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Amazon’s Whale Strategy

A week before yesterday’s launch of the Fire Phone, Amazon sent all of the attendees a copy of the children’s book “Mr. Pines Purple House” with a note from Jeff Bezos stating:

I think you’ll agree that the world is a better place when things are a little bit different.

Beyond the book, the first thing different about the event was that it was open to the general public. Over 60,000 people ended up applying to attend, and Amazon opened the event with a video featuring several of those applicants. The message was clear: this event was about, and for, Amazon’s most loyal customers. And so is the Fire Phone.

It’s not the Phone that’s Different; It’s the Strategy

At first glance, there is very little about the phone that feels different, at least in the ways that matter. Firefly is compelling, while Dynamic Perspective feels like a whole lot more trouble that it’s worth – both for Amazon and for end users. The camera looks impressive, and unlimited cloud storage is indeed a feature all smartphones should have. Still, much of this is at the margins: what we expected from Amazon was along the lines of Jeff Bezos’s promise for the Fire tablet line: “Premium products at non-premium prices.”

Instead the Fire Phone is right up there with an iPhone 5S when it comes to price,1 and it’s sold with the exact same contract you would get with that iPhone.2 There is no margin compression, no subsidized data. There’s nothing different at all. Unlike the Fire tablets, which most assume are sold at near cost in order to drive usage of Amazon’s services – especially Prime video and Kindle books – the Fire phone seems unlikely to attract any new customers to the Amazon ecosystem. And perhaps, that is what makes it so different: the Fire Phone seems to be not only a different strategy for Amazon, but a new kind of smartphone strategy full-stop.

How Will Amazon Ultimately Make Money?

The chief question observers have about Amazon is when exactly they will start making profits, and, more importantly, how. Last quarter Amazon made a mere $108 million on $19.74 billion in sales, good for a price-to-earnings ratio of over 500. While some have suggested that Amazon is trying to eliminate competitors so it can raise prices, it seems much more likely that a significant raise in Amazon’s prices would cost them more customers than it would be worth.

A more plausible argument Amazon’s eventual profitability is predicated on their total revenue and gross margins; while Amazon’s net margin last quarter was only 0.5%, its gross margin was a healthier 28.8%, which comes out to $5.69 billion in gross profit. Were less of that gross profit invested in growth, Amazon could very quickly begin generating significant return for shareholders. Still, though, this suggestion isn’t entirely satisfactory either: slowing investment works in the short-term, but Jeff Bezos is famously long-term focused, and over time less investment would lessen Amazon’s competitive advantages.

The Whale Strategy

The Fire Phone’s high price highlights what may be a third way: call it the whale strategy, for it entails a disproportionate amount of profit being generated by the same sorts of loyal customers who opened yesterday’s Keynote. In this view, instead of the Fire Phone being a means of driving e-commerce, e-commerce is in fact a means of capturing customers and building loyalty; Prime deepens the connections, and the profitability; and at the final stage, the Fire Phone makes more profit in a single purchase than anything that came before, even as it drives an even deeper connection with the customer.

It helps to look at this strategy as a sort of funnel:

Amazon Whales are the top one percent: Prime subscribers who buy the Fire Phone

Amazon Whales are the top one percent: Prime subscribers who buy the Fire Phone

Looking at the actual numbers involved makes this implications of this strategy even clearer:

Screen Shot 2014-06-19 at 11.20.54 PM

Various reports suggest that Prime subscribers make up about 10% of all Amazon shoppers. Presuming that is the case, and that 10% of Prime subscribers buy the Fire Phone, Fire Phone buyers could make up 4% of Amazon’s gross profit despite being only 1% of Amazon’s customers.3 Moreover, nearly 40% of that additional profit would be derived solely from the phone itself. In fact, the incremental $150 dollars in annual phone profit (spreading out the expected $300 gross margin over two years) would have the same impact as converting 2.5 normal shoppers to Prime subscribers.

Ultimately, this may be Amazon’s endgame: unlike Apple, a vertical company which offers services to differentiate its phones, or Google, a horizontal one that offers services to everyone, and phone software for free to ensure access, Amazon is offering a phone to more fully monetize a segment of its broad base of e-commerce customers, and maybe, at long last, turn some sort of profit.

Will It Work?

I have admittedly gone out of my way here to paint a strategy that makes sense of Amazon’s announcement yesterday. In truth, I’m a bit more skeptical.

Amazon has always had a unique relationship to the physical world: from a consumer perspective they’re totally virtual, yet their primary business is things you can actually touch. In that sense something like the Fire phone is perfect for Amazon: it tightly binds the virtual to not only what is on your computer screen, but to what is on your hand, and with Firefly, most of the objects you interact with everyday.

The question, though, is if the Fire phone is perfect for Amazon’s customers. Just because someone loves Amazon doesn’t mean their entire life is about buying things. And while it’s true that Amazon has gone to great lengths to make the Fire Phone compelling as a phone, it’s still an inferior offering as compared to a high-end Android phone or especially an iPhone when it comes to things like apps. In this respect it’s fair to compare the Fire Phone to Facebook Home and the HTC First: just because people love Facebook didn’t mean they wanted Facebook to dominate their phone, and by extension, their lives.

Moreover, I was troubled by the faint sense of hubris in yesterday’s presentation; it was 45 minutes too long and included far too much self-congratulation and navel-gazing. We get that the design process for Dynamic Perspective was hard, but that doesn’t mean we care. More broadly, Amazon is a horizontal company: they ought to be serving everyone. Having their own phone introduces the wrong sort of incentives when it comes to Amazon’s efforts on Android and the iPhone; it’s the same danger I see in Microsoft focusing on both services and devices.

Ultimately, I think Amazon would have been better off investing the considerable time and effort it took to bring the Fire Phone to market into better marketing Prime, as well into a concerted campaign to get users to add and use an Amazon app – with Firefly functionality – on their smartphones. Those Apple-like phone margins may look attractive in the short term, but hasn’t Amazon always been the king of the long term?4

  1. The base model does have double the storage
  2. Amazon is severely constrained by virtue of the fact they primarily compete in the US; because of subsidies, it is very impossible to undercut other phones in price, and mid-range phones are especially handicapped when iPhones are available for $200 out-of-pocket
  3. Other assumptions and references:

    • The numbers for annual e-commerce spend for normal and Prime subscribers are from this Quartz article
    • I assumed the Fire Phone buyers would further increase their ecommerce spend by the same percentage as Prime subscribers relative to normal shoppers
    • I also assumed the Fire Phone shoppers buy a new phone every two years (and thus divided an estimated $300 gross margin by 2)
    • I did not calculate the profit from any other Fire devices, although Fire Phone buyers are much more likely to have a Fire tablet, Kindle e-reader, and/or Fire TV

  4. Yes, you could argue that the Fire Phone is a long term investment

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