The metamorphosis of Kindle and of Amazon

In celebration of the Kindle Fire and the new Kindle, the CEO of Amazon wrote a very interesting letter (which can be found on the main page of Amazon).

A particular section has been stuck in my head and tonight (thanks to reading The Strain for half the night) it finally struck me why. First, let’s consider what Mr. Jeff Bezos wrote:

There are two types of companies: those that work hard to charge customers more, and those that work hard to charge customers less. Both approaches can work. We are firmly in the second camp.

This is really, really interesting. Particularly when you take a look at the diagram in this article on why the iPad and Kindle Fire are Mirror Opposites.

  1. iTunes feeds the funnel for iPad. Apple makes most of its money from the iPad.
  2. Kindle Fire feeds the funnel for Amazon.com.

So, and we are taking major liberties here, we could translate Mr. Jeff Bezos’ statement into -

There are two types of companies: Those that work hard to create a very attractive ecosystem where the price of entry is a premium device, and those that work hard to create a very attractive and low-priced device that brings you into their ecosystem.

Both approaches work. We are firmly in the second camp because we think we can sell people everything.

Both approaches do indeed work. Amazon is certainly in the second camp.

Why else would it sell the Kindle Fire (whose bill of materials alone is around $191) for $199? Why else would it sell the new Kindle for $79 (an insane price no matter how you look at it)?

This strategy is a very dangerous strategy and my gut feeling is that it’s not going to work the way Amazon intends and it is going to cause a metamorphosis of Amazon.

The Coming Metamorphosis of Amazon

Going back to the excellent Apple/Amazon/Funnel article, we get this gem -

  • Apple can happily ‘just about break even’ on music downloads because of the way it helps sales of their high margin i-devices
  • Amazon can happily price the Kindle Fire so aggressively that it is priced more like an MP3 player (and expect to lose money for the near term at least) because of the volume of sales of content it expects / hopes it will drive

Notice the rather critical part -

… expect to lose money … because of the volume of sales of content it expects/hopes it will drive.

Hopes and Expectations don’t make a good bedrock for future profit. Especially when the Internet and the common people are busy driving the value of content to zero.

Amazon can’t let that happen (except perhaps in certain loss-leaders like music).

To Guarantee Profits, Amazon has to Build a Very Closed Ecosystem

If people start buying Kindle Fires and Kindles and buying/getting content elsewhere, Amazon will never make a profit.

This forces Amazon to do some interesting things -

  1. Amazon has to lock users into its ecosystem. That’s why we have no ePub support. That’s why there is unlimited Cloud Storage for Amazon content but just 8 GB storage on the Kindle Fire. That’s why Kindle Fire doesn’t have an SD Card slot. That’s why Amazon has to build a custom version of Android and its own Android App Store.
  2. Amazon has to figure out how to make money from content. Amazon has to ensure it makes money from content because it’s selling Kindles and Kindle Fires at a loss. It’s a painfully amusing situation - content owners themselves can’t make profits from their content and yet Amazon is expected to make a profit from its 30% cut.
  3. Amazon has to figure out how to sell more and more things to users. Since there is no guarantee that selling content will make up for subsidized Kindles, Amazon has to sell people everything it can (including kitchen sinks and designer shoes).

Amazon wants to become ‘The One Shopping Destination’. However, it is taking such big risks to achieve this that it is putting itself into a position where it MUST become The One Shopping Destination.

A closed ecosystem is one way to try to guarantee things don’t go to Hell. Amazon is, perhaps to a larger degree than it realizes, trapping itself into this ‘Closed Ecosystem’ requirement. It’s already at a stage where it needs the Closed Ecosystem just to make a profit.

What if the Profits from Content don’t materialize?

Amazon has been delaying gratification and growing bigger and reinvesting into growth. There are a few possibilities:

  1. It doesn’t want gratification. It’s OK with forever delaying gratification. In that case all bets are off.
  2. It expects that all this delaying will lead to amazing gratification at a future point of time.
  3. It expects gratification at a slow but steady pace for many, many decades.

If Amazon is trading instant gratification for constant gratification over a long period of time, or even if it is trading instant gratification for huge gratification at a future point of time, it needs to find a way to profit from existing customers.

Every customer getting a subsidized Kindle or Kindle Fire has a ‘Delayed Gratification Tax’ attached to her. What happens if the Content Strategy fails? What if all these customers turn around and say – We never signed up for the ‘Delayed Gratification Tax’.

The funny thing about us (as humans and as customers) is that you can almost guarantee that all of us will forget we got a subsidized $199 Kindle Fire  as soon as we get it. As soon as Kindle Fire is in our hands we will simply want content for free or for ridiculously cheap prices (perhaps not all of us, but enough of us to make profiting from content sales rather difficult).

Update: Thanks to gous for a wonderful comment. First, this gem -

What strikes me is how vulnerable to disruption the digital content side of Amazon looks. The Google that created Android would scent blood and attack by attempting to drive the selling price of that content to zero so as to sell ads. Whether that Google still exists is another story.

And then this great link: Musings by Michael Mace on Amazon and Apple.

Gous’ comment above really is what I meant to point out and didn’t do a good job of.

Amazon must either make the Content Strategy work or a Metamorphosis will happen

We don’t know what the metamorphosis will be.

We do know that if all this ‘Delaying Gratification’ and ‘Taking a Hit on Kindle and Kindle Fire’ doesn’t get rewarded down the line, Amazon will be in some amount of trouble. Companies in Trouble do very interesting things.

If its Content Strategy works, Amazon will rule the retail world – to an extent that makes Wal-Mart seem trivial. If its Content Strategy doesn’t work, Amazon will be in a rather interesting conundrum.

We don’t know what the metamorphosis of Amazon will be (in case its Content Strategy doesn’t work) but we do know what might be the facilitator.

The Metamorphosis of Kindle and the Metamorphosis it will facilitate

Kindle and Kindle Fire play a very critical part in Amazon’s Content Strategy, and they will play an even more critical part if the Content Strategy fails.

Consider another section from Mr. Jeff Bezos’ letter:

 We are building premium products and offering them at non-premium prices.

Again, we’ll take some liberties (we aren’t good at denying gratification), and restate it as -

We are building premium mini-Amazon stores and making them very compelling by offering them at non-premium prices.

The Kindle and the Kindle Fire are not exactly devices -

  1. They are mini Amazon.com tributaries. It’s the perfect analogy – tens of millions of little tributaries joining into the great Amazon.com river and turning it into something vast beyond comprehension. What happens when there are 27 million Kindle device owners and they all are gifted Amazon Prime and do 80% of their purchasing from Amazon.com? What happens when the number grows to $100 million?
  2. They are a direct channel from customers to Amazon. A channel where Amazon doesn’t have to pay Google for traffic or CBS for advertising slots.
  3. They are an emotional and physical connection between Amazon and Customers. We only have to look at devotees of the various tech religions (Android, Apple, etc.) to see how powerful this could be.
  4. They are behaviour capturing devices. We don’t mean ‘in an evil way’ – just in a ‘what does she buy, what does he wish for, what do they covet’ sort of way.
  5. They are a defence against competitors.

We are way beyond the stage where Kindles were eReaders. The Kindle has metamorphosed into an Amazon.com tributary.

Ask any shopkeeper what he would give to have mini-stores in customers’ hands. Ask grocery stores why they hand out those points cards and membership cards. Ask any marketer what she would give to get a full history of customers’ purchases and customers’ explicit and implicit wish lists.

All of that is dwarfed by what the Kindle and the Kindle Fire promise to deliver to Amazon.

In the end it will come down to Kindles and Kindle Fires

Pick whichever path you like - Each ends with there being a hundred million Amazon.com tributaries in people’s hands.

If Amazon’s Content Strategy works then each is a steady source of profit for Amazon. And that’s just from the content.

If Amazon’s Content Strategy fails it might still be able to profit by ramping up the mini Amazon store aspect.

If everything else fails, Amazon still has a hundred million direct channels to customers. Companies are willing to pay for Search Ads and even for Ads on sites where people have zero intent to buy anything. What would companies be willing to pay for a channel where customers’ main intent is to buy?

We haven’t considered all the aspects and all the possibilities. Once you have Kindles in enough users’ hands there are a lot of different things that can be tried.

Amazon, if it is forced to metamorphose, will almost certainly base the transformation on the hundred million Kindles and Kindle Fires it will have in circulation. At its core, Kindle is a hedge of a spectacular kind – it plays an absolutely vital role no matter what happens. It’s gold and stocks at the same time. It’s emerging markets and developed markets in parallel. It’s the Schroedinger’s Cat of retail.

If Amazon’s gambles pay off, Kindle and Kindle Fire will be the channels delivering consistent and comforting gratification to Amazon. If Amazon’s gambles fail, they will morph into devices of resurrection.

That letter from Mr. CEO is genius. Perhaps explaining exactly why Amazon is in the second camp would be overkill. However, it would certainly be interesting to hear more on exactly why Amazon is working hard to charge customers less and why/how it is able to sell premium products at non-premium prices.

17 Responses

  1. Good analysis. A refreshing contrast to the starry eyed ” Isn’t Amazon just so wonderful and friendly” talk we having been seeing. Amazon is certainly betting big on it’s ” Kindle Everywhere” strategy.

    • thanks.

      Yes, it’s strange how much Amazon is focused on the Kindle now. Also interesting how much B&N is betting on Nook and Nook Color. What are these companies seeing in terms of non-ebook sales? I’d love to be able to get a look at ‘Amount of non-book purchases’ Kindle and Nook owners are making from Amazon and B&N.

    • I realized the other day that book companies are not losing any money on me. Yeah, I get the freebies and thus don’t buy the actual book; BUT I realized that almost all of the freebies are physical books that I would borrow from the library rather.than spend my money on them.

  2. Hi switch11,

    thank you once again for your wonderful blog! :)
    Probably you’ve been asked a million times, but it’s very difficult for me to find relevant information. I’m living in Europe and I’m quite surprised by the lack of availability of Kindle Touch (both WiFi and 3G) for international costumers. Last year I ordered my Kindle 3G the very day it was announced, but now the only available option is the not so enticing Kindle 4.

    I’m not asking about Kindle Fire because it seems pretty obvious that many key selling points, for example buying and streaming music/movies through Amazon, would not be available to EU costumers.
    For the Kindle Touch, my guess is that maybe we are too close to holiday season and Amazon wants to make sure not to disappoint U.S. costumers by running out of devices too soon. Maybe you have a better guess or know more?

    Marco

    • Marco – your guess is probably the best one. They probably want to ensure they can handle US demand.
      To that I’d add – Chances are that a new Nook Touch 2 or something similar comes out OR Amazon ramps up capacity. And there is a chance it expands availability to countries other than the US. UK might get priority. But then it would probably be worldwide.

  3. Look who cares at this point, I am delighted to have Amazon offer it’s Kindle Fire and a price that all can afford. I have the Kindle and to upgrade to the Fire I hope l won’t be disappointed. With that being said, if you charge less, more will buy!!! Not rocket science guys. When the kindle came out how many of the millions of people got it for their reading needs? Move over apple and let amazon do it’s thing, it sounds a bit to me that Apple is jealous, and the Nook camp as well. You all can have a piece of the pie. Isn’t it like everything else that marketers do to get the general public to buy into, many styles and makes for several competitors and we all shop and get what we personally want from whom ever!!!! Stop the wars and let the average person pick from the litter of e-readers on the market. If not happy one will get it at the next corner. Simply put do your homework,and the price will dictate who the winner is. Amazon is not just now getting started, this is not their first rodeo!!! They will make money hand over fist, get over it you nay-say-ers and by one now while that price is reasonable. Wish it offered more Gig- byte but they will do that at the next corner in this must have technology. The funny thing just like the i-pad, they (apple) knew they had the i-pad2 on the table when they sold the i-pad and many bought it, just to be disappointed, not months later the i-pad2 was out for sale and at a high price to say the least, and could everyone go out and whip out $799 for i-pad2. The smart thing for Apple should have been to realize the economy and yet they did not and went and gouged the customer. Was that simpathetic? not not not. So worry not as to what Amazon is selling their Kindle Fire for, no kudos to Amazon and l am a loyal customer. I have the i-pad, but like the kindle better, so l buy into it, by my own choice as many others will!!!!!

    • Thanks for your comment.

      At this point – you’re right it’s not an issue. However, Amazon is taking on a sort of debt. It’s not a good strategy.

  4. What strikes me is how vulnerable to disruption the digital content side of Amazon looks. The Google that created Android would scent blood and attack by attempting to drive the selling price of that content to zero so as to sell ads. Whether that Google still exists is another story.

    See some musings By Michael Mace and commenters:
    http://mobileopportunity.blogspot.com/2011/09/amazon-vs-apple-no-its-amazon-and-apple.html

  5. Here are some disconnected thoughts on the latest release. I’ll be adding more in subsequent posts, so I’m numbering them for easy reference.

    1. The Fire is being sold without Special Offers. That means the SO version will cost only $170 or so when it comes out. Wow!

    2. Many commenters don’t realize that Amazon isn’t just, or even mostly, a retailer. It’s fastest-growing business, and the one with the greatest profit margins, is its “mall”–i.e., the shopping venues it provides to other companies that sell at, or at least take orders and ship goods through, Amazon’s site. I’ve read that it gets nearly as much revenue form this source as from its own sales. Expanding its attractiveness as a mall is a big part of what is behind this move to turn Kindles into tributaries to Amazon, I suspect.

    3. The motivation for this loss-leader pricing wasn’t mainly, I suspect, to entice mobile customers into the Amazon store and sell them digital goodies. That could have been done that nearly as well, and profitably, with a $250 price. Rather, my guess is that it’s intended to cut B&N’s Color Nook off at the knees.

    This is supported by Amazon’s similar low-ball pricing on its new e-ink readers, which are going for a similar lower-percentage price than forecasters were expecting. (E.g., $79 instead of $99, etc.) These devices will not be able to download video or to have the buying-portal potential of a color tablet, so there wasn’t much strategic urgency to get them into the hands of the public and expand the customer base. Hence the company’s main motive was most likely to cut the Nook 2 (B&N’s e-ink reader) down to size.

    I surmise that Amazon wants to establish itself as king of the e-book hill. And it’s smart to do so. Publishing is a major business, and establishing e-book dominance means that in ten years, when e-books fully supplant paperbooks, Amazon will be the world’s biggest publisher. Winning that battle will be victory enough. The rest is gravy—gravy that in the meantime provides current and future income to fund its high-stakes bid to knock back the Nook.
    (I posted the item above (#3) yesterday in a thread on the financial site, Seeking Alpha.)

    4. Although the Fire isn’t a direct competitor to the iPad, its pricing makes it a diagonal competitor. The 10-inch Fire will be a semi-direct competitor, if it’s price is around $300 or $325. (Or less with SO.)

    This may be payback for A) Apple’s attempt to skim a cut off Amazon’s e-book sales on the iPad; and B) Apple’s involvement in setting up the agency model, which removed a key advantage Amazon had over B&N in pricing and kept Amazon from knocking its opponent out of the ring at an early date. This leveling of the playing field in turn allowed B&N’s Nooks to sell well against the Kindle.

    Job’s may not have thought ahead to the possibility that Amazon would counterpunch with such reckless effectiveness (being willing to take a loss on sales). That’s what can happen though, when you PO a big player. (This is the sort of mistake that JB wouldn’t make, I don’t think–at least not one of this magnitude.)

    The agency model is likely what forced Amazon to revise its strategy and “go for broke” with loss-leader pricing, shifting from making a profit on the hardware. It intends, I surmise, to thereby greatly accelerate the e-book revolution and (in five years, say) mostly replace current paperbook publishers as the direct publisher of e-books. The playing field will then be tilted, pricewise, in Amazon’s favor. So it’s not just Apple that’s getting payback–it’s the Agency model publishers as well. (This speculation is supported by Amazon’s promotion of low-priced e-book offerings since the agency announcement, a policy that is consistent with an attempt to stick a spoke in their wheels.)

    The publishers should have played ball with Amazon–they’d have eked out a few more years of profitability that way. But they, like Apple and B&N, couldn’t imagine what comeback Amazon, thus provoked, would be able to mount. That’s because they’re not in JB’s class.

    5. JB’s motto has always been, “Get big fast.” (It was even the title of a book about him.) That thinking is part of what is behind this go-for-broke pricing. It’s a very sensible strategy, as long as you don’t overdo it, the way the company did in the early days with reckless acquisitions. This motto is in its corporate DNA, and is another reason why Apple & publishers should have thought twice before riling JB.

    • 5. is very interesting. I wasn’t aware of that.

      Agreed on 3. Nook Color is a major threat to Amazon’s dominance. Bezos knows this and is moving against it. However, B&N hasn’t shown its hand. I suspect B&N’s Nook Color 2 will blow away Kindle Fire technologically. Nook Color 1 had IPS screen etc. last year. It came in at $249 and it was selling 700K units a month last Holiday season.

      I think Nook Color 2 vs Kindle Fire is going to be a very interesting battle. It’s unfortunate B&N isn’t stronger financially.

      ***

      I do agree with 4. People don’t realize that Kindle Fire makes people wonder what makes iPad worth $300 more.

      When people see Tablet X for $500 it’s easy to say iPad 2 is better. When they see a pretty good tablet at $200 they start wondering.

      • From the day it started (mid-nineties) until a decade or so later, Amazon never once showed a profit. All revenues were plowed into making the site bigger faster better and when necessary into starting price wars other competitors with smaller war chests would lose, driving them out of business. Amazon’s business model is based on that, all the way from 15 years back — get mindshare and become the number one big honcho. They did it in books first mostly because that was where the opportunity was back then, followed by DVDs, ditto.

        Those items have in common that they’re very easy to price compare on — a DVD from Target will be the same as one from Amazon. Your next Pear tree for your garden, or your dinner meat, are much less comparable. Other segments are less comparable because there are many ways to refer to things — there are tens of thousands of different pots for your plants around, and dozens if not hundreds of ways to name them.

        Back in 2000 during the dot com crisis, everyone thought that surely now that the trees were no longer growing into heaven and VCs were no longer throwing money around like it grew on those trees, that amazon would go bankrupt or have to change strategy. Never did happen. And now they’re big, they’re profitable, and they’re the first name people worldwide think of when they think of ecommerce. Which is what they wanted.

        Apple went exactly the other way — they made sure they made a healthy profit on every single product sold, even though that made them lose sales for a while. And then they plowed large percentages of their money into R&D to make their products the best they could possibly be while maintaining that margin.

      • “I suspect B&N’s Nook Color 2 will blow away Kindle Fire technologically.”

        If so–and Amazon would likely have some inside awareness of this if it were coming–then it was smart to underprice it.

  6. (Excuse me for the misplaced apostrophes in items 1-5 above.)

    6. I read very recently a blogger who claimed that once e-book sales become 20% of a book’s total sales, it becomes more profitable for an author to publish direct to digital himself, thru Amazon, than to let a paperbook publisher do so for him. If this is the case, then Amazon’s strategy to accelerate the e-book revolution has only a short way to go before it causes massive authorial defections to its side. (Authors aren’t big fans of their publishers for the most part anyway.) Then Amazon will be in the driver’s seat. (And poised to enjoy a cold dish of revenge.)

    7. When Amazon came out with its Special Offers models, I figured that it signaled a switch from a focus on books to one on general merchandise–and I was bold enough to say so on various Kindle blogs. (Somewhere–I don’t have the links.) That’s why I dubbed them “Kindeals”–because that was what they were going to be about, strategically, to Amazon. I’m feeling vindicated.

  7. What all of this forgets is that Amazon isn’t just an ebook/book company, they have many other successful silos of business like their Cloud Services. B&N is only a book company. Apple is only a device company. Amazon does both of those, plus many others. That gives them the means and diversity to meet their customers needs.

    People want well-made, affordable devices with affordable content, delivered seemlessly, and Amazon gives it to them. Their cloud services are the same, they save our company $10,000/month over a data center and have better up time and easier maintenance. They also have the number one ranked customer service.

    Amazon was one of the few tech companies to not only survive the dotcom bust but to thrive. I think Jeff Bezos knows what he’s doing.

    • Yes, my main point would be – Amazon has gotten addicted to delaying gratification. It’s also assuming that it can keep growing non-stop.

      Those are both dangerous things i.e. not building up a cash hoard, assuming never ending growth.

      If you compare the amount of cash Microsoft and Apple have Vs what Amazon has. It’s a bit strange that Amazon is trying to most expansive things out of the three.

      • Yup. Get Big Fast assumes payoff at the end of the line. Right now some of Amazon’s businesses are profitable enough so that they can pay (and to spare) for the expansion, at a loss, of others. This strategy doesn’t come without its own risks — both that you sink a huge amount in a market and still don’t “win” at the end, or not for long enough to recoup, and that your existing, profitable markets (which are paying off a long loss making buildup themselves) close down too soon so you’re left with a not-yet profitable and a no-longer-profitable arm. Diversification helps there.

        It’s a lot like putting it all on red a few times over, winning, and then putting about a third or so of your bankroll on red every next throw.

        It works as long as you don’t hit black either on the first few goes (pets.com, anyone), or in the later stages, too many times in a row.

        Now admittedly, this roulette wheel (due to canny choices by Jeff Bezos) has a lot more red in it than Black — but it’s still possible to hit the 0 green as well.

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