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What Amazon Can Learn from HP

Is the HP TouchPad fire sale frenzy replicable? Probably only for Amazon, which can sell hardware at a loss.
August 30, 2011

Last week, as HP slashed prices on its touchpad, consumers went nuts. Best Buys and other retailers sold out in a frenzied rush. As I speculated at the time, the news of this ravenous market for second-tier tablets would probably be of particular interest to Amazon, particularly if it could afford to price its tablet remotely near the $99 price point that so motivated consumers last week. A New York Post source “with knowledge of the plans” now says that that’s exactly what we can expect to see–maybe not quite a $99 tablet (which, after all, is less than an entry-level Kindle), but at least one that’s “hundreds less” than the cheapest iPad, currently priced at $499.

Why is Amazon the leading contender to dominate the second-tier tablet market? Because it’s the one player in the space that can sell tablets at a loss, and still wind up making money hand over fist in the long run. Apple makes the bulk of its revenue, still, from hardware. It definitely turns a profit from iTunes sales, but only the merest fraction when compared to hardware sales, as evidenced dramatically by this chart via BusinessInsider. About 80% or more of its revenue comes from hardware, while a tiny sliver–a few percentage points at most–comes from iTunes. In a recent quarter, over two-thirds of the company’s entire revenue came from iOS device sales alone. Of course, it’s important not to conflate revenue with profits–but Apple’s costs on its most popular items remain well below their sales price. The iPhone gross profit margin was pegged at about 60% last year; that figure’s a bit lower for the iPad 2, but still strong–roughly 25%, per one analyst. Apple, for now at least, is a hardware company.

That’s not true of Amazon, whose hardware mainly exists to push consumers content in its various forms. In fact, analysts suspect that Amazon already sells the Kindle at a loss, according to MarketWatch and the Wall Street Journal. (Market research firm iSuppli tore down the Kindle 3G and estimated the cost of its components as a mere $33 less than its sales price–and that’s before manufacturing, software, licensing, and others costs.) Said Rotman Epps, a Forrester Research analyst, “There is no way manufacturers can get there [to the number-two tablet spot] without subsidizing the cost…. And Amazon is one company that can do that.”

It can do that simply because it has so much content in its store; e-books and music, of course, and it has moved into movie and TV downloads and rentals. It could also drive profits by advertising daily deals and shopping specials on a tablet, observes GigaOm’s Kevin Tofel. Amazon already experiments with subsidizing the Kindle in this way; consumers can currently purchase a “Kindle With Special Offers” for $25 off the price of a regular Kindle.

In theory, if Amazon managed to turn a tablet into an efficient enough media-consumption machine, it could give the things away and still wind up turning a profit. Not that it would. A recent Forrester Research report says, “If Amazon launches a tablet at a sub-$300 price point — assuming it has enough supply to meet demand — we see Amazon selling 3-5 million tablets in Q4 alone.” Other research has suggested that around $350 represents a “sweet spot” for tablet pricing.

How low can Amazon go? How low will it choose to go? And will consumers respond with anything like the ravenous alt-tablet hunger we saw last week? We should find out soon enough–possibly in late September or October, if the Post’s source is to be believed.

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