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Why Amazon's Fire Phone Had To Be Expensive, And May Be Unsellable

Mark Matchen profile picture
Mark Matchen
5 Followers

Summary

  • Amazon needed to make a magical phone or discount heavily to compete with Apple and Samsung. It did neither.
  • The argument for a subsidized phone is available: it is designed to push high-value sales through Amazon's channels. Amazon has more potential here than Apple or Google.
  • Amazon didn't subsidize because it can't. It could cost billions, and the sales it would generate are themselves hardly profitable.
  • A just-OK phone at full price makes little sense now. Amazon must have planned to subsidize, and bailed as its stock sank, and forecasts for coming quarters went south.

The Amazon (NASDAQ:AMZN) Fire smartphone has arrived to mixed, but mostly quizzical reviews. The quick dissections which are a Web staple have been performed. The comparison charts, mostly to the Apple (AAPL) iPhone 5s and the Samsung Galaxy S5, have been compiled. Unboxing videos will soon litter YouTube.

I'm not going to do the feature blow-by-blow here. I'm interested in the economics of the launch, for the consumer and for Amazon. Mostly, I'm interested in what the product's introduction really tells us about the economics of Amazon.

Lots of business writers have weighed in on the Fire's pricing: $649 without a contract, right up there with the Apple and Samsung flagship phones. This defied all expectations. Amazon was supposed to enter the market with a competitive phone at a bargain price. They could do this, the argument went, because more than their competitors' phones, the Fire phone would pay for itself on the back end, with massive new revenue streams from all the product purchasing Fire users would be doing from - who else? - Amazon. In fact, this was supposed to be the very reason for Amazon to try and break into the phone duopoly to begin with.

What's the toughest business in the world to crack? De Beers' diamond monopoly, circa 1960? Consider how hard it is to challenge Apple and Samsung in the smartphone space today. Forget market share - think profits. According to Canaccord Genuity data, as reported by AppleInsider, the two companies took a remarkable 109% of feature phone/smartphone operating profits in Q313. Wait, what? That means - yes, everyone else put together is losing money. (Sony (SNE) led the also-rans with a 0% share. I guess that's something. Actually, it's nothing.)

You need to have the brass of a Jeff Bezos to wade into

This article was written by

Mark Matchen profile picture
5 Followers
I am an individual investor who closely monitors the medium and long-term strategies and prospects of a narrow range of companies in the personal electronics and computing industries. I am not connected professionally to any organization promoting the securities of any company.

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Comments (35)

Compute_This profile picture
I don't get it. The obvious solution was to pull in the Google ecosystem. Then the Fire Phone would be at least as good as Samsung's, but also with the extras Amazon provided. Does Bezos hate Google so much he is willing to doom his shiny new phone by marooning it on its own desert island? Help me understand...
AllenLin profile picture
I disagree. I think a "lowball" cheap phone would have been a big mistake. The market is already flooded with cheap phones that don't sell. Bezos took a page out of Steve Jobs playbook in aiming to make the best and coolest product. As we all know from Apple's history, if you do that right, you win big.
Mark Matchen profile picture
Allen, let the games begin! You're right that the cheap phone providers are in a race to the bottom. High margins are great. Just remember, the strategy worked for Apple, and is working for Samsung, but it's not working for anyone else right now. Check out Blackberry, Motorola, Sony, LG and others – they all have premium phones, some of them superb. Doesn't seem to matter.

Remember, I didn't say that Amazon was coming to market with a low-end phone; I said they were coming to market with a subsidized, high-end phone. That should have been their disruption strategy.

"The best and coolest product" only matters at the beginning of a category's lifecycle. Apple had that for a few years with the iPhone, but it doesn't any more. The iPhone is not head and shoulders above the others (although I wouldn't trade mine). Once a category is mature, other factors take over, and price becomes increasingly important. The Fire's coolness factor is a) debatable and b) moot.
K
For Amazon's 1st phone, Fire is a BIG achievement.
It seems to be in par with best phones out there if not slightly better, minus the apps. If they have this capability AND compete with WalMart toe to toe, they deserve some credit.

They already have AMZN app.
I use it on Iphone. I'm sure it will get an upgrade.

The Phone Price point is an easy fix. Calm down.
They CAN lower the price at any time just as Apple has done.
Have you seen those idiotic prepaid smart phones? Insulting.
This phone would thrive in that space. That market share alone would be sufficient for AMZN.
S
The idea that Amazon could compete with the Apple ecosystem is ridiculous. So it is best not to assume that Amazon was trying to do that.

What ecosystem could Bezos be looking at?... All of retail?

Like Apple, Amazon may not need to measure market share by a percentage of people who own one of their phones. I don't think Apple want to capture a huge percentage of market share, they want to be the elite, must-have product. And I think Amazon is doing the same here in a different way. They may measure it by the percentage of dollars in the (different) ecosystem that they want to get a share of.

If it makes it easier for folks who flow all their retail purchases through Amazon to do so then that grows Amazon's share of retail.

Can they make the Amazon app a must-have so that Apple/Android phone makers cannot resist them and they still own the margin? Then they can just retire the hardware, the hardware team, and the whole idea of an Amazon phone. But still get the retail margin! Awesome sauce!

[Total disconnect] Amazon isn't using a phone to fight Apple here, it's fighting WalMart.
Why in the world does no one, anywhere, not one analyst, or a single person posting comments, bring up the one key essential point:

How much does this product cost Amazon?

Exactly how much money is at stake here? It doesn't seem to me to be an easy thing to develop and manufacture a smartphone. You've got overall design, hardware, some intense software modifications, a support service to train and put in place, advertising, marketing; you've got to spend time and effort negotiating the various components and putting together a supply chain, and probably a dozen key details I can't even imagine.

Then you have to immediately start planning for future iterations of the phone!

How many phones do you order, how many components do you order, are you going to have too few or too many, and most importantly, how much does all this cost?

How much money is at stake here?

What is the potential write-off if the phone doesn't sell?

How many phones have to sell to make the whole enterprise viable?

Why is nobody asking and answering these questions?

As is typical with Amazon, you don't even know the playing field, how the points are scored, or how much one has to score to win.
Mark Matchen profile picture
Hey eenk, that's an interesting question, although it's not totally germane to my point. The short answer is, it would have cost a bloody fortune. Apparently, four years of development. They probably had to buy up a wad of patents. They developed a highly differentiated version of Android. Again, the cost would be enormous.

But so what? That money is gone. As they say, each phone after the first costs about $100 to build. The first one costs a billion, or more. That money was sunk long ago. By this time last year and later, it was too late to do anything about it. They just had to forge ahead and make the best of it. That's why I said they now have the worst case scenario. They don't have a phone that sells on its merits and they don't have the market share to generate lots of ancillary income.
furma profile picture
No it was not yet wholly spent. with their "Mayday" feature and pride in having 10 second access to live help, Amazon has to hire and train probably thousands of employees, say at $30k/year each BEFORE a single phone is sold and continue to keep them on even if there is a lack of demand for the phones. Not to mention the office space needed for these employees, computers/tech, etc. This just one cost that say Google does not have.
D
I agree with you comment, the money to develop this phone is a sunk cost. Amazon may be forced to substantially lower the price to clear the inventory. Maybe they're able to recover the cost of the inventory.

Amazon risks losing credibility with Wall Street if this phone doesn't sell well and once that's gone then they stock corrects to a PE that's appropriate for a retailer and not a start-up with unlimited growth potential.
Peter Larson profile picture
Alternative possibility:

Amazon wanted to subsidize, AT&T didn't want them to.

Bezos has no hand in this relationship.
Mark Matchen profile picture
I don't understand your thought, Peter; can you elaborate? Amazon is providing the phones to AT&T for a certain price. AT&T is probably roughly doubling that price for retail. Then AT&T applies a standard offset against the retail price based on the terms of a contract, if any. If Amazon gives AT&T the phone for $200 less to begin with, then the no-contract price should be roughly $400 less. The contract price could be zero.

Yes, AT&T and Amazon would have had extensive discussions about this, and I can only speculate about that. AT&T might have said that they thought the best play was the high price play. They would have said that based on their product mix and customer mix and who knows what else. It's also possible that Amazon is paying them some cut of sales generated through the phone.

But in general, I don't know why you think Bezos has no hand in this.
Peter Larson profile picture
Sorry, that was a Seinfeld reference: he has no "hand" in the relationship. IE, no negotiating power.

He certainly had a hand in the design and negotiation. But he doesn't have the leverage to disrupt this industry.

Apple and Samsung DO have significant leverage against the wireless carriers. If the latest Iphone or Galaxy isn't available on T-mobile, for example, they know they will lose a lot of business. It doesn't need to be that extreme; if Apple demands another 5-10% in margin from a carrier that's billions in profits.

So let's say you're a T-mobile executive and Bezos comes to you with this phone and he says he plans to give it away for free, and you would be the exclusive carrier. Your first thought isn't how well will this phone sell- your first thought is what will Apple and Samsung do in response? Maybe they'll do an exclusive deal with the competition, maybe they'll demand you discount their phone to the same price and eat the difference. Even if the Amazon phone is a smashing success, it won't make up for the sales you'll lose if there is any retaliation.

So you tell him no dice. Not even interested.

Amazon hears the same thing from all the other carriers, until they are left with just AT&T who will deal with them.

AT&T is big enough that they know Apple and Samsung won't retaliate, but they also make a pretty penny selling marked up handsets through their own retail stores. So, they tell Amazon: we'll sell your phones. But we're planning on charging consumers $200 (with contract) in our stores, and you better not undercut us on price on your website.

Then what choice does Bezos have? He needs a carrier.
J
Amazon.com electronic best sellers sales rank position of 77 ! At this rate it will be our of the best sellers in less than a week.
Mark Matchen profile picture
You've got that right, John. I don't think any product has ever had the promotion the Fire is getting on the Amazon site, and look at the results. Sinking like a stone.

http://seekingalpha.co...

Some people here have suggested Amazon went with the high price for early adopters, and will drop the price in time to undercut the iPhone 6. Or simply that dropping the price, if necessary, is an easy thing to do. Wrong on both counts. Screwing your most loyal customers is a great way to lose them, fast. And acts of desperation don't play well with consumers – or reviewers. Products need an identity. Amazon has given the Fire a luxe identity. Tossing it on the bargain table isn't going to save it now.
D
Amazon has to show Wall Street that they're innovative otherwise their stock will crash and they'll be forced to show a profit like all other long-term viable companies. However, Amazon gets a "pass" from Wall Street because there's a myth that they will one day be massively profitable. The reality is that they lose money on nearly every shipment. They are a retail and logistics company masquerading as a hi-tech company.

This phone is marginally innovative and doesn't do anything that isn't already available by using an App. I predict this phone will be an epic failure and it may be the moment referred to by analysts as the "turning moment", the kick to the backside that Wall Street needs to wake up to see how massively overpriced Amazon is compared to other companies. Bezos is drunk with power and hubris to think he can compete with Apple. He's flown way to close to the sun and he will crash and burn like many more experienced companies who have tried to design an "iPhone killer" before him. R.I.P. Amazon!

k
Amazon isn't trying to make an Iphone killer, and if Amazon didn't spend 14 Billion plus in expanding warehouses alone the past few years (not to mention over a billion in corporate real estate, countless hundreds of millions on data centers, and an unknown amount of R&D on various ventures) they would be ringing in major profits. If you look at cash flow and revenues a strong case can be made that Amazon is undervalued, this why the stock price is valued as it is - Institutional investors don't put the type of money they have into AMZN because they think it's an unprofitable entity with no future prospects.
D
"if Amazon didn't spend 14 Billion plus in expanding warehouses alone the past few years (not to mention over a billion in corporate real estate, countless hundreds of millions on data centers, and an unknown amount of R&D on various ventures) they would be ringing in major profits."

Hmmm, hmmm, the "BIG IF", that's of course what Amazon wants Wall Street to believe. Tell me, how can Amazon can undercut retail prices so much and still afford to pay $5 or more to ship a product to me? Retail margins aren't that large.

Of course they're undercutting prices to buy market share and they lose money on the shipments. The customers they're gaining are hugely price inelastic and they'll buy from anyone with a lower price.

I just reviewed their 2013 financial statements and it shows they lost $3B last year (shipping cost > shipping revenue).

The bottom line is Amazon is one big black hole and investors who invest in it have to do so with a belief that management will make the right decisions and one day the company will be hugely profitable. I think Amazon's time will run out soon and the stock will deflate to a more realistic valuation.
k
Amazon's 2013 Net Income was +274 Million. Even if they did break dead even, they would've done so while expanding infrastructure, global presence, and investing in R&D. People have been speculating the demise of Amazon for many years, at last check those who've shorted AMZN have lost their lunch, I'll stay away from that expensive bandwagon myself.
m
Before people discount the amazon phone, you should think about the target market.

1. You've got Android (and Blackberry), where getting support generally consists of calling your friends or going on message boards.

2. You've got Apple, where getting support means you go online or directly to the Apple store.

Nobody is "really" making a huge decision about going from an iPhone to an Android based on price. There's "what's cool", functionality, and support.... price comes quite a bit further down the list.

If that amazon 911 can beat out the seething pile of hipsters at the Apple store, Bezos is going to get some action from their potential customers. If he can keep them, then this is just going to become a growing investment of loyal revenue.

There is room in the market for a well supported product.

Anyway, I'm a fan of Bezos. I was initially dismissive, but I see potential.
k
I think you've made a great point Morris. Amazon is looking to attract loyal customers and increase loyalty in existing customers. The phone is not a stand alone device marketed at a target audience of people who've never used Amazon services. Rather it is another tool in the Prime toolbox used to increase stickiness of the already loyal Prime members and hopefully attract some new ones who've been on the fence. This theory also helps explain why they've went with AT&T as the exclusive carrier. AT&T subsidizes their efforts and reduces risk when AMZN is potentially targeting lower sales than most would think. The key here is the management of the supply chain, if handled correctly they can make a couple bucks on incremental price at offering and then sell the phone at cost down the road for primarily Prime purposes. To me it is the same approach as the Amazon Music efforts. They aren't trying to overtake Pandora and Spotify overnight but are rather adding incremental value to their Prime membership.
J
This makes sense. This also explains why this phone has relative low specs to it's price , especially given that it's cheaper for amazon to sell and market it, and it seems that mayday(amazon 911) could be the most expensive part in this phone.
J
Thanks for this post. This may be oversimplified but why wouldn’t the strategic play here be: 1) Release the phone at full price to show a) that it is a “premium device”; b) soak up some incremental full price demand; and c) pull back into the P&L some of discounting hit you had previously layered into your projections, so that 2) Around the time of Apple’s next release, when your stock has rebounded because your losses were lower than projected, you then discount the price to take shine off of the next iPhone?
Rockbear profile picture
Very good insight in another costly adventure by Jeff. The problem now: Apart from the Drones not much is left to be set in motion. Hardly any field left that hasn't been worked during the last several month. Profits? - The question is not "if" the stock will get decimated but "when" and what news will be the trigger. Will it be hard and fast or rather a continuation of the path already set in motion. Amazon should be seen as a combination of a search engine and a logistics company plus some less related activities. None of them would justify a valuation that comes even close to the one that Amazon commands. Finally the history of retail has always been a story of "cutting out the middleman" and $AMZN is exactly that.
k
The phone is targeting Prime customers. Prime customers get a free year of the service added on ($100 value) and will be the most enthralled with the concept of the FIRE phone as their personal shopping gadget. The phone's goal is to increase 'stickiness' of Prime members (which are already very sticky by the way) and hopefully entice a few new ones. Amazon was never looking to overtake Apple and Samsung in the smartphone market, anyone who thought that coming in was mistaken.
M
If the Board is finally demanding fiscal sanity from Mr. Bezos, that should be good news for his investors. Plowing the profits into the company to increase efficiencies makes sense; but you have to actually bank some profits each quarter to stay solvent. If the killer feature on the phone is the Firefly feature--I think that is the name of barcode reader-- perhaps it could be produced as an app for Android/Apple using the cameras on their phones, with some kind of confirming message. This won't be as cool as one button shopping from your phone; but it would certainly add some percentage to sales for a lot less than a $200 charge for each customer.
Mark Williams Int. profile picture
Compelling.

And don't forget the key external factor, that could never have been anticipated when Amazon set out with this project, and was perhaps the tipping point for Bezos: The Alibaba IPO very much coinciding with the Q2 losses being formally announced, and which is going to be a huge magnet for nervous AMZN investors looking for the next shiny.
RadarTheKat profile picture
Excellent article. The only inaccuracy is that bit about using Target's air conditioning. Nope, Target blocks my internet access when I'm in the store. Only way to connect is via their in store wifi as a guest, which they can then limit access to ensure you can't get to the Amazon servers. This is yet one more reason I hate Amazon and will never buy anything from that company; the unethical practices they promote and enable force companies like Target to inconvenience me when I'm in their stores. I don't blame target and usually take the moment to connect to their guest wifi network if I feel like I'm going to want to get on the internet for some reason while I'm walking around in a target store.
v
How can Target block 4G access?
David at Imperial Beach profile picture
Interesting hypothesis.

An alternative hypothesis is that Bezos, suffering as he does from inflated ego syndrome, thought that everybody would love his baby as much as he does and pony up accordingly. When your ego gets invested in a project it is quite difficult to accurately gauge what value others might attach to it. Does anybody know if Amazon did any focus group studies on this project?

Personally, I think the UI does have enough wow-factor to make it want-worthy to at least that portion of the public who love 1) shiny rectangular objects with UIs that move in response to your own movements, 2) Amazon Prime and 3) feels that their lifestyle would be enhanced by point-and-shoot shopping. That said, I do not qualify as a member of the target audience.
Robert Cleveland profile picture
Very insightful, a last minute switeroo once the numbers came into focus for them. Then, they are spending big on building out more warehouses for faster shipping, except studies show the consumer likes but won't pay for 1 or 2 day shipping, in terms of fully paying the cost. So they are building an expensive overhead of buildings and employees to address a market that is not there, namely people willing to pay the cost of 1-2 day shipping. Bezos has become a mad hatter, and the clock is ticking for him...
Nathan Brooks profile picture
Great article.
nowandlater profile picture
Great article. I know they don't make any money, and they put out a less-than-remarkable expensive phone. I hadn't put two and two together as you had regarding the subsidies
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