Season 2, Episode 1 Zappos (with Alfred Lin)

In this episode of Acquired, hosts Ben Gilbert and David Rosenthal, along with guest Alfred Lin of Sequoia Capital, delve into the story of Zappos and its acquisition by Amazon. Lin, formerly the COO of Zappos, shares insights into the company's customer-centric approach, the challenges of ecommerce, and the strategic decisions that led to its growth and eventual $1.2 billion acquisition. The conversation covers Zappos' early days, its struggles with funding and competition, and the cultural synergies with Amazon that made the acquisition successful. Additionally, the episode touches on the importance of non-consensus thinking in startups, the significance of large markets, and the value of hard work in creating business moats.

• Ben Gilbert and David Rosenthal inform listeners about the poor audio quality in the second half of the episode due to technical issues.
• They considered not releasing the episode but decided the interview content with Alfred Lin was too valuable to withhold.
• They apologize for the audio quality and express hope that listeners will enjoy the interview regardless.

"We had a problem that we didn't catch until afterwards that makes it sound like a conference call with a poor connection."

The quote highlights the unexpected technical issue they faced with the audio quality, which they wanted to acknowledge and apologize for before the interview began.

• Ben Gilbert and David Rosenthal introduce themselves as the hosts of the podcast "Acquired."
• They welcome Alfred Lin, who is featured in the episode to discuss Zappos.
• The episode marks the beginning of a new season with a focus on themes and miniseries, starting with a review of the Zappos M&A transaction.

"I'm Ben Gilbert... I'm David Rosenthal... And we are your hosts... And I'm Alfred Lin."

The quote introduces the speakers of the episode, setting the stage for the discussion about Zappos.

• Alfred Lin is currently a VC at Sequoia Capital, co-heading their US venture business.
• Lin's background includes being the chairman and COO of Zappos before its acquisition by Amazon.
• The episode will focus on Lin's experiences at Zappos, as well as his earlier entrepreneurial ventures.
• Lin is also humorously referred to as the "human trash compactor of Pizza" by Tony Hsieh, which ties into the Zappos story.

"Today Alfred is a VC at Sequoia Capital... he was the chairman and COO of Zappos..."

The quote summarizes Alfred Lin's professional status and his significant role in the history of Zappos.

• Zappos was founded by Nick Swinmurn, who was frustrated by the difficulty of finding a specific pair of shoes in stores and online.
• In 1999, Swinmurn decided to quit his job as a webmaster and create Zappos, an online shoe retailer.
• The term "webmaster" is nostalgically mentioned, reflecting the early days of the internet.

"The founder of Zappos was Nick Swinmurn... he couldn't find a place where you could buy his shoes... He thought it was a good idea to just quit his job and create a website and start Zappos."

The quote details the motivation behind Nick Swinmurn's founding of Zappos due to a personal shopping frustration.

• Alfred Lin, Tony Hsieh, and Sanjay Madan were friends at Harvard, where they started a pizza business.
• The business involved buying pizzas from the grill managed by Hsieh and Madan and reselling them by the slice at a profit.
• Lin learned an early business lesson about the value of quarters for laundry and the concept of arbitrage.
• The friends discussed customer experience and community-building, which foreshadowed their future business philosophies.

"Tony and Sanjay were actually very entrepreneurial, even back then... I always got $2 even though I asked for a dollar 25 or dollar 50."

The quote illustrates the entrepreneurial spirit of Lin and his friends at Harvard and an early lesson in value perception.

• After college, Lin, Hsieh, and Madan moved to the West Coast, where they founded LinkExchange.
• LinkExchange was an early internet advertising network that was eventually sold to Microsoft.
• The venture was a learning experience for Lin, who observed the hard work involved in venture capital from his interaction with Sequoia Capital.

"We sold a little too early before that... the success of Sequoia has a lot to do with partnering with the founders and the management teams of their companies."

The quote reflects on the timing of the sale of LinkExchange and the importance of investor-founders partnerships in venture capital.

• After selling LinkExchange, Lin and Hsieh started a venture fund called Venture Frogs.
• They raised $27 million and invested in 27 companies over one year, with a concentrated portfolio approach.
• The fund targeted internet companies and achieved a high return despite the challenging investment climate of 1999.
• Lin and Hsieh identified companies in their portfolio where their involvement could make a significant impact, such as Tellme Networks and Zappos.

"We ended up making 27 investments, but it was over one year... it ended up being a seven and a half to eight x fund after fees."

The quote provides insight into the investment pace and success of Venture Frogs in a relatively short timeframe.

• Ben Gilbert discusses the differentiation between a feature, a product, and a company.
• A feature may be useful but does not have the potential to build a meaningful business or user base.
• Founders sometimes need to pivot if their initial idea is only a feature, but Sequoia does not focus on helping founders pivot to non-passionate ventures.
• There are founders who are resistant to change, making it difficult for venture firms to influence them.
• Companies may fail due to incorrect assumptions about the business or business model.

"Sometimes you have a feature, it's not a product or you have a product, but it's not a company."

This quote emphasizes the importance of distinguishing between a mere feature and a viable product or company, which is critical for business success.

• Even with a great product and correct assumptions, companies can struggle to raise money.
• The story presented to investors and the ability to acquire capital are crucial.
• Zappos faced difficulties raising funds during the "nuclear winter" after the dot-com bubble burst.
• Despite growth and break-even status, investors were hesitant due to the broader e-commerce market's reputation.

"And unfortunately, there is also class of things where maybe the product is great and the underlying assumptions are right and the founders will listen and work hard, but it can't raise money for whatever reason..."

This quote highlights that a good product and a hardworking team may still face challenges in fundraising, which can be a significant obstacle for business growth.

• Zappos was unique in its early break-even status compared to other e-commerce companies.
• The company raised only $10 million in primary capital but leveraged vendor credit and debt smartly.
• Understanding the cash conversion cycle was key to Zappos' financial management.
• Zappos' limited funding forced it to be innovative and disciplined in customer acquisition strategies.

"The company only raised $10 million for primary capital... Zappos did burn $100 million of free cash flow. It was just smart about how it did it."

This quote illustrates how Zappos managed to grow into a billion-dollar company with relatively little primary capital by being strategic with its financial resources.

• Acquiring customers in the early days of e-commerce was challenging without established channels.
• Zappos experimented with various advertising methods, including banner ads and print ads.
• They discovered Google as an effective channel before it became highly competitive.
• Zappos also utilized SEO and negotiated co-branded print ads to share costs with brands.
• The company had to continuously innovate as competitors began to adopt similar strategies.

"There was a lot of acquisition channels that just didn't work and we tried all of them... we had to do that. We had to do SEO. We had to figure out SEO optimization."

This quote shows that Zappos had to be creative and persistent in finding effective customer acquisition channels in a time before digital marketing was well-established.

• Zappos faced skepticism from shoe manufacturers who doubted the viability of online shoe sales.
• The company initially used a dropship model but transitioned to holding inventory to improve customer service.
• Zappos' growth required overcoming the reluctance of brands to sell to internet businesses.
• The lack of competition after the dot-com bust and limited funding forced Zappos to be resourceful and efficient.

"We need a shoe salesman... consumers would never buy shoes on the Internet."

This quote reflects the initial resistance from shoe manufacturers to the concept of selling footwear online, a challenge Zappos had to overcome.

• Zappos' leadership met with Jeff Bezos, but the company was not ready to sell at that time.
• Amazon later launched endless.com, a direct competitor to Zappos, with aggressive strategies like free overnight shipping.
• Zappos had to decide whether to match Amazon's offerings and how to differentiate itself.
• The company continued to focus on selection, vendor relationships, and customer service to compete.

"We weren't thinking that he was coming down to buy the company at all."

This quote captures the mindset of Zappos' leadership during the initial meeting with Jeff Bezos, indicating they were not anticipating an acquisition offer at that time.

• Amazon's entry into the shoe market with endless.com posed a threat to Zappos' business model.
• Zappos had to adapt by offering free shipping both ways and eventually free overnight shipping.
• Amazon's approach to discounting and shipping promotions was innovative and competitive.
• Despite Amazon's aggressive tactics, Zappos continued to grow and differentiate its offering.

"The only way you can react is figure out what you want to match that and how you differentiate against that."

This quote reflects the strategic thinking required of Zappos when faced with a formidable competitor like Amazon, focusing on differentiation and matching certain services.

• Growing markets provide a win-win situation for consumers and businesses.
• Amazon and Zappos both experienced growth without significant competition.
• A natural monopoly is ideal, but even without it, a large business can be valuable.

"One of the advantages of being in a growing market where the consumer trends are in your advantage is that for a period of time, it's a win-win situation for the consumer and those involved."

This quote emphasizes the benefits of operating in a market that is expanding and has favorable consumer trends, as it allows for mutual benefits for both consumers and businesses.

• Enduring multiple financial crises is part of building a long-lasting company.
• Zappos noticed a slowdown before the financial crisis became apparent to others.
• Despite the crisis, Zappos was not overextended and had a substantial line of credit.

"Well, if you want to build a long enduring company, you're going to endure a lot more than just one or two financial crises."

Alfred Lin suggests that surviving financial downturns is a necessary challenge for a company that aims to last over the long term.

• Banks faced liquidity crunches during the financial crisis, impacting Zappos's credit.
• Verbal agreements on extending credit lines for various product categories were not always honored.
• Employees faced personal financial struggles, including losing homes and needing liquidity.

"We had some technical issues where we had verbal agreements that we would extend from shoes to all. They would lend against shoes to handbags to apparel."

This quote highlights the difficulties Zappos faced with banks during the financial crisis, where verbal agreements on credit extensions were not fully upheld, especially when it came to lending against different product categories.

• The acquisition by Amazon was valued at $1.2 billion in stock.
• Negotiations included the decision to opt for stock over cash due to the tax benefits and potential for appreciation post-financial crisis.
• Different views on Amazon's stock led to varied approaches among stakeholders post-acquisition.

"Amazon is going to acquire Zappos for $1.2 billion in stock."

This quote marks the significant financial event where Amazon agreed to acquire Zappos, and the deal was structured to be in Amazon's stock, which had substantial implications for Zappos's shareholders.

• Zappos remained an independent subsidiary post-acquisition, which was novel at the time.
• Decentralized organizations are seen as more innovative due to less centralized decision-making.
• The management structure changed, with Zappos's board being replaced by an Amazon board.

"When you have a whole business, I think it really does make sense to run it independently unless you can find a good reason why you should integrate."

Alfred Lin discusses the rationale behind keeping Zappos independent after the acquisition by Amazon, highlighting the benefits of decentralized decision-making in fostering innovation.

• Both Amazon and Zappos share a common value of being customer-obsessed.
• The companies learned from each other's approaches to customer service and efficiency.
• Zappos's unique approach to customer service was recognized and valued by Amazon.

"I get tingly weeped when I see customer obsessed companies."

Jeff Bezos's quote, as referenced by Alfred Lin, underscores the shared value of customer obsession that made Zappos an attractive acquisition for Amazon.

• Zappos's use of Kiva Systems for warehouse automation impressed Amazon during due diligence.
• Amazon initially thought Kiva would not be efficient for their operations but later adopted the technology extensively.
• Kiva's success at Zappos contributed to Amazon's decision to acquire the company that made Kiva robots.

"It turned out it's still efficient because you can get into much larger distribution centers."

Alfred Lin explains how Kiva Systems' robots proved to be efficient for Zappos, which was a factor in Amazon's decision to acquire Kiva Systems later on.

• The acquisition is categorized as a business line, allowing Zappos to operate as a separate entity.
• The cultural fit between Amazon and Zappos was strong despite surface-level differences.
• Amazon's interest in Zappos included learning about merchandising and efficient operations without advanced technology.

"It was a business line that they acquired. I think they also were very interested to learn about some of the things that we built related to merchandising."

This quote from Alfred Lin categorizes the acquisition as a business line and highlights Amazon's interest in Zappos's expertise in merchandising and operations.

• Amazon was the only serious contender for buying Zappos.
• Zappos might have remained independent or been bought by another company, but the management decided to sell to Amazon.
• Walmart is mentioned as a company that buys others and keeps them independent, but it's hard to imagine others besides Amazon that would allow Zappos to operate as they did.
• Alfred Lin (Speaker D) believes it is important not to dwell on what could have been, as life does not offer do-overs.

"I don't think anybody else was serious. I don't think we would have sold to anyone else." "Well, I think Walmart has shown that they'd be willing to buy companies and keep them independent."

The quotes emphasize that while Walmart might have been a potential buyer that allows for independence, Amazon was the only serious contender, and Zappos' management was not considering other buyers seriously.

• Ben Gilbert (Speaker A) and Alfred Lin (Speaker D) discuss the importance of investing in markets, not just ideas or founders.
• A large market is a key factor for a company's success, regardless of the product.
• Founders and markets are both important; the right founder is crucial in a big market.
• Companies are more than their ideas or products; they consist of the team, the problem being solved, the innovation, the market, and the go-to-market strategy.

"It reminded me so much of a Sequoia investment thesis that we invest in markets, not ideas, and we invest in markets over founders in many ways." "Yeah, I think you're right that markets are large. Markets are very important."

These quotes highlight the investment philosophy that prioritizes markets over individual ideas or founders, suggesting that a company's potential is strongly tied to the size and characteristics of the market it operates in.

• The initial skepticism about selling shoes online is compared to the early doubts about Stitch Fix.
• The importance of being right and non-consensus is emphasized for founding a company or investing.
• Zappos' approach to the market, including the decision to sell shoes online, was seen as a "dumb idea" that could be a competitive advantage since it was non-consensus.
• The facts about the market size and existing mail order sales supported the belief that the Internet could be a larger market for shoe sales.

"Tony almost deleted the voicemail, right. Because who's going to buy shoes online? It seems like a dumb idea." "Yeah, we're going to be the only ones doing this dumb idea."

These quotes reflect the non-consensus thinking that was behind Zappos' early strategy. The idea of selling shoes online was initially considered dumb, but it was this non-consensus approach that allowed Zappos to carve out a unique space in the market.

• Hiring the right people, such as Fred Mossler, is crucial to bridge the gap between new and old paradigms.
• Early-stage investing requires imagination to envision the company with all the right pieces in place.
• Zappos needed to fill in gaps, such as shoe industry experience and customer service, to build a successful company.
• The process of building a company is about assembling all the necessary components and having a vision for the future.

"We went out and hired Nick Swinmurn because we're missing shoe." "The company coming together has a lot to do with making sure you have all those right pieces."

These quotes discuss the importance of assembling the right team and filling in the gaps in expertise to build a successful company. The hiring of Nick Swinmurn is highlighted as a strategic move to bring necessary industry experience to Zappos.

• The discussion touches on the importance of founders being both mission-focused and mercenary.
• Founders need to be passionate about solving problems in unique ways and building a sustainable business model.
• The idea of doing "hard things" to build a moat around the business is emphasized.
• Examples of hard things include Amazon's investment in warehouses and server farms, which created a competitive advantage.

"People ask this all the time, whether we back mission focused or mercenary founders." "Most of the founders that are successful, they want to build an enterprise that exists much longer than themselves."

These quotes discuss the balance between being mission-focused and having a mercenary mindset. Successful founders are described as those who are passionate about their mission but also understand the importance of building a sustainable business.

• Doing hard things can create a moat and protection for a business.
• Amazon's investment in warehouses and server farms is cited as an example of doing hard things that others do not want to do.
• The contrast between eBay and Amazon's business models is discussed, highlighting the attractiveness of high-margin, easy-to-explain business models versus the complexity and capital intensity of Amazon's approach.

"Some of the hardest things to replicate are the hard things that people do to build a real moat around the business." "Amazon builds real moats."

These quotes highlight the strategic advantage gained by doing difficult tasks that competitors are unwilling to undertake. Amazon's investment in infrastructure is used as an example of building a sustainable competitive advantage.

• The acquisition is evaluated in terms of its success for Amazon.
• The unique aspects of Zappos, such as its customer-centric approach, were considered valuable to Amazon.
• The acquisition is seen as a good use of capital, although not transformative.
• The conversation concludes with personal book recommendations from Alfred Lin and acknowledgments of the value of curiosity and learning from historical figures.

"I think that on its own, Zappos was a great business." "It's hard to see this not being a good use of capital for Amazon."

These quotes reflect the assessment of Zappos' acquisition by Amazon, suggesting that while it may not have been transformative, it was still considered a good use of capital due to Zappos' strengths as a business.