When retail giant Amazon (AMZN) first announced that it was getting into the competitive tablet market with its Kindle Fire, many wondered if the strategy would work. This doubt had little to do with any perceived flaws in execution by Amazon, but more to do with the road kill that Apple (APPL) had left behind by anyone with enough nerve to get in the way of its iPad.
These included prominent companies like Research in Motion (RIMM) who could only toy with its Playbook and Hewlett-Packard (HPQ) who introduced the TouchPad and immediately realized that it was out-of-touch. One might even throw Cisco's (CSCO) Cius tablet into the mix. All in all it has been a long list of disappointments. It seems only those on Google’s (GOOG) Android platform have had any degree of success. So for now, it remains Apple against the field.
On November 15, Amazon unveiled its Kindle Fire at retail price of $199, well below the iPad’s $499 introductory model. Unlike previous threats from the aforementioned companies, this time there are reasons to think that it can be a real threat to Apple’s advantage. Clearly Amazon’s gamble was that the discounted price would be reason enough to entice consumers to opt for the Fire over the iPad. Early sales numbers suggest that it may have been right, but for how long? Particularly when one considers that each Fire sold is eating up into its profitability.
Amazon loses approximately $10 for each sale of the Fire - something that causes me to think that it does not view the Fire as a means of revenue, but as a channel for selling its other products and services - a strategy that has already worked for the Kindle. A recent article by Information Week revealed some interesting theories. The article notes that the following:
Amazon will make up for the loss through the additional sales generated by Kindle, particularly sales of physical, high-margin consumer goods. The real benefit of the Kindle Fire to Amazon will not be in selling hardware or digital content. Rather the Kindle Fire, and the content demand it stimulates, will serve to promote sales of the kinds of physical goods that comprise the majority of Amazon's business.
The strategy isn't without risk. By pricing Kindle Fire aggressively its $300 less than the least expensive iPad 2 and $50 cheaper than Barnes & Noble's Nook Color. Amazon is hoping the device will generate enough incremental revenue through e-commerce sales to more than make up for the loss it's taking on each unit. But if consumers balk, the company could have little more than a money-losing paperweight on its hands.
Another issue to consider is that that Amazon doesn’t own the content on which it is hedging its bet. In that regard, it faces a similar fate as Netflix (NFLX). That said, I still have a hard time believing that consumers would balk at what already looks like not only a great price point, but a phenomenal Android-based alternative to the iPad.
So far consumers have agreed. The Fire has generated a lot of excitement and has been rumored to have shipped 5 million units. Amazon has clearly had an impact on the iPad. Several surveys and tech analysts have suggested that at least 25 percent of consumers who have once decided to purchase an iPad have opted to put those plans on hold.
Since the announcement of the Kindle Fire, Amazon’s stock price has risen to new highs, but since then it has declined 25 percent upon its Q3 announcement. The numbers arrived mixed and investors were not sure which direction to go. Amazon continues to show that growing its top-line is not a tough task, but it acknowledges that it does come at a cost.
It reported revenue growth of 44 percent – 37 percent of which grew organically. Some have suggested that was still below expectations. It improved its gross margins, but investors were not pleased to learn that expenses jumped 65 percent, while costs of marketing also grew 54 percent. This is where we have to ask if the Fire strategy will work and the fact that it loses money on each device sold.
There is no doubt that Amazon will continue to dominate the ecommerce space for many years to come. By the early success of the Kindle Fire, Amazon continues to show that it has the ability to execute and evolve into growth areas. Investors who are looking to capitalize on its recent 25 percent “hiccup” should really consider taking a long look at current levels. Admittedly, the price remains at tad expensive at a forward P/E of nearly 90, but with early indicators of “Fire sales” and Prime subscriptions, it is possible that the price may not get any better than this.
Disclosure: I am long AAPL, CSCO.