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Despite losses, strategy could pay off for the enterprising Android tablet maker

Yesterday, following Amazon.com, Inc.'s (AMZN) big tablet reveal, Gene Munster, a Piper-Jaffray analyst known for his estimates of Apple, Inc.'s (AAPL) sales, sent out a research note comparing the profitability of Apple's $500 iPad 2 with Amazon's $200 Kindle.

Mr. Munster estimated that the iPad 2 was turning a profit of 30 percent of its MSRP, while Amazon would lose $50 per Kindle Fire sold.  However, he didn't provide a specific source of his figures or much of an explanation.

We dug into this a bit more.  It turns out that iSuppli did teardowns [1][2] of this year's iPad 2 and last year's Galaxy Tab from Samsung Electronics Comp., Ltd. (SEO 005930).  

Now iSuppli's numbers are hardly infallible, but given that the LCD market hasn't move much price-wise in the last year, for tablet screens, it can be assumed that the Galaxy Tab's 7-inch display cost in the bill-of-materials gives a good estimate of what the LCD touch-screen unit on the Kindle Fire costs.  Combining this with the extra cost of the iPad 2's largest amount of onboard NAND memory, we estimate that the difference is indeed in the neighborhood of $100.

The Kindle Fire Fire-Sale

So what does this mean for Amazon.com -- and for Apple?  Well, for Apple it's a testament of how valuable the company's brand is.  Apple can have its cake and eat it too.  It can sell a grossly marked up device, and at the same time post the kind of huge sales that brings in strong auxiliary revenue streams such as app sales and advertising revenue.

Fig.: Apple doesn't have to offer big price cuts to get customers to bite.
[source: Entercom Digital Dev Blog]

Amazon.com isn't that fortunate.  Despite arguably launching the consumer tablet with its Kindle e-Reader, Amazon.com has yet to establish itself as a major competitor in the new tablet market, which has been dominated by Apple and Samsung.

In order to gain ground Amazon.com appears to be adopting an approach similar to console makers in that it's pocketing a loss up front, in order to persuade early adopters to jump on board, leading to overall positive revenue via the auxiliary revenue streams.

Overall this approach could pay off for Amazon.com.  The Kindle Fire is currently the cheapest fully functional Android tablet device on the market and its software offers nice differentiation over competive offerings.

Amazon pockets 30 percent of app sales revenue.  And it gets $79 for its Amazon Prime membership, which it's promo-ing on the tablet (which provides users with streaming movies and TV episodes).  If it can get one in every two customers to bite on the Amazon Prime membership, and get the average customer to spend $33 on apps over the device lifetime, it's broken even.  If it can do data mining on the users' web-browsing, or sell users some of its massive ebook collecton, it will likely turn a profit (under the above scenario).

In short, the "fire-sale" price of Amazon.com might not be such a crazy idea after all.  Maybe Hewlett-Packard Company (HPQ) unwittingly stumbled onto the secret to tablet success after all, during its TouchPad fire-sale.


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RE: more fun with math
By TakinYourPoints on 9/29/2011 6:35:14 PM , Rating: 2
Yeah, Amazon can't be selling it at a loss.

The problem is that hardware still needs to make some profit, even if it is following the "razor blade" approach. Selling at a loss can work for game consoles partly because the companies selling the hardware initially at a loss make it back on the enormous license fees from every game sold and proprietary accessories with huge markup.

Selling movies, music, applications, and books don't carry very good profit margins in comparison. Almost all of the wholesale cost goes towards RIAA, movie studios, book publishers, app developers, what have you. Then there is the cost of doing business, servers, bandwidth, advertising, etc etc. Apple has released profit margins on iTunes since it began and it has consistently been at around 10%, even with the gradual addition of movies, books, and applications. This is well below the average 25% profit margin that Apple has between all of their products.

I am using iTunes as an example because their numbers are the most public, but everyone has roughly the same wholesale costs with digital media. The value in selling this media is keeping consumers tied into an ecosystem, whether it is iOS, Android, Amazon, XBox, PS3, whatever. It just isn't as profitable as selling hardware.

Maybe Amazon is willing to accept less profit on the hardware, but they cannot be willing to sell it at a loss. It doesn't make financial sense unless they believe that it will lead to more sales of physical goods from Amazon as well.

As it stands, Amazon never sold the Kindle at a loss. It was $400 in 2007 and has dropped only as component costs dropped and increased production drove down their wholesale component prices. I don't expect that they're going to change all of a sudden and start giving away tablets for people to possibly buy digital media which already has razor thin profit margins, it just doesn't make sense.

The Piper-Jaffrey numbers are suspect, thanks for your post.


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