Amazon Fire TV Bundle Takes Sacrificing Margins to the Extreme

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Amazon (AMZN) is a merciless retailer, determined to do to big box competitors like Walmart (WMT) what it has already done to companies like Borders. [Ed. note: R.I.P.] It’s also known as a hardware producer, one willing to sell its products at cost — or even a loss — in order to undercut the competition.

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Source: Amazon

The strategies are interwoven. Get more hardware into people’s hands and they’ll become Amazon customers who use the devices to buy stuff, contributing to that first objective … eventually.

The hardware cost-cutting reached extreme levels in June when Amazon bundled its new Amazon Fire TV and a 7-Inch Kindle Fire HDX tablet for $249. At $79 off the retail price for the pair, this was almost like getting a free Fire TV — just two months after the set-top streamer was released.

Considering Amazon was already making next to nothing on each device at the regular retail price, what kind of madness is it to eat another $79?

The kind of madness that contributes to a projected loss of between $410 and $810 million for AMZN when its time to report Q3 earnings.

Apple (AAPL) margins are the envy of the industry, usually more than 50% on smartphones while All Things D’s Arik Hesseldahl reported margins ranging from 45% to 61% on the iPad Air. Meanwhile a teardown of 2012’s Kindle Fire HD proved typical of Amazon’s strategy. According to Gizmodo’s Brian Barrett, the $200 Amazon tablet had $165 in parts alone (that doesn’t count marketing, assembly, shipping and R&D) meaning AMZN was ultimately losing money on each one it sold.

Amazon always reassures investors that it’s playing a long game. Making money on hardware is immaterial to its bottom line. What counts is getting as much hardware out there as possible. If this means displacing iPads by seriously undercutting their price and preventing someone from buying an Apple TV or Google (GOOG) Chromecast by offering what amounts to a virtually free Amazon Fire TV, that’s merely short-term pain for long-term gain.

But does that long-term gain even exist?

The closest thing to an independent, definitive study on the issue was a definitive yes.

In December, Consumer Intelligence Research Partners published a study of Amazon’s U.S. customers based on a three-month survey period (a PDF of the report is here). Among the findings:

  • Kindle device owners spend an average of $1,233 per year at Amazon, $443 more than customers who don’t own a Kindle device (who spend an average of $790)
  • Kindle owners make Amazon purchases 50% more frequently than non-Kindle device owners
  • Kindle device owners buy a greater range of products, making purchases from an average of 6.4 different departments compared to 5.5 departments for non-Kindle device owners
  • As of September 2013 Amazon had an installed base of 20.5 million Kindle devices, and 40% of all Amazon buyers owned a Kindle device

If Amazon is making its money on selling products (other than Kindle devices), then breaking even or taking a loss on tablets is clearly worth it. Trading a one-time loss on a Kindle Fire tablet in exchange for three or four years of $443 in additional sales of higher margin goods seems smart. And to be clear, those Kindle device owners aren’t just buying digital content like e-books and MP3s, they’re shopping across Amazon’s departments.

Let’s throw another stat into the mix: the growth of mobile e-commerce.

According to eMarketer, purchases from mobile devices (including tablets) hit $42.13 billion in the U.S. in 2013 — a 70% jump. It expects that number to hit $57.79 billion for 2014. Shopping from mobile devices is growing significantly faster than overall retail sales (which were up 4.2% in 2013), making it even more important to get your mobile devices to consumers.

That Amazon bundle may have amounted to an essentially free Amazon Fire TV as the lure, but it also included a Kindle tablet, just what Amazon wants to get into buyers’ hands. And the Fire TV is a content purchasing platform, too.

One final factor in Amazon’s discounted hardware strategy: momentum. Amazon went all in on hardware once it ventured into tablets. That meant developing its own Fire operating system, building its own app store and a lot of money sunk into research and development.

The more hardware it gets out there, the more momentum its platform gains and the better its chances of eventually being able to bump up the margins to actually make money off the hardware itself. Raise prices too soon and risk having people go with iOS or Android instead, and then the years of hardware investment is at risk.

For now, it’s all about building up the user base, even if that means AMZN gets beat up in the short term.

There have been recent cracks in the hardware pricing strategy, though. The most notable is the new Fire Phone (reviewed here), priced not at a discount but at the same premium $649 you’d pay for an iPhone 5S or Samsung (SSNLF) Galaxy S5.

And that “almost free Fire TV” deal has recently been re-priced at $279. Maybe the pressure after the latest money-losing quarter and subsequent double-digit AMZN decline had something to do with the price adjustment, but even at the reduced $49 discount, Amazon is still probably losing money on every sale.

But, again, that was the plan all along. Now we just have to wait and see if it pays off.

As of this writing, Brad Moon did not hold a position in any of the aforementioned securities.

Brad Moon has been writing for InvestorPlace.com since 2012. He also writes about stocks for Kiplinger and has been a senior contributor focusing on consumer technology for Forbes since 2015.


Article printed from InvestorPlace Media, https://investorplace.com/2014/08/amazon-fire-tv-amzn/.

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