sales levels.
The lending environment also went from very loose to very tight. I’m pretty sure a lot of good companies had liquidity issues because of the debt crisis. Of course – there were also a lot of marginal companies that were lent a lot of money in ’07 and ’08, so who knows what Zappos situation was!
10% is not “a rather poor” net margin for online retail. That’s actually quite good. For comparison, Amazon does about 5%.
[...] Salmon at Reuters concludes Sequoia ‘forced’ Zappos to sell, while Ben Metcalfe raises some questions about Zappos’ way of treating customers and employees, saying this approach appears to not [...]
A fast-growing company that is profitable can still have liquidity issues, as it needs to grow inventory along with sales (in addition to growing the team, etc.) So I think you’re making a big leap in the first half of your argument, that makes it weak. Hope this feedback helps.
Sure Zappos has high customer service costs, but they spend less on traditional marketing and advertising as a result. While their profit margins might be lower (we don’t really know), their sales have grown on a hockey stick curve largely down to their wow factor.
Build an incredible brand over the long-term, and continually strengthen your “competitive moat”, those are two of the criteria Warren Buffett looks for.
Retail is a tough game for the long-term and Zappos is only ten years in; that’s nothing.
Before any conclusions can be made, it would be wise and fair to read “delivering happiness” book completly and not just extracts.
Having just finished reading Delivering Happiness (by Tony) and Crush IT (by Gary), I tend to agree with the sentiments posted on Ben’s blog.
Whilst both guys are extremely intelligent, they are also exceptional spinners & hustlers and given the information they have chosen to share with thus so far, it should be reasonably easy for all of you to see this.
Both have an agenda that is clearly displayed in their books.
Tony pushing his “deliver WOW customer service” tagline, which in turn makes customers think Zappos will do just about anything for them.
Whilst Gary is pushing his “I’m authentic” tag line” .. I tend to believe he is, but I don’t think he’s added anything to his brand equity, by writing a book.
… I’m side stepping now, so I’ll come back to my point.
At the end of the day, Zappos was more than likely not a very (if at all) profitable company. Nor was it ever meant to be.
* Zappos was Tony’s home.
* Zappos was Tony’s family.
* Tony is an ‘innovator & creator’, he builds things and shapes their growth,this what drives him.
As long as his customers are happy, hiss staff are happy and the business is moving forward. His job is done.
If only we could all live like this, the world would be a better place.
- Paul.
————
About Me: I have run several e-commerce businesses over the last 10 years now and have been involved more start ups than I care to remember. 33% highly successful, 33% motoring along nicely, and 33% worth of duds… Can’t win them all.
Ready Tony’s book was almost like reading a path I’ve traveled myself…
All the best.
Zappos differentiates on culture.
I find it difficult to believe they wouldn’t have turned a profit given the high margins and obvious quest for profitability (Delivering Happiness gives some insights) – they were never ignoring profitability in exchange for culture.
How would a company like Zappos exist in a competitive field, online without their differentiating culture? (agree with SteveR)
Not impossible, but difficult.
Although I’m in agreement the brandishing of $1bn milestone as a PR excercise seems hollow without profitability numbers, it’s much easier for a company generating $1bn to be profitable through cost reduction than it is for company generating far less.
I do not believe customer service is what made Zappos so successful. Why? I could create a clone of Zappos and create the BEST customer service. You get 5 long years to try the shoes, dun like it? return it, and I’ll give you TWICE your money back. How do you like that customer service?
Don’t be naive. Zappos became a brand name because of EXCELLENT search engine marketing and optimization, and marketing to get referrals. Once u get those first 5 million customers, then you add on the customer service to RETAIN them. But customer service is the major reason they became successful. It’s important for retaining customers but wasn’t the crucial factor that launched them into success.
There’s noone to give good customer service to if u got no customers in the first place.
As a shoe retailer, I’ve always been skeptical of Zappos’ business model. Sure they sell lots of shoes, but their profitability has never matched their PR genius. First, sales of $1b, glorified in trade magazine Footwear News, that is really $635m, seems suspicious at best. Second, unlike fine wine, shoes do not become more valuable as they sit in the warehouse. In fact, it is very difficult to sell out-of-fashion shoes for any price, let alone regular retail. So I’m not exactly sure what they do with high-end fashion shoes that are returned, on their dime, 364 days later…but of course that doesn’t happen very often! Excessive inventory levels can be the kiss of death to a retailer, any retailer, let alone one that stocks the amount of shoes Zappos does. Just wondering!
I shop there. I think their return policy rocks and they have the best prices. *shrugs* I think they’re probably doing very well as it seems to me any objective consumer would come to this same conclusion.
Although your criticisms seem founded largely on speculation this has sparked an interesting discussion.
[...] was essentially a 1.2x revenue multiple. However, Zappos was well known to run razor thin margins, rumored to be well in the single-digits. If this is true, then Zappos likely changed hands at well over a 30x EV/EBITDA [...]
[...] Salmon at Reuters concludes Sequoia ‘forced’ Zappos to sell, while Ben Metcalfe raises some questions about Zappos’ way of treating customers and employees, saying this approach appears to not [...]
Unless this page was written and then updated elsewhere or the above published date of June 2010 is not accurate, one could find Zappos.com, Inc.’s audited financial statements. Those statements were filed with the SEC no later than September 2009.
For 2008 vs 2007, it had annual net sales of about $635mn vs $527mn and operating income of $21.8mn vs $32.5mn. Those are operating margins of 3.4% vs 6.2%. We know what happened in Sep and 4Q08, which would have been that year’s biggest sales period.
After ten years operating, Amazon.com, Inc. had 2005 vs 2004 net sales of $8.5bn vs 6.9bn and operating income of $432mn vs $440mn or operating margins of 5.1% vs 6.4%. One can conclude that at similar ages of existence, they both had comparable margins.
The difference in capitalization and cumulative losses however is huge. By 2005 Amazon had cumulative losses of about $2bn while Zappos had cumulative losses of just around $17mn by 2008. This doesn’t include Amazon’s $1bn+ convertible bond.
Perhaps comparison to Amazon is not fair. It looks though that Zappos was on a similar trajectory as Amazon. Both had high growth. Both had plans to expand beyond their respective initial target markets of books and shoes. Both also had visionary leaders at their 10-year anniversaries but one leader had firm control with long-term semi-perpetual capital while the other was controlled by his investors with foci on exits to return fund capital.
Perhaps the key points of the story are matters of control, time horizons and getting buy-in from backers on your vision.
I have read (and studied) Delivering Happiness and the Zappos Culture Book. The basic fundamentals of their business model are ok and worth further developing (though Tony’s book is not the only good read out there). The weak spot is that there is hardly anything mentioned about their hard core systems, (financial) reporting, analyzing and optimizing. Details about (historical) profitability, cash flow, supply chain management, working capital management, growth and how to finance growth in a more sustainable manner are unfortunately missing.
It is clear that without the right people (cultural fit) you cannot grow a business like Zappos, but as you can read in Delivering Happiness there where a few very critical moments in their history, which especially related to (lack of ) cash flow and possibly profitability as well. When the moved to keeping inventory, obviously their working capital and financing needs went up, but that topic is not further explained.
For the a detailed financial statement / P+L overview (2008 – 2009), you may check this link: http://www.slideshare.net/Devcorporate/zappos-financials-1781754 and draw your own conclusions.
In other words, more (scientific) and practical research needs to be done on how this model can be further developed and optimized.
Marcel Wiedenbrugge
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