Tactics and Strategy: Is Amazon's New Tablet Doomed?

Razors and razor blades.

In the annals of business triumphs, Gillette's underpricing the razor in order to stimulate sales of over- priced razor blades is generally considered one of the most successful consumer strategems of all time. It produced an annuity of margin boosting profits that lasted decades. So could Amazon's decision to underprice its tablet in order to stimulate sales of the content it can push through that channel be a high tech repeat?

The problem is that Amazon's low price, high volume strategy requires considerable investment. It's margins are already less robust than those of Apple, the competitor whose virtual monopoly it has chosen to assault. It is not clear for how long it can continue to support a loss leader - a product whose profits are insufficient, if they exist at all - and the notion that consumers will pay for content specific to the Fire is far from certain.

That consumers will lug around several devices for specific tasks seems counterintuitive. There are also concerns that the new tab will cannibalize sales of the ebook Kindle; concerns that Amazon's decision to cut its price drastically would appear to confirm.

The Fire may have been either a brilliant gambit designed to offer the sort of disruptive innovation around which legends are made and fortunes secured - or it could be a desperate distress signal. JL

Martin Peers reports in the Wall Street Journal:

Amazon.com's new Kindle Fire will spark a shake-up in the tablet market. But it also may burn into its already-paltry profit margins. In unveiling a tablet designed for much more than reading, Amazon is taking direct aim at Apple's dominant iPad. But while Apple sells digital content like music cheaply to lure consumers into paying premium prices for its hardware, Amazon hopes to sell both its hardware as well as the content at cut-rate prices.

The Fire, for instance, will sell for $199, less than half the price of Apple's cheapest iPad. That is certain to appeal to a broad range of cost-conscious consumers. Consumer surveys by Forrester Research and others make clear price is the most important criterion for consumers selecting a tablet. Forrester found that consumers on average expected to pay $257 for one. But there is a reason why other tablet makers haven't priced that low. Analysis of components in various tablets by IHS iSuppli found materials costs alone were $262 and above.
And that is before other costs like marketing; Amazon, like Apple, will use TV advertising to promote its device.

Losing money on tablets would be self-defeating for those companies whose main business is selling hardware. That isn't necessarily the case for Amazon. As Chief Executive Jeff Bezos emphasized, its strategy is building "premium products at nonpremium prices."

Amazon may be able to justify losing money on the hardware if the tablet provides a profitable boost to its retail business, particularly its digital music, video and bookstores. Indeed, Mr. Bezos showed off the Fire's ability to play video and music and its book-reading capabilities.

There are a couple of flaws in this strategy. First, surveys generally show the most common purposes for which people plan to buy a tablet are email or web surfing, ahead of watching video, playing games or reading books. Moreover, assuming most new tablet owners use the devices for watching video, there is a variety of online video sources including YouTube or Netflix, which don't require anyone to buy or rent movies or TV shows from Amazon.

As for books, Amazon already has the Kindle e-reader, including new versions unveiled Wednesday, with which to promote its e-book sales. Yes, the addition of color could help Amazon sell more children's picture books, where Barnes & Noble's Nookcolor and the iPad have had an advantage over the Kindle. Mostly, though, anyone buying the tablet to read likely would opt for the even cheaper Kindle.

Amazon's new Kindle Fire, which will offer magazine content and streaming videos, takes aim at Apple's tablet dominance. How does the Kindle Fire stack up against the iPad 2? Should Apple be worried? Stu Woo and Dan Gallagher join digits.

Even assuming some people buy more music or video from Amazon, those may not be particularly lucrative given that most of the money flows back to the content makers. Apple has said in the past that its iTunes-based retail outlets do little better than break even.

Certainly, the Fire could reinforce the value of Amazon's Prime service, which offers free shipping on most physical goods ordered from Amazon for $79 a year. More recently, Prime members have been able to stream videos for free, a service that will be accessible on the tablet. While the content includes a lot of old TV shows, Amazon steadily is broadening it.

Widening the Prime membership should boost Amazon's retail market share. ITG Investment Research has calculated that Prime subscribers buy two to three times as much as non-Prime subscribers. But Prime is an expensive way to build market share. Amazon's shipping cost as a portion of net sales reached 4.9% in the second quarter, up from 2.8% in 2005 when Prime was introduced. Then there is the cost of buying the rights to video streaming it is giving away free.

Apple certainly now faces a real competitive challenge to its iPad. But given Apple's enormous financial resources—$76 billion in cash and investments as of June 30, a dozen times Amazon's—as well as its software expertise and design track record, this is hardly a fair fight.