It is well known and deeply believed, that Amazon.com (NASDAQ:AMZN) is supposedly pursuing a “razor and blades” strategy with its Kindle readers, from the entry model all the way up to the Kindle fire.
Since Amazon.com is selling these at or below cost, the theory goes that they’ll make it up later, by selling higher margin content for the devices. This is supposed to mimic the strategy successfully pursued by Gillette with their blades, or even other instances like the way the mobile operators subsidize smart phones.
There might be a problem with this theory. Indeed, there might be are several problems with this theory.
First, Amazon.com does not control the blades
The content that Amazon.com is selling is not Amazon.com’s. It’s from other publishers, be it books, music, videos or even apps. This has an obvious consequence – the content is subject to competition both to buy it, and to sell it. Result – the content is low margin for distributors, whereas the blades Gillette sells are high margin and the mobile service itself is also high margin.
Second, Amazon.com does not control the devices, either
While the blades “play” only on Gillette’s razor, and the (locked) smart phone plays only on the mobile carrier’s network, the content Amazon.com competes to sell plays both in its device, and in other devices as well. Once again, this means huge competition; once again, this means low margins.
Third, Amazon.com is subject to adverse selection
Since Amazon.com does not really control the device or the content, Amazon.com needs to follow strategies that make it “the place to go”, for both its device and its content. And what are these strategies? You see them daily on Amazon.com – it’s offering freebies or deeply discounted product, be it e-books, music (who doesn’t remember Lady Gaga’s promotion?), or apps (free app of the day). Now, the market is very knowledgeable about this, so every time Amazon.com offers something at a deep discount, a ton of people show up to claim it, and they develop the habit of only buying when it’s on a deep promotion. Result: again, margins suffer greatly.
This effect can be seen in all its glory in this sentence (which also illustrates one attempt by Amazon.com of freeing itself from the first problem described here – by becoming a publisher of books):
What’s really the bottom line on Amazon’s publishing record so far? Analyst Laura Hazard Owen dug into numbers: “Of the 149 titles Amazon has published since 2009, 30—about a fifth, not a bad hit rate—were Kindle bestsellers at some point in 2011, at positions ranging from 1 to 98. Most of the books became Kindle bestsellers when Amazon sold them at promotional prices.” (The average price of an Amazon Publishing book that made the Kindle bestseller list was $2.77, compared to the average Amazon Publishing e-book price of $6.91, as mentioned above.)
"We made it into their top 20 paid apps with 17 downloads, something that takes many thousands of downloads on the Google Market, and iOS stores," ShiftyJelly co-founder Russell Ivanovic told Business Insider.
Amazon.com is subsidizing devices to sell subsidized content on them; both moves penalize its margins, and are mostly impossible to reverse (without huge market impact on Amazon.com’s share price). There really is no pot of gold at the end of this strategic rainbow – Amazon will still not own the content or the device channel, when it is all over.
Indeed, the last few years have seen the rise of a much larger threat to Amazon.com’s position: the emergence of apps connected to a particular mobile operating system as the preferred means to sell digital goods. This is a huge threat to Amazon.com because Amazon.com does not control any of the leading mobile operating systems. Apple (NASDAQ:AAPL) controls iOS, and Google (NASDAQ:GOOG) mostly controls Android. And it doesn’t matter much if Amazon.com ends up selling tens of millions of profitless Kindle fires, as those will still be a drop in the ocean of hundreds of millions of iOS and Android devices.
Such threat is currently underappreciated.
Disclosure: I am short AMZN.