Amazon’s Three Difficult Choices

  • Posted: 02 October 2011 08:17 PM #61

    The case against the Kindle as a low end tablet disruption

    By Horace Dediu

    “...before we jump to analyzing the disruption hypothesis we should determine whether and to what extent Amazon profits from the device directly. Profitability gives us a clue to where Amazon will apply resources and thus establish its trajectory of improvement.”

    In other words, If you make your money from selling razors (as Apple does with its hardware) then you apply your resources to making better razors and you try to keep the cost of your razor blades to a minimum. If you make your money from selling razor blades (as Amazon does with its goods and services) then you apply your resources to making better razor blades and you try to keep the cost of your razors to a minimum.

    In a combined system where one asset is used to leverage another?the subsidized being sacrificed to benefit the profitable?success is conditional on one element being ?good enough? while the other ?needing improvement?.

    Apple sells content at cost to increase hardware sales. Amazon sell hardware at (or below) cost to increase goods and content sales.

    If the hardware is indeed commoditized and cannot be usefully improved, then this model works. If, on the other hand, the hardware and systems software can benefit from dramatic improvements in technology then the model fails.

    Translation: If the table has very little room for improvement, then the subsidized model succeeds. However, if Apple is able to rapidly and successfully improve the tablet then the Amazon low cost tablet model fails.

    In consoles, the vendors maintain long hardware product life-cycles to recover their hardware investment and subsidy by maximizing the number of games attached to each console.

    In other words, the makers of consoles want a very long product cycle - they do not want to upgrade their consoles very often - because that would cost them money. They want their consoles in your home for years and years and years without an upgrade because the console makers make their money on the sales of games, not consoles.

    Apple wants the exact opposite. If Apple were in the console business, they would be selling cheap games and putting out a better console year after year after year. The Apple model would encourage you to buy a console every year or at least every other year just as the actual Apple model seeks to get consumers to buy their iPhones and iPads on an annual or semi-annual cycle.

    A long cycle console business model cannot survive in a short cycle console market UNLESS there’s little or no room for console improvement. I think we all agree that tablets have lots of room for improvement, so Amazon cannot sit on their hands and let their tablet designs go stale. And this is antithetical to the Amazon model since they don’t want to put any of their money into their tablets.

    The second example is the TV set-top box business.

    This is the reason why Apple TV is having such a hard time taking off. Since the money is in the content, the cable companies subsidize the set-top boxes. The cable companies want the cheapest and longest lasting set-top boxes possible and they are willing to give them away at cost or below cost. Apple and TiVo struggle to sell their set-top boxes at a premium because the existing set-top boxes are “good enough”.

    As an aside, there are people like me who think that Comcast’s set-top boxes were inflicted on us by the devil himself. That is why I’m willing to pony up the dough to own both TiVo and an Apple TV. Most people, however, are satisfied with the low cost, good enough solution provided by their cable TV providers.

    The margins for Kindle content are thin. Very thin. ... The amount of content that needs to pass through the Kindle ecosystem (with lower prices than Apple charges) will need to be astronomical to make it profitable on the shortened cycle time the (iPad) enjoys. Thus the Kindle is likely to languish in a leisurely update cycle with users encouraged to hang on to their devices for years.

    Please note that although Horace does not think that the Fire can be a low-cost disruptor, he tentatively agrees that the Fire may be a “new market disruption”. More on that later.

         
  • Posted: 02 October 2011 08:21 PM #62

    I think Amazon buys itself some time with the Fire.  Eviscerating the tablet market at the low end to gain a beachhead, then march toward Apple with an incrementally-enabled tablet. 

    The key differentiator favoring Apple will be apps, enterprise, and integration with a more rounded ecosystem. 

    Amazon markets a tablet user who consumes on a functional device.  Apple markets a a tablet to a user who both consumes and creates.  In transportation terms, Amazon sells a Honda motorcycle and Apple sells an Acura coupe.

         
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    Posted: 02 October 2011 08:42 PM #63

    Mav - 02 October 2011 06:32 PM

    It’s exhausting to do so but I continue to make clear that I like Amazon as a company.  I buy stuff from them!

    I spend a great deal with them too.  More than any other retailer bar none.  I just don’t think it’s a good investment.  Low prices and a great return policy make for a great buying experience but as an investment ... not so much.  Especially with a nosebleed high PE and thin margins.

    BTW, I’m sitting on some Jan $130 AMZN puts.

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    Posted: 02 October 2011 09:44 PM #64

    incorrigible - 02 October 2011 11:42 PM
    Mav - 02 October 2011 06:32 PM

    It’s exhausting to do so but I continue to make clear that I like Amazon as a company.  I buy stuff from them!

    I spend a great deal with them too.  More than any other retailer bar none.  I just don’t think it’s a good investment.  Low prices and a great return policy make for a great buying experience but as an investment ... not so much.  Especially with a nosebleed high PE and thin margins.

    BTW, I’m sitting on some Jan $130 AMZN puts.

    Count me in with the crowd that spends way too much at Amazon.  Last Christmas the only other store pretty much was the Apple Store.  As far as the stock with the high P/E it is priced for perfection.  I wonder how the whole battle between the states trying to get revenue via sales tax will work out.  It’s a big loop hole that all the politicians will think is easy money.

         
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    Posted: 02 October 2011 10:23 PM #65

    pats - 03 October 2011 12:44 AM
    incorrigible - 02 October 2011 11:42 PM
    Mav - 02 October 2011 06:32 PM

    It’s exhausting to do so but I continue to make clear that I like Amazon as a company.  I buy stuff from them!

    I spend a great deal with them too.  More than any other retailer bar none.  I just don’t think it’s a good investment.  Low prices and a great return policy make for a great buying experience but as an investment ... not so much.  Especially with a nosebleed high PE and thin margins.

    BTW, I’m sitting on some Jan $130 AMZN puts.

    Count me in with the crowd that spends way too much at Amazon.  Last Christmas the only other store pretty much was the Apple Store.  As far as the stock with the high P/E it is priced for perfection.  I wonder how the whole battle between the states trying to get revenue via sales tax will work out.  It’s a big loop hole that all the politicians will think is easy money.

    AMZN just threatens individual states with “we’ll move if you tax us and take jobs” (see Calif.), most states budgets are in the crapper with little resources for fighting them, sooooo that leaves the Feds who are favoring corps.  at this point in time and can’t agree on anything right now. Ill be really surprised if much ever happens on the tax front.

         
  • Posted: 02 October 2011 10:42 PM #66

    Mav - 02 October 2011 06:32 PM

    It’s exhausting to do so but I continue to make clear that I like Amazon as a company.  I buy stuff from them!

    Great company. One of the best. Survived the dot.com bust and thrived. Changed the way I shop.

    Mav - 02 October 2011 06:32 PM

    It’s just that in terms of strategy, Apple’s is better AND more sustainable.  There’s enough room for multiple successful smartphone and tablet vendors.  But I think the best approach is one that can cash flow your operations without having to buy your way into follow-up business.  Again, not to say Amazon’s approach can’t work.  But their margins are already tiny.  You need Amazon tablet buyers to buy more than they were already buying at a higher margin, for the tablet purchase to be profitable to Amazon when the tablet goes up to that great big recycling heap in the sky 2 years from now.

    My first thought was that Amazon never should have gone into the kindle business. They should have concentrated on getting Amazon on every device.

    However, that being said, I think they’re doing their tablet exactly right. Going head-to-head with Apple right now is only going to give you a cracked head and an awful headache. Amazon is playing it smart. They’re going where Apple isn’t and where Apple has no intention to be. Very well done.

    Not sure their model is sustainable. Low cost isn’t going to save them. But perhaps by focusing on delivery (silk) and leveraging their incredible talent for maintaining a store in the cloud, they may make the Kindle a huge success by making carving out a new category, much as Apple has done with the iPad.

         
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    Posted: 03 October 2011 01:30 AM #67

    Mercel - 02 October 2011 11:21 PM

    I think Amazon buys itself some time with the Fire.  Eviscerating the tablet market at the low end to gain a beachhead, then march toward Apple with an incrementally-enabled tablet.

    Let’s wait and see how Dell, Lenovo, Samsung, etc. respond in the next few weeks with pricing on the low end. That beachhead might be better defended than Amazon thinks.

    The iPad 2’s BOM is in the $350 range. No way Amazon can match Apple’s economies of scale, so let’s assume they can break even at $350 with lower quality components. Sell it at $299 for a loss.

    By the time this 10” Amazon tablet appears, iPad 3 will either already exist or be just around the corner. A6 + high-res screen at the same $499 price point. What if Apple decides they have the capacity to keep the iPad 2 around at $399? 25% price differential sounds like a lot, but $100 isn’t as big a deal as it once was.

    But we’re getting way ahead of ourselves. The first tablet is still vapor at this point.

         
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    Posted: 04 October 2011 04:16 AM #68

    In case this hasn’t been posted yet:

    You’re a funny guy, Mr. Bezos.

    Dear Customer,

    There are two types of companies: those that work hard to charge customers more, and those that work hard to charge customers less. Both approaches can work. We are firmly in the second camp.

    We are excited to announce four new products: the all-new Kindle for only $79, two new touch Kindles ? Kindle Touch and Kindle Touch 3G ? for $99 and $149, and a new class of Kindle ? Kindle Fire ? a beautiful full color Kindle for movies, TV shows, music, books, magazines, apps, games, web browsing and more, for only $199.

    These are high-end products ? the best Kindles we?ve ever made. Kindle and Kindle Touch have the most-advanced E Ink display technology available, and the 3G Kindle Touch adds free 3G wireless ? no monthly fees and no annual contracts. Kindle Fire brings everything we?ve been working on at Amazon for 15 years together into a single, fully-integrated experience for customers ? instant access to Amazon?s massive selection of digital content, a vibrant color IPS touchscreen with extra-wide viewing angle, a 14.6 ounce design that?s easy to hold with one hand, a state-of-the-art dual core processor, free storage in the Amazon Cloud, and an ultra-fast mobile browser ? Amazon Silk ? available exclusively on Kindle Fire.

    We are building premium products and offering them at non-premium prices.

    Thank you for being a customer,

    Jeff Bezos
    Founder & CEO

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  • Posted: 04 October 2011 09:24 AM #69

    Dear Customer,

    There are two types of companies: those that work hard to provide customers with extraordinary value. and those that work hard to charge customers less. Both approaches can work. We are firmly in the second camp.

    Corrected.

         
  • Posted: 04 October 2011 04:20 PM #70

    I like my wife’s Kindle, but iPad killer?  No.

         
  • Posted: 14 November 2011 10:59 AM #71

    When this topic was started, we could only assume that the Kindle Fire would be a meager product.  Now the reviews have confirmed it.

    In the short term Amazon gets a boost from coming out with a hot product.  In the long term, the reputation of Amazon’s products have been severely tarnished.

    I can’t see Amazon’s move into tablets as anything other than desparation.  Amazon’s revenues from all kinds of media are being siphoned off by the iDevices, its music store and app store are not very competitive, and its having to nearly give away streaming video as part of its already money-losing Amazon Prime offering.  If Amazon doesn’t do something fast, it becomes just a distributor of physical goods.  So it does something fast…and poorly.

    Amazon is going to have spend hundreds of millions in R&D to compete against Apple, all for a money-losing product?  To defend the sales of media, which is itself a revenue shrinking area of its business?  How is this good for Amazon?

    Whatever all this says about AAPL (not very much since AAPL was already a screaming buy before the Kindle Fire was unmasked as a noncompetitive product), it surely puts a spotlight on AMZN’s super-rich PE. 

    It may take several years to play out, or maybe a lot sooner, but AMZN is toast.  It’s just a matter of time.

         
  • Posted: 14 November 2011 12:07 PM #72

    Meager product perhaps.  But AMZN is up $4.

         
  • Posted: 14 November 2011 03:19 PM #73

    Mercel - 14 November 2011 04:07 PM

    Meager product perhaps.  But AMZN is up $4.

    Which just shows how stupid investors (of all stripes) can be.

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  • Posted: 15 November 2011 01:30 AM #74

    Gregg Thurman - 14 November 2011 07:19 PM
    Mercel - 14 November 2011 04:07 PM

    Meager product perhaps.  But AMZN is up $4.

    Which just shows how stupid investors (of all stripes) can be.

    What’s left in AMZN appreciation for people to be buying it here?  Amazing.

         
  • Posted: 15 November 2011 10:51 AM #75

    Mercel - 15 November 2011 05:30 AM

    What’s left in AMZN appreciation for people to be buying it here?  Amazing.

    I’m generally skeptical of the impact of manipulation in AAPL’s stock price, but the more I watch it move, the more it seems like shorts are successfully manipulating investors who see that AAPL’s price “just doesn’t make sense”, and bet on correction that just doesn’t come. 

    Could the same manipulation be happening with AMZN, in reverse?  The only sensible AMZN investment at this point is to short, but if the counter-sensical investors can keep the stock going up, the common sense investors get creamed.

    EVENTUALLY, common sense has to prevail.  But if the counter-sensical folks get out fast enough when it does, they’ll be ok. 

    If this explains even part of the action of AAPL and AMZN, my bet is that when the dams break, they will break dramatically.  Until then, patience, my friends.