So as to break my series of negative articles, I'll write on something where Amazon.com actually did well. By doing what I am going to explain, Amazon.com (NASDAQ:AMZN) managed to increase prices and margins substantially, and it has already had an effect on its P&L in Q4 2012.
So what was it?
Back in 2011, when Amazon.com launched the first of the Kindle Fires, its pricing ($199) for the device was pretty aggressive. Teardowns at the time showed that the BOM (bill of materials) approached the price Amazon.com was charging for the device. Together with other costs from design, warranties, deliveries, etc, it was pretty obvious that Amazon.com was selling this device below true cost, and it immediately had a negative gross margin impact on Q4 2011. Back then, gross margin on 1P sales from Amazon.com fell to just 9.7% from the more usual 11-12% Amazon.com was showing both before and after that quarter.
Now, when Amazon.com launched the Kindle Fire HD during 2012, there were two significant differences:
- First, the BOM for the device was lower than for the original Kindle Fire. iSupply estimated the BOM at $174 per unit, versus the $201.70 per unit estimated for the original Kindle Fire. This is not insignificant, Amazon.com should have sold between 5 and 6 million units during Q4 2012, and the price was still $199, giving Amazon.com an advantage of around $27.7 per unit. That's between $139 million and $166 million of a positive impact for Amazon.com's bottom line, and it helps explain why the Q4 2012 gross margin on 1P sales got back to a more normal 11.1%.
- But it didn't stop there. Amazon.com also took the chance to remove the charger from the Kindle Fire HD package, and to sell it separately. The reasoning is that many people already have chargers and so it makes for less waste. The true reason, of course, is that not only does it increase margins on every Kindle Fire HD sold through a lower BOM, but it also makes for another chance to charge $19.99 for something which was included previously. At the end of the day, this would actually mean that for someone buying the Kindle Fire HD with charger, the equivalent price would be $199+$19.99, so this is was a significant price increase in a segment which usually only sees price decreases.
From the number of comments on the charger, one would say that about 40% of the Kindle Fire HD buyers bought the charger. At a 50% gross margin on the charger, that would make for a further $25 million to $30 million in benefits for Amazon.com from this move.
Between keeping the price on the Kindle Fire HD with lowered BOM and removing the charger, Amazon.com managed to get an additional $164 million to $196 million in profits that it would have otherwise not gotten. This is not an insignificant amount for Amazon.com which explains most of the improvement (or normalization) in Amazon.com's 1P gross margin during Q4 2012, to levels which were, except for Q4 2011, those that Amazon.com usually achieved.
Disclosure: I am short AMZN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.