The Fuqua School of Business
4/16/011
D. E. Shaw & Co.
The Manhattan skyline was hazier than normal on this late June 1994 day as David Shaw
looked from his 39th floor office, with its book-lined wall and buffed aluminum table shaped on an
ancient mathematical ratio, towards the Hudson River. Today, he was trying to predict what his
very popular and accomplished senior vice president would tell him. Two days earlier, Jeff Bezos
had announced his interest in leaving D. E. Shaw & Co. to launch an online bookstore. At that time,
the two talked for several hours and David told Jeff that he could have a bright future at the firm,
and reminded him that he would be giving up a seven-figure income and deferred compensation for
uncertainty. David convinced Jeff to reflect on his decision for 48 hours, during which time David
did his own reflecting. The idea for launching an online bookstore was developed under David’s
initiative, with David’s direct assistance, and with D. E. Shaw & Co.’s money. Should he lay claim
to the idea? Should he give Jeff additional incentive to stay with the firm? Basically, he questioned
whether D. E. Shaw & Co. should be in the online retail bookselling business.
David E. Shaw
David E. Shaw was born in 1951, and spent most of his early adult life in Los Angeles.
After graduating from the University of California at San Diego, he earned a Ph.D. in computer
science at Stanford University. While at Stanford, David distinguished himself both academically
and by his extra-curricular activities. While still a student, he founded a successful computer
software company called Stanford Systems Corporation. (See Exhibit 1 for a photograph of David
Shaw.)
In the early 1980s David accepted a teaching position with the faculty of computer science
at Columbia University, and eventually took over as head of Columbia University’s project on NonVon computers used in artificial intelligence. Growing tired with academia, he left Columbia
University in 1986 for Morgan Stanley’s proprietary trading unit. The unit invested some of
Morgan Stanley’s money using trading models based on algorithms. David was hired on to develop
the unit’s technology and introduced distributed-network computing, but his curiosity refused to
limit him. Here he learned about finance, became interested in computational trading and
developed a few ideas himself. In 1988, two years after he joined Morgan Stanley, he left to start
the firm that bears his name: D. E. Shaw & Co.
This case was prepared by Andrew V. Frankel (MBA candidate, 2002) for Foundations of Strategy as the basis for
discussion rather than to illustrate either effective or ineffective handling of an administrative issue. D. E. Shaw & Co.
did not cooperate on this project. Certain assumptions were made based on press accounts and the author’s own
experience as an outside consultant to D. E. Shaw & Co. on investments in the former Soviet Union, and who reported
directly to David Shaw and Jeff Bezos.
Copyright © 2001 by Andrew V. Frankel. All Rights Reserved. No part of this publication may be reproduced, stored in
a retrieval system, used in a spreadsheet, or transmitted in any form or by any means –electrical, mechanical,
photocopying, recording, or otherwise—without the permission of the copyright holder. The copyright clearance, contact
Andrew V. Frankel; e-mail: avf2@duke.edu.
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D. E. Shaw & Co.
The Company
David founded D. E. Shaw & Co. in 1988 with roughly $28 million in capital. The initial
investment capital came from less than ten investors and was arranged by Donald Sussman, of
Paloma Partners, a successful trader himself. By mid 1995, the firm’s capital had grown to over
$350 million, and average annual returns were slightly better than 25 percent, with no losing years.
The firm’s success was attributable to several factors. David was extraordinarily selective
in his hiring practices. Only one percent of applicants were hired. David believed in hiring raw
intelligence. Employees, including secretaries, were vetted based on SAT scores, academic
transcripts, and personal recommendations. The firm did not hire for a specific position or people,
for that matter, with any knowledge of finance. Rather, D. E. Shaw & Co. hired people with
degrees primarily in computer science, mathematics, statistics, and physics from the very best
schools and taught them finance. The assumption was that the person would someday make money
for the firm.
The culture of the firm was decidedly academic and quantitative. Employees dressed in
blue jeans – David was an exception, preferring to wear a suit and tie -- and worked flexible hours.
There was no formal vacation policy. Employees took vacations when they needed them. The
firm’s quantitative culture was physically represented by its company logo, a microprocessor switch
(see Exhibit 2), and by the rectangles cut into the walls that one architectural magazine said evoked
images of computer chips (see Exhibit 3). And there were a large number of computers, including
over 50 Sun Microsystem workstations.
The collegiality of the firm did not extend, however, to one area. The firm was
exceptionally secretive, and in this way it more resembled the National Security Agency, than an
academic department or Wall Street firm. Employees were required to sign a rigid non-disclosure
agreement.
The firm’s management style also reflected some ambiguity. On the one hand, employees
were encouraged to do things differently, if they thought it was better. On the other hand, most
important decisions emanated from the center and were made by David himself. In fact, David
closely scrutinized many minor details. This ambiguity and general lack of organization led to a
high turnover rate. In 1992, the firm hired Mark Lipton, a finance professor from the New School
of Social Research, to address this problem. Lipton discovered communication problems and
recommended that David write a mission statement, which David never did.
Proprietary Trading
The firm describes itself as “the intersection between technology and finance.” The firm
makes trades based on algorithms that scour worldwide markets in stocks, bonds, currency futures
and, particularly, options for tiny price anomalies. Most of the trading is done by computers, which
execute millions of trades of one-eight to a quarter of a point that other investors never see. (See
Exhibit 4 for a view of D. E. Shaw & Co.’s trading floor.) Trading volume can reach 10 million
shares in a single day, an amount equivalent to ten percent of the entire daily volume on the New
York Stock Exchange.
The firm’s algorithms identify undervalued securities and hedge all investments.
Computers create a market neutral position by selling a long bond, for example, against a short
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D. E. Shaw & Co.
position in hundreds of securities. This trading strategy helped disguise D. E. Shaw & Co.’s
investments, and helped ensure the firm’s low risk strategy and abnormally high profits.
Explores New Business Opportunities
However, by late 1991 D. E. Shaw & Co. was beginning to see limits to its quantitative
proprietary trading. Some of its trading strategies could not absorb more capital without a
significant negative effect on returns. Inefficiencies in the market were being squeezed as more
“smart money” entered the market. As a result, the firm found itself with excess capital. So, with
the consent of his investors, David began brainstorming with staff to see if they could come up with
promising new business ideas that respected the firm’s cautious investment philosophy. The result
was that for every ten ideas generated, nine were dismissed almost immediately.
Beginning earnestly in 1992, the firm explored a number of business opportunities,
including trade finance, investments in the former Soviet Union, and custom derivatives. In early
1992, David put Jeffrey Bezos in charge of developing off-board trading in listed securities, the
“Third Market” project. By early 1993, the first off-board trade was completed. In 1994, David put
Jeff in charge of exploring commercial opportunities on the Internet, a decision that eventually led
to the current situation.
Online Commerce
The Internet – or ARPAnet as it was originally know -- was initially developed by the
Defense Advanced Research Projects Agency (DARPA) for redundant computer-to-computer
communication, designed to withstand disruption in the event of nuclear war. Its users were mostly
academics. In the 1980s, the network was broken into two parts: Milnet for government and
military traffic and the NSFnet (so named because it received funding from the U.S. National
Science Foundation) for academic use. In 1991, the first commercial Internet connection,
Commercial Internet Exchange, became available.
Prior to mid 1993, navigating around the Internet required the knowledge of basic UNIX
computer commands. There were two main methods for distributing information. Telnet allows
users to log into a remote computer via the Internet. FTP allows a remote computer to run the
server, but requests are limited to uploading or downloading a file. (See Exhibit 5 for a brief
description of several programs used for navigating the Internet.)
In 1993 an important change came when Tim Berners-Lee, a British computer specialist at
the European Laboratory for Particle Physics (CERN) in Geneva, developed the World-Wide-Web.
The networking protocols developed by Berners-Less enabled the user to navigate the Internet with
point-and-click commands made possible by “hyperlinks.”
The second milestone came in October 1993 when a group of software developers working
at the National Center for Supercomputer Application (NCSA) and students at the University of
Illinois at Champaign created a program for browsing the World-Wide-Web. Before Mosaic,
finding information on the World-Wide-Web required knowing commands like “Telnet
191.1000.82.900.” But the real breakthrough came, however, a few months later when this team of
software developers created a version of Mosaic that ran on the Apple Macintosh as well as on
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D. E. Shaw & Co.
Microsoft operating systems that they made available for free. Several hundred thousand users
acquired Mosaic in less than a year.
The development of the World-Wide-Web, the accessibility of Mosaic, and commercial
online services such as America Online and Compuserve helped grow the Internet in early 1994 by
2,300 percent per year, from roughly 2,000 users of the Internet in 1981 to about 20 million users.
NSFnet, the main U.S. high-speed backbone of the Internet, was opened to private
commerce in fall 1992. Already, nearly 60 percent of all registered domain names were commercial
organizations, or dot com’s. By June 1993, commercial use accounted for 29 percent of all Internet
traffic. Still, several problems stood in the way of the commercial viability of the Internet.
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The Internet was so slow that people were calling it the “World Wide Wait.”
For security reasons, buyers and sellers were reluctant to use credit cards.
There were problems identifying customers.
But most important, the technology that existed was not broadly enough adapted.
Jeffrey Bezos
Jeffrey Bezos was born on January 12, 1964 into a closely-knit upper middle class family.
Jeff’s stepfather, a Cuban refugee, was an executive with Exxon. Jeff spent most of his childhood
in Texas or Florida, and showed an early interest in science fiction and aptitude for technology. At
the age of nine, Jeff was the subject of a 1977 book on the education of gifted children in the
Houston area. Several years later, he graduated as Florida’s Palmetto High School class
valedictorian.
Jeff headed to Princeton University in 1982 with the intent to major in physics, but he
switched his major to electrical engineering and computer science when he discovered he was not
going to be the next Albert Einstein. Graduated with a 4.2 grade-point average in his major
(Princeton awards a 4.3 for an A+), Jeff had offers from Anderson Consulting and several other
more established firms, but chose instead to join a start-up financial telecommunications company,
Fitel. Fitel was building a global telecommunications network to settle cross-border equity sales.
Jeff joined Fitel in May 1986 as manager of administration and development. In February
1987, he was promoted associate director of technology and development and put in charge of
developing and promoting Equinet, a network designed for cross-border trades.
In April 1989, he left Fitel for Bankers Trust. There he developed software to manage the
firm’s pension fund clients, and after 10 months on the job, at age 26, he was named the youngest
vice president in the history of the firm.
Feeling stifled at Bankers Trust, Jeff was ready to leave the financial industry altogether
when a headhunter convinced him to interview with D. E. Shaw & Co. Jeff was so impressed with
David Shaw, that he joined the firm in December 1990.
Jeff spent most of his time at D. E. Shaw & Co. leading a unit charged with exploring and
developing new business for the firm. For example, Jeff was put in charge of the Third Market
trading operations, and was rewarded for his efforts with the promotion to senior vice president, at
age 28, and the youngest of four at D. E. Shaw & Co.
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D. E. Shaw & Co.
Explores Internet Opportunities
In early 1994, David Shaw asked Jeff to begin exploring commercial opportunities on the
Internet. David was quick to realize the commercial potential of the Internet. Jeff met regularly
with David for a few hours each week to brainstorm ideas, and then Jeff would go off and conduct
exhaustive research.
Jeff drew up a list of 20 viable products to sell on the Internet, and based on several criteria
narrowed that list to five (compact discs, videos, computer hardware, computer software, and
books) before ultimately settling on books.
Jeff settled on books for a number of reasons:
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The bookselling industry was large and fragmented, with no single dominant publisher or
retailer. This would make it difficult for competitors to lock out an outsider (see Exhibits 6
and 7).
U.S. book sales had been growing at a steady rate for several years. Worldwide book sales
were expected to reach $82 billion in 1996. (See Exhibit 8 for information on retail sales by
U.S. bookstores.)
He wanted a low-priced product that would be acceptable to first-time purchasers on the
Internet concerned about security and reliability.
There are over 3 million books in print worldwide across all languages (compared to
roughly 300,000 CDs). That large number meant he could leverage the Internet’s search
capabilities that made it easy to “browse” by title, author, publisher, and keyword.
There was no way to have a 3 million-title bookstore in the physical world. The largest
physical bookstores only have roughly 175,000 titles, while the number is considerably less
for the typical mall bookstore (about 25,000 titles).
It would not be possible to compete with an online bookstore by catalog sales, because if
one were to print a catalog of all books in print, it would be larger than 50 New York City
telephone books.
A list of books in print was already available on CD-ROM.
Books could be easily obtained directly from publishers or distributors.
Books do not require explanation. Everyone knows what a book is.
The people currently using the Internet were frequent buyers of books.
At the time Jeff was developing his idea, the Internet Shopping Network launched.
Organized like a “virtual” shopping mall, it was a one-stop source for over 10,000 software and
hardware items. Several retail booksellers had also already established themselves online. (See
Exhibit 9 for a list of online bookstores.) Jeff expected that Barnes & Noble, the largest U.S. retail
bookseller, would sell books online eventually, but he believed a first-mover advantage built on
strong customer service would allow his online bookstore to compete.
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D. E. Shaw & Co.
Exhibit 1: David E. Shaw
Source: D. E. Shaw & Co. web page
Exhibit 2: D. E. Shaw & Company Logo
Source: D. E. Shaw & Co. web page
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D. E. Shaw & Co.
Exhibit 3: Lobby Interior at D. E. Shaw & Co.’s New York Office
Source: D. E. Shaw & Co. web page
Exhibit 4: D. E. Shaw & Co.’s Highly Computerized Trading Room
Source: D. E. Shaw & Co. web page
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D. E. Shaw & Co.
Exhibit 5: Internet Navigation Programs Existing Prior to the World-Wide-Web
Archie: Searches public archives, telling the user all the different places on the Internet where he
can find the information he seeks.
Gopher: Uses menus to browse through available information and transfer it to one’s computer.
WAIS (Wide-Area Information Servers): Similar to Archie or Veronica but smarter. WAIS
responds to questions with a list of possible choices.
Veronica: Collects all the words in the Gopher menu lists. Like WAIS, it builds a database that can
be searched with simple questions.
Exhibit 6: Comparative Bookstore Market Share, FY1994
Sales
(US$,
million)
Total All Bookstores
10,570.0
Four Largest Chains
3,611.5
Barnes & Noble
1,622.7
Borders Group
1,511.0
Crown Books
305.4
Books-A-Million
172.4
All Other Bookstores
6,958.5
Source: American Booksellers Association
%
100
34.2
15.4
14.3
2.9
1.6
65.8
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D. E. Shaw & Co.
Exhibit 7: Retail Bookselling Channels, 1994
Retail Bookselling Channels
1994
21.4%
24.3%
Barnes & Nobles and
Borders Group, Inc.
Nonstore outlets (mail
order, book clubs,
warehouse stores)
Independent stores
54.3%
Source: Consumer Research Study on Book Purchasing
Source: Consumer Research Study On Book Purchasing
Exhibit 8: 1991-1993 Retail Sales for Bookstores (Unadjusted)
1991
1992
(US$,
(US$,
Period
millions)
millions)
January
750
813
February
499
548
March
520
541
April
497
526
May
523
553
June
529
587
July
539
589
August
807
889
September
778
854
October
597
640
November
655
636
December
1,037
1,153
Total Bookstore Sales
7,731
8,329
Total Retail Sales
1,855,937
1,951,589
Source: American Booksellers Association
9
1993
(US$,
millions)
992
569
604
586
617
624
615
996
916
704
690
1,297
9,199
2,073,839
% Increase
1992 over
1991
8.4
9.8
4.0
5.8
5.7
11.0
9.3
10.2
9.8
7.2
-2.9
11.2
7.7
5.2
% Increase
1993 over
1992
22.0
3.8
11.6
11.4
11.6
6.3
4.4
12.0
7.3
61
10.7
12.5
10.4
6.3
D. E. Shaw & Co.
Exhibit 9: Selected Bookstores Available Electronically As of June 1994
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Computer Literacy, Sunnyvale, California
o Registered its domain name cdbooks.com on August 25, 1991
o Accepted book orders via e-mail
o Catered to computer engineers and scientists
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BookStacks Unlimited, Cleveland, Ohio
o Registered books.com on October 9, 1992
o In 1993, offered a connection to the Internet with Telnet
o In 1994, launched a website on the World Wide Web, offering about 400,000 titles
o Most of its titles sell at list price
o Books searchable by author, title, subject, keyword, or ISBN
o Purchases earn credits towards free books
o Publishes an electronic newsletter
o Invites users to share their reviews
o Ten percent of profits go to a non-for-profit that helps Americans to read
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Wordworth’s, Cambridge, Massachusetts
o Registered wordsworth.com on December 23, 1992
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The Internet Book Shop, United Kingdom
o Founded in 1993
o First appeared online in June 1994
o Lists about 780,000 titles, and expects to have more than 2 million in the near future
o Expects to add German-language titles
o Does not stock books itself; rather, it relays orders to traditional retailers and earns five
percent on each sale
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The Internet Bookstore, Arlington, Virginia
o Opened for business on May 31, 1994
o Requires that a user plug in an encryption device into the computer’s printer port
o Customers download electronic books that are formatted in plain ASCII text
o Information on available books includes: a one-line catalog entry, a one-paragraph “blurb,”
and an extended write-up that can run to several pages
o Revenues are divided between the publisher (60%), The Internet Bookstore (30%), and the
operator of the Internet node (10%)
o Does not allow returns
o Books are priced at about 30 percent of the hardcover price
o Once an order is placed, delivery is completed in 30 seconds
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Harper San Francisco
o Set up an ordering service on CompuServe in November 1993
o As of mid-December 1993, the company sold about 400 books through its electronic
bookstore
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Future Fantasy Books, Palo Alto, California
o Sells science fiction books
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Quantum Books, Massachusetts
o Inventory of 20,000 titles that is constantly changing
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D. E. Shaw & Co.
Bibliography
David E. Shaw and D. E. Shaw & Co.
1. “Morgan Stanley to Use Sun Systems For Automated Trading; Purchase Includes
Workstations, Network, Application Software,” Business Wire, March 17, 1987
2. “Computer Whiz Tops Trading Rivals By Using Math to Master Markets,” Craig Torres,
The Wall Street Journal Europe, October 15, 1992
3. “D.E. Shaw Invades the Third Market With Risk Technology,” Ivy Schmerken, Wall Street
& Technology, February 1, 1994
4. “’Computational Finance’ With David Shaw,” Michael Peltz, Institutional Investor, March
1, 1994
5. “Reprogramming D.E. Shaw; Why Does One of Wall Street’s Great Traders Want to
Become A Banker?,” Hal Lux, Investment Dealers Digest, September 4, 1995
6. “Profiles; New Executive: David E. Shaw; Street Computer Whiz Takes A Mega-Bite Of
Tech Start-Ups: Clinton Advisor Extends Reach Of Trading Shop Via Techno-Spending,”
Alice Lipowicz, Crain’s New York Business, October 30, 1995
7. “Getting Real: For Years, D.E. Shaw Billed Itself As a Maverick Home to Financial
Wizards, But When Trouble Came, It Looked A Whole Lot Like Any Other Street Firm,”
Heike Wipperfurth, Investment Dealers Digest, April 12, 1999
8. “The Shaw Tank Redemption – Fund Manager Bounces Back With New Successes,”
Robert Clow, New York Post, November 26, 2000
The Internet and Internet Commerce
1. “The Significance and Impact Of the Commercial Internet,” William Schrader and Mitchell
Kapor, Telecommunications, February 1, 1992
2. “On-line Bookstores Carry Big Inventories,” Ash Nallawalla, The Age, March 9, 1993
3. “Growing Internet Connects Worldwide Web Of Users,” Frank Bajak, Austin-American
Statesman, May 31, 1993
4. “Millions Of Users Plug In to Huge Computer Network,” John Eckhouse, The San
Francisco Chronicle, June 1, 1993
5. “’Cyberbiz’” On the Internet: a WAIS to Go,” Larry Krumenaker, Searcher, July 1, 1993
6. “Book Stacks Unlimited Now On Internet,” Worldwide Videotex Update, Worldwide
Videotex, November 1, 1993
7. “Mosaic Software Places A World of Information Just A Click Away,” John Markoff, New
York Times News Service, Portland Oregonian, December 19, 1993
8. “Computer Services Seen As a Sales Tool for Books,” Sarah Lyall, The New York Times,
December 20, 1993
9. “Publishing On the Internet For Fun and Profit,” Peter E. Dyson, The Seybold Report On
Desktop Publishing, April 4, 1994
10. “Linking Up to A Global Network,” Wallys W. Conhaim, Link-Up, May 1, 1994
11. “Browse These Hangouts, Maybe Buy A Book or Two,” Miguel Llanos, The Seattle Times,
May 22, 1994
12. “Techno-Babble Internet Changing the Face of Reading,” Yardena Arar, Los Angeles Daily
News, June 27, 1994
13. “The Internet Bookstore Opens For Business,” Link-Up, July 1, 1994
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D. E. Shaw & Co.
14. “Business In Cyberspace: Commerce Ventures Into the Internet,” Nate Zelnick, PC
Magazine, August 1, 1994
15. “Silicon Valley Big Guns Promote Business On the Internet With CommerceNet,” Jim
O’Brien, Computer Shopper, August 1, 1994
16. “U.K. Internet Shops Show Slow, Steady Growth,” John Mutter, Publishers Weekly,
October 9, 1995
Jeffrey Bezos
1. “Amazon.com Founder Discusses How He Started the On-Line Book Store,” Catherine
Crier, Fox News: The Crier Report, September 2, 1997
2. “Jeff Bezos: How He Built A Billion-Dollar Net Worth Before His Company Even Turned
A Profit,” Lesley Hazelton, Success, July 1, 1998
3. “Five Questions With Jeffrey P. Bezos,” Saul Hansell, The New York Times, October 11,
1998
4. “7 Selling To Customers; Amazon.com,” Eryn Brown, Fortune, May 24, 1999
5. “Playboy Interview: Jeff Bezos,” Playboy, February 1, 2000
6. “Taking On All Dot.comers,” Geoffrey Owen, Management Today, April 1, 2000
7. “Child Prodigy, Online Pioneer; Amazon.com Founder Bezos hires Great Minds. But Will
It Matter?,” Mark Leibovich, The Washington Post, September 3, 2000
Books and Manuscripts
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1999 Masters Thesis: Online Bookselling 1999, Anita E. Hennessey, New York University
Center for Publishing, 1999
Amazon.com, Get Big Fast, Robert Spector (HarperBusiness, New York: 2000)
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