Why I Sold Zappos

Why I Sold Zappos

Tony Hsieh built his online shoe retailer into an
e-commerce powerhouse. But with credit tightening and investors eyeing
the exits, Hsieh was forced to ask: Was selling Zappos really the only
way to save it?

tonyheish.jpg 

The first time Amazon.com tried to buy Zappos,
we said no without even thinking.

It was the summer of 2005, and Zappos, the start-up into which I’d
poured the past five years of my life (and almost all of my money),
finally seemed to be on the right track.

Zappos sells shoes and apparel online, but what distinguished us from
our competitors was that we’d put our company culture above all else.
We’d bet that by being good to our employees — for instance, by paying
for 100 percent of health care premiums, spending heavily on personal
development, and giving customer service reps more freedom than at a
typical call center — we would be able to offer better service than our
competitors. Better service would translate into lots of repeat
customers, which would mean low marketing expenses, long-term profits,
and fast growth. Amazingly, it all seemed to be working. By 2005, gross
merchandise sales were $370 million, and we made the Inc. 500. We
weren’t profitable yet, but we were close to breaking even, and our
revenue was growing quickly.

At the time, we made almost all our money selling shoes, but our hope
was that we’d eventually go into all sorts of other businesses. We saw
Zappos as a global brand like Virgin — except whereas Virgin was about
being hip and cool, Zappos would be about offering the best service. The
plan was to grow sales to $1 billion by 2010 and eventually go public.

These ideas about the power of our company culture had yet to be
proved. As I talked to Amazon founder and CEO Jeff Bezos, who
visited our headquarters in 2005, I realized that to Amazon, we were
just a leading shoe company. If we sold, we’d probably be folded into
their operations, and our brand and culture would be at risk of
disappearing.

That was why we told Jeff that we weren’t interested in selling at
any price. I felt like we were just getting started.

Four years later, Amazon came calling again — and again my
impulse was to say no. Our sales had grown steadily since 2005; by 2008
we were doing more than $1 billion in gross merchandise sales annually
— two years ahead of our original plan. We were now profitable, and our
culture was even stronger. As before, our plan was to stay independent
and eventually go public.

But our board of directors had other ideas. Although I’d 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.

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.

That wasn’t our only potential cash-flow problem. Our line of credit
was "asset backed," meaning that we could borrow between 50 percent and
60 percent of the value of our inventory. But the value of our inventory
wasn’t based on what we’d paid. It was based on the amount of money we
could reasonably collect if the company were liquidated. As the economy
deteriorated, the appraised value of our inventory began to fall, which
meant that even if we hit our numbers, we might eventually find
ourselves without enough cash to buy inventory.

These issues had nothing to do with the underlying performance of our
business, but they increased tensions on our board of directors. 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.

On some level, I was sympathetic to the board’s position. The truth
was that if we pulled back on the culture stuff, the immediate effect on
our financials would probably have been positive. It would have reduced
our expenses in the short term, and I don’t think our sales would have
suffered much at first. But I was pretty sure that in the long term, it
would have ruined everything we had created.

By early 2009, we were at a stalemate. Because of a complicated legal
structure, I effectively controlled the majority of the common shares,
so that the board couldn’t force a sale of the company. But on the
five-person board, only two of us — Alfred Lin,
our CFO and COO, and myself — were completely committed to Zappos’s
culture. This made it likely that if the economy didn’t improve, the
board would fire me and hire a new CEO who was concerned only with
maximizing profits. The threat was never made overtly, but I could tell
that was the direction things were going.

It was a stressful time for me and Alfred. But we’d gotten through
much tougher times before, and this seemed like just another challenge
we needed to figure out. We began brainstorming ways that we could get
out from under the board. We certainly didn’t want to sell the company
and move on to something else. To us, Zappos wasn’t just a job — it was
a calling. So we came up with a plan: We would buy out our board of
directors.

We figured to do so would cost about $200 million. As we were
talking to potential investors, Amazon approached Alfred about buying
Zappos outright. Although that still didn’t seem like the best option to
me, Alfred sensed that Amazon would be more open than last time to the
idea of letting Zappos continue to operate as an independent entity. And
we felt that the price Amazon was talking about was too large for us to
ignore without potentially violating our fiduciary duty to our
shareholders.

In April, I flew to Seattle for an hourlong
meeting with Jeff Bezos. I gave him my standard presentation on Zappos,
which is mostly about our culture. Toward the end of the presentation, I
started talking about the science of happiness — and how we try to use
it to serve our customers and employees better.

Out of nowhere, Jeff said, "Did you know that people are very bad at
predicting what will make them happy?" Those were the exact words on my
next slide. I put it up and said, "Yes, but apparently you are very good
at predicting PowerPoint
slides." After that moment, things got comfortable. It seemed clear that
Amazon had come to appreciate our company culture as well as our strong
sales.

Still, I had plenty of concerns. Jeff’s approach to business had been
very different from my own. One of the ways that Amazon tries to
deliver a great customer experience is by offering low prices, whereas
at Zappos we don’t try to compete on price. If Amazon gets a lot of
customer service calls, it will try to figure out why — maybe there’s
something confusing about the product description — and then it will
try to fix the problem so that it can reduce the number of phone calls,
which keeps prices low. But at Zappos, we want people to call
us. We believe that forming personal, emotional connections with our
customers is the best way to provide great service.

But as I talked to Jeff, I realized that there were similarities
between our companies, too. Amazon wants to do what is best for its
customers — even, it seemed to me, at the expense of short-term
financial performance. Zappos has the same goal. We just have a
different philosophy about how to do it.

I left Seattle pretty sure that Amazon would be a better partner for
Zappos than our current board of directors or any other outside
investor. Our board wanted an immediate exit; we wanted to build an
enduring company that would spread happiness. With Amazon, it seemed
that Zappos could continue to build its culture, brand, and business. We
would be free to be ourselves.

Negotiations with Amazon began shortly afterward. Amazon
initially offered to buy Zappos in cash, but that didn’

t sit well with us. In our minds, a cash deal felt too much like we were
selling the company outright, so we proposed an all-stock transaction.
Zappos shareholders would simply trade their stock for Amazon stock. We
saw the deal less as an acquisition than as a marriage. An all-stock
deal would be analogous to a married couple opening a joint bank
account.

In June, Jeff sent a formal proposal to buy Zappos in stock, which
our board voted to accept on July 20. We persuaded Amazon to let us
break the news to our managers. So at around noon on July 22, an hour
and a half before the markets closed and the deal was publicly
announced, I stood in front of about 50 of our most senior employees in
our training room and explained what we were doing. It was a speech
about the most important thing in my life, and all the nervousness that I
used to feel when I first started speaking in public came back.

I spoke for half an hour and told them to explain to their staffs
that nothing was going to change: They would still have their jobs, and
the Zappos culture would still be our own. But now, we would be able to
do new things more quickly.

At first, everyone in the room was anxious — some had assumed I was
leaving the company; others didn’t know what to think — but as I spoke,
I could see the relief come over people’s faces. They went back to
their desks, gathered their staffs, and told them what was happening.
Within a couple of hours, everyone had gone back to work. In the
hallways, I overheard employees talking about how excited they were
about having access to Amazon’s resources. Two days later, I gathered
our Las Vegas team — roughly
700 employees at the time — in a conference center to address any
additional questions. Party music filled the room, and employees threw
beach balls around into the crowd. The energy was amazing. It felt like
the beginning of the next leg of our journey.

The acquisition closed on November 1, at a valuation of $1.2
billion (based on Amazon’s stock price on the day of closing). Our
investors at Sequoia made $248 million. Our board was replaced by a
management committee that includes me, Jeff, two Amazon executives, and
two Zappos executives. As CEO, I report to the committee every quarter,
and Zappos is responsible for hitting revenue and profitability numbers.
But unlike our former board of directors, our new management committee
seems to understand the importance of our culture — the "social
experiments" — to our long-term success. In fact, one Amazon
distribution center recently began experimenting with its own version of
Zappos’s policy of paying new employees $2,000 to quit if they’re
unhappy with their jobs.

Otherwise, Zappos continues to operate independently. Our
relationship is governed by a document that formally recognizes the
uniqueness of Zappos’s culture and Amazon’s duty to protect it. We think
of Amazon as a giant consulting company that we can hire if we want —
for instance, if we need help redesigning our warehouse systems.

In the first quarter of 2010, net sales at Zappos were up almost 50
percent, and we’ve added several hundred new employees. The growth has
made Amazon very happy, but it’s also creating new challenges. I’ve
noticed that at company happy hours, you don’t see as many employees
from different departments hanging out with one another.

To address that, we’ve begun tracking employee relationships. When
employees log in to their computers, we ask them to look at a picture of
a random employee and then ask them how well they know that person —
the options include "say hi in the halls," "hang out outside of work,"
and "we’re going to be longtime friends." We’re starting to keep track
of the number and strength of cross-departmental relationships — and
we’re planning a class on the topic. My hope is that we can have more
employees who plan to be close friends.

That’s just one small thing that we’re doing to make sure our culture
gets stronger and that our employees are happy. We have close to 1,800
employees now, and I think we’re proof that a company doesn’t have to
lose itself as it grows bigger — or even after it gets acquired.

This article is adapted from Hsieh‘s
new book,
Delivering Happiness: A Path to Profits, Passion, and
Purpose. Inc. senior writer Max Chafkin contributed additional
reporting.

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