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.

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