Amazon's core? Frugality

March 26, 2012: 2:29 PM ET

Amazon has transformed itself from an online book seller into one of the world's most important technology giants thanks in large part to a devotion to thriftiness.

amazonFORTUNE -- If such a thing as corporate DNA exists, it has animated the rise of the last decade's most successful technology companies. Google had a relentless focus on data, Apple a Zen-like obsession with simplicity, and Facebook a world of social connections to mine. Amazon has relied on an altogether more prosaic trait: thriftiness.

The Seattle-based online book store transformed itself into an e-commerce giant by developing a gospel of saving that informs everything from its operations to its brand identity and new products like the Kindle Fire tablet. "Cost-cutting is the corner-stone of Amazon (AMZN)," says RJ Hottovy, director of equity research at Morningstar (MORN). Because the firm doesn't suffer the costs of maintaining real-world stores, it has been able to charge consumers less.

According to the Chicago-based investment banking firm William Blair & Company, the prices of goods sold by Amazon are up to 13% lower than its online and brick and mortar competitors. With more than 160 million active users, the company currently accounts for 20% of all U.S. online retail sales. Analysts expect it to grow further, picking up new customers at a clip of 20% year-over-year. Meanwhile, overall online retail, which accounts for 10% of all U.S. sales is expected to also grow, albeit more slowly at approximately 1% a year by some estimates. Online retail is expected to be worth some $226 billion this year, according to Forrester Research (FORR).

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That has shaped the firm's brand in the minds of consumers. To competitors, Amazon has increasingly become a challenger, and in some cases like the defunct Circuit City and Borders, played a hand however small in their doom.

In the last year, the company has become even more aggressive. One Saturday last December, it made shoppers a compelling offer. Those who used its free Price Check mobile app to compare the price of an item at a physical store with Amazon.com's price received 5% off the same product. (The maximum discount was $5 for each item.) This reportedly tripled usage of the Price Check app that particular weekend but also generated heavy criticism, with one New York Times op-ed describing the tactic as "scorched-earth capitalism." The company countered that, "the goal of the Price Check app is to make it as easy as possible for customers to access product information, pricing information and customer reviews, just as they would on the Web."

For Amazon, savings are more than a competitive matter. Indeed, the company holds "frugality" up as one of 14 leadership principles. (It "breeds resourcefulness, self-sufficiency and invention," the company says on its corporate site.) That goes back to 1994, when CEO Jeff Bezos jump-started the e-commerce company and jury-rigged a desk out of a door. "Door desks" became a popular staple within the company years after it went public, and remained "the quintessential example" of Amazon's frugality, ex-employee Greg Linden explained in 2006. The company still hands out the "Door Desk Award," a title given internally to select employees who have a "well-built idea" that creates a significant savings for the company and enables lower prices for customers.

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That same sense of frugality bleeds into other areas of corporate culture as well. In 2009, Bezos revealed at the company's annual shareholders meeting that all the light bulbs were taken out of cafeteria vending machines. "Every vending machine has light bulbs in it to make the advertisement more attractive," Bezos explained. "So they went around at all of our fulfillment centers and took all the light bulbs out." While Amazon estimated then the measure saved just tens of thousands a year on electricity, it speaks to the way the $48 billion company thinks.

The question now is, can Amazon keep prices low as it grows? Last year, the company spent $4.6 billion on 17 new fulfillment centers, which helped push operating expenses up 44% for the year. And this year, the company plans to continue spending, opening more fulfillment centers and potentially updating products like the Kindle Fire tablet, a product many analysts believe the company is losing money on. Some investors have been skittish about Bezos' spending.

Management hasn't shied away from large acquisitions either. To wit, the $775 million takeover of Kiva Systems, a manufacturer of robots that move items around warehouses. The acquisition will be the second-largest for Amazon, which already employed Kiva robots for Zappos and Quidsi, the parent company of Diapers.com and Soap.com. "Often, lowering your infrastructure costs or distribution costs is the pathway to lower prices for high quality, service, and selection," explains Citigroup (C) analyst Mark Mahaney.

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The move may prove costly in the short-term, but could streamline operations further by increasing the number of items being processed and shipped through Amazon warehouses. That, in turn, could give the company advantages over competitors and cost advantages over time. And while analysts Fortune spoke to wouldn't quantify just how much the acquisition might save Amazon in the long run, they did say it could chip away at the significant costs of fulfilling orders. (According to Citigroup, Amazon spent $4.5 billion just on fulfillment costs last year, the equivalent of 9.5% of the company's 2011 revenues.)

There's also the issue of state sales taxes. To date, Amazon hasn't charged sales tax in many states, a significant factor in its ability price aggressively. According to The Wall Street Journal, the company so far has taken measures to keep it that way. One tactic reportedly includes having staff who travel around the U.S. consult a map indicating which states require company permission before entering, the belief being that the employee's actions could become cause for Amazon to collect taxes in those states. If Amazon were forced to pay state sales taxes, which many analysts believe is inevitable, it may narrow the lead Amazon has over other competitors, halving its cost advantage. William Blair & Company compare the change to raising a bar six inches for a high jumper who can already clear it by one foot.

Still, there would be ways to keep prices under control, whether it's experimenting with shipping costs or the pricing structure of Amazon Prime. "I wouldn't really look at it as a major blow," says Hottovy. "Given what they were able to do in terms of customer acquisition right now, I think you'll have loyalty remain even if you see some sort of pricing parity with other competitors."

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About This Author
JP Mangalindan
JP Mangalindan
Writer, Fortune

JP Mangalindan is a San Francisco-based writer at Fortune, covering Silicon Valley. Since joining in 2010, he has written on a wide array of topics, from the turnaround of eBay to the evolution of net neutrality. A graduate of Fordham University, Mangalindan has also written for GQ, Popular Science, and Entertainment Weekly.

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