Wireless Watch: Amazon smartphone will confirm the new mobile economics Jul 12, 2012 – Rethink Research
Significance: The mobile device market has traditionally been split between premium products increasingly differentiated by their software, and low cost, price-driven models. Now the two are converging to create a new category, dominated by web majors – low cost devices which nevertheless deliver high value to their users and vendors, because of their advanced content and apps experience. Amazon’s Kindle Fire, now mimicked by Google’s Nexus 7, have marked out the new territory and with both firms also eyeing handsets, Apple and Microsoft will respond too, driving their media offerings to wider bases. Samsung and Sony have many of the elements to try to join this select band, but other phonemakers, as well as web players like Facebook, will struggle to make the huge investments required.
The mobile device industry has been turned on its head in the past year, and various events suggest the conventional handset model has run out of steam. This is partly because the smartphone has become a multipurpose computer, ushering in an era when the user experience and the software, even more than the hardware, determine success – and software driven players have used that shift to outwit the traditional handset makers. But it will not be enough for Nokia, Motorola and RIM to deliver new and compelling user experiences. They will also have to adapt to an entirely new set of economics, where margin must be found in software and content even while brand awareness still lies mainly in hardware design. With Amazon, Microsoft and Google all leaping into the device game, sacrificing device profits in order to wed users to their content platforms, even Apple may have to rethink some of its assumptions on smartphone margins.
Apple has been the master of delivering an integrated smartphone/software experience, with both aspects driving revenue and profit. However, its offerings remain expensive – fine for its premium gadgets, but as it increasingly seeks mass market reach, it is expected to operate a two-tiered strategy for the iPhone and iPad, with lower cost ‘mini’ models. These will be the devices that are forced to go head-to-head with the new wave of products from Apple’s deadliest enemies, Google, Microsoft and perhaps most dangerously Amazon. With those companies strengthening their hardware/content and multiscreen platforms - and asserting design and brand control over their devices – Apple will face a more close-run contest than ever before.
That will also mean a shift in its normal margins. We do not expect the firm to enter the low end of the smartphone market where vendors mainly compete on price and profits really are slight. In the user segments which are driven by content more than gadgetry – the ones Amazon is targeting – there will still be plenty of margin for the cleverest players, but it will be more heavily weighted towards sales of contents and services than in the high end smartphone arena. There, while media has been an increasingly important element of profit and differentiation, Apple’s devices still provide an object lesson in how a company can still make money from good hardware design and strong supply chain control.
By contrast, Amazon’s Kindle Fire showed the retailer being disruptive by virtually ignoring the race to create a beautiful premium device, and instead treating hardware as a loss leader. It assumed – rightly, as early indicators and Google’s haste to mimic suggest – that the hit on hardware profits would be more than offset by increased media revenues, driven by its famously addictive content consumption and purchasing experience, now showcased on an optimized platform.
Google seems to be taking a similar line with its forthcoming Nexus 7 tablet, tying a low cost device tightly to its various stores and to its own brand (no more hiding behind third party brands and ‘Android Market’). Research firm UBM TechInsights believes the Nexus 7 will cost about $184 in components and assembly, compared to $153 for the Kindle Fire, which means only about $15 in profit for Google (less after marketing and other overheads). A similar study from IHS iSuppli suggests the bill of materials may be lower than thought, at $151.75, with an extra $7.50 for the added memory in the 16Gb version. That suggests some room for profit, though the terms with manufacturer Asus are not known. Delivering higher specifications for the same retail price was necessary to differentiate from Fire – especially as new models are due soon – but like Amazon, Google knows an affordable but attractive gadget could return dividends in advertising and media revenues. Google has previously suggested it can earn about $10 per user per month through advertising and data.
And now Amazon is expected to unveil a smartphone too (as may Microsoft, though the jury is still out on whether the Windows giant can leverage its media assets as effectively as Amazon and Apple to support its own-branded hardware efforts).
All this activity, plus Google’s acquisition of Motorola, is creating a new sub-category within the mobile industry – the low cost device with high value, highly differentiated content. That will mean intense efforts in supply chain efficiency on the hardware side, and enhancing software and web services on the other. And other web players may join too – Facebook has been expected for months, and Samsung (or at least one of its many faces) will also seek to play in this game. Samsung already has the advantage of hardware scale and price competitiveness, but has a way to go to layer a really bighitting content platform on top.
The reason the economic challenges are different from those which traditional handset makers understand is that the choice is no longer between selling a cheap phone and a premium phone. Cheap and low margin hardware can still deliver good profits by adding content and apps. But this cannot be confined to one type of gadget. It is about delivering an affordable content platform which encompasses handsets, tablets, phones, browsers, gaming systems and TVs.
If all that hardware is to be self-branded – giving the content giants full control of the user experience – it will require huge investment in design, marketing and ODM relationships. Even more, with gadgets becoming front ends for huge cloud-based offerings, credible players will need to invest massively in content and cloud infrastructure – this has been a decade’s effort for Amazon, and Bezos is keen to stress that driving devices down to $79 (which he sees as the sweet spot for mass uptake in the US) is a trivial challenge compared to creating that platform, and the $15bn media business which rides on it.
As commentator Ashlee Vance pointed out in a BusinessWeek column: “Apple, Microsoft, and Google have built up immense chests of cash for exactly this battle. Amazon doesn’t have the cash of its rivals, but the company has over a hundred million customers’ credit cards and its own well trafficked storefront—resources matched only by Apple.”
That leaves little room for smaller or more specialized players, a group which actually includes large but single-focused firms like Nokia and RIM, which have failed to reach beyond the handset into other form factors or groundbreaking stores. Samsung may well muscle into the charmed circle, and Sony could too if it harnesses its natural assets more effectively in future. But other phonemakers will increasingly have to play in the traditional model – engaging in price wars as the premium margins shift to new form factors like tablets, and to content.
Facebook, ZTE and others will be well behind, but the big four will still have the battle of their lives on their hands, and many hurdles, from limited track record in hardware (except Apple) to immature software platforms (Microsoft). Amazon appears to be the wild card because the other three are so accustomed to fighting one another on all kinds of platforms, yet the retailer has helped set the new rules with its Kindle strategies – which it now aims to expand to other devices, judging by hints dropped by CEO Jeff Bezos.
In particular, it has aggressively driven the new approach to device economics, aided by its determination, from the start, not to rely on hardware for profits, and its naturally low margin business. Bezos said when the Fire was unveiled: “We’re a company very accustomed to operating at low margins. We grew up that way. We’ve never had the luxury of high margins, there’s no reason to get used to it now.” However, he still had to justify the strategy to shareholders, given the short term hit that hardware makes on Amazon’s results while the firm waits for the increased content purchasing to kick in. Like a carrier, Amazon is spending on marketing and subsidizing devices in order to generate regular income over the lifetime of that product – and revenues which would not be obtained on less controlled platforms (a Kindle ereader owner spends an average of $20 a month on content and that is set to increase to $25 in 2012, while by comparison, people with the Kindle application on an iPhone spend $5 a month. On a tablet, with its video, magazine and apps stores, the spend should be far higher).
Amazon’s CFO Tom Szkutak said last year: “When you think about the economics of the Kindle business, we think about it in totality. We think of the lifetime value of those devices. So we’re not just thinking about the economics of the device and the accessories; we’re thinking about the content. We are selling quite a lot of special offers devices, which include ads, so we’re thinking about the advertisement and those special offers and those lifetime values.”
Amazon, like Google and Apple, may struggle with TV, but it has a fighting chance in handsets despite its late entry to the space. And if it establishes its brand, it hits Google almost as much as it hits Apple, because it aims to establish its own Android implementation as a rival to Google’s as the default experience on the OS. The success of the Fire has been a mixed blessing for Google – while it has provided a credible Android challenge to the iPad at last, Amazon runs its own content store and a heavily customized UE, so Google is almost excluded from the Fire’s services and revenues.
One of Amazon’s weapons is developer appeal – programmers generate far higher revenues per user in Amazon AppStore than in Google Play, according to app store analytics firm Flurry. For every $1 generated by Apple's App Store, AppStore delivers an average of $0.89 per user, compared to just $0.23 per user in Play. This highlights Amazon’s unquestioned expertise in the digital retail experience and the firm is also reported to be looking to acquire new elements for its platform, such as a mobile advertising network. It recently acquired 3D mapping firm UpNext, according to reports.
As for the purported smartphone, Bloomberg sources indicate Amazon will work with Taiwanese manufacturer Foxconn and will target the high growth market for users who do not currently have a smartphone or buy significant amounts of digital content. Like the Fire, the aim will be to attract a new base rather than going head-to-head to steal iPhone or Galaxy users.
Meanwhile, analysts at NPD DisplaySearch believe Amazon will release four new Kindle Fire models in August to September. Analyst Richard Shin’s supply chain sources indicate there will be three 7-inch variations, including a low cost option with 1024x600 display and no camera; and two with 1280x800 displays and camera, one of them also boasting cellular connectivity for the first time. There will also be a high end, 8.9-inch model with 1920x1200 display but no 10-inch offering.
Of course, the other big looming hardware/content challenge comes from Microsoft, with its Surface tablets and rumors of smartphones to come. Like Google, Microsoft has all kinds of conflicts in becoming a hardware vendor, because of its reliance on third parties to support its platforms, but like Google, it seems to want to set out a gold standard for how device vendors should design their products in order best to showcase the software and content – and drive those all-important media revenues. The problem for Microsoft is that the PC vendors are not very motivated to encourage content consumption, as unlike mobile players like Samsung, they have no significant way to share revenues from media or advertisements. That leaves Microsoft with the problem that it could invest in the necessary cloud and content resources, but be left – as it has been to date – with devices that are sub-optimal for harnessing them. Hence, implied CEO Steve Ballmer at the firm’s worldwide partner conference this month, the need to design its own tablets for Windows 8.
Like Windows Phone, W8 will be tightly integrated with content assets, notably the growing Xbox content hub. And it will need to adapt to many new form factors rather than staying within its declining PC heartland. Ballmer said: “Surface is just a design point. It will have a distinct place in what's a broad Windows ecosystem. And the importance of the thousands of partners that we have that design and produce Windows computers will not diminish. We have a mutual goal with our OEM partners to bring a diversity of solutions, Windows PCs, phones, tablets, servers to market. And what we seek to have is a spectrum of stunning devices, stunning Windows devices. So, every consumer, every business customer can say, ‘I have the perfect PC for me’."
Ballmer was more aggressive in an interview this week with Computer Reseller News. He said: “We are not going to let any piece of this [go uncontested to Apple]...Not the consumer cloud. Not hardware software innovation. We are not leaving any of that to Apple by itself. Not going to happen. Not on our watch.” This is the key of course – getting the hardware/software balance right in the user experience and the profit strategy. That is the common challenge for everyone that does not want to be consigned to a handset or PC hardware price war. Players will need to adopt a whole armory or weapons. Amazon will need an advertising network, probably, and is already investing in patents to protect itself, and may extend its MVNO activities beyond the ereaders, with their embedded and ‘free’ 3G. Apple still has a considerable way to go with its cloud experience. Microsoft has more challenges than natural advantages once the traditional PC models start to break down. But for consumers, all this could signal a huge wave of investment in innovation and new services.
Google and Amazon limit their tablets’ reach:
With Apple apparently poised to launch a mini iPad, the key tablet battleground could shift to the 7-inch form factor. These products, as epitomized by the Amazon Kindle Fire, rely heavily on a highly integrated and portable content experience, which Apple will be well positioned to support. Strange, then, that both Amazon and Google seem to be keeping their content stores within US shores.
Amazon recently announced plans to extend its Android AppStore beyond the US later tthis year, and already supports international versions of several key stores, including Kindle – but not its video-on-demand services. This has confined the market opportunity for the Fire to north America so far, even though content and video sales are essential to Amazon’s business model for the tablets.
Now Google is going down the same road, according to CNet, which says non-US buyers of the new Nexus 7 slate will not gain full access to its features and content. While US buyers will be able to access the full range of music, TV, video and magazines showcased at the recent I/O developer conference, those in Canada, the UK and Australia (the other Nexus 7 launch markets) will only be able to download a limited selection.
UK customers will have access to the Google Play store (formerly Android Market), but not the additional movies, books and music promised specifically for the new tablet. "Currently, the UK store offers apps, movie rentals, ebooks and devices. We're clearly eager to expand this in time, but currently, that's the offering in the UK," a Google spokesperson told CNet. Google Music is still available only in the US, a year after its launch.
Contrasting Q2 fortunes for Samsung and HTC:
Samsung and HTC usually kick off the smartphone vendors’ quarterly results season, but in Q2 2012 their fortunes are in stark contrast. Smartphones drove the Korean vendor to record profits despite pressures in other divisions, while HTC saw its profits halved year-on-year.
Samsung only releases headline figures at the start of the season, and will follow its preliminary report with full details later in the month, but the highlights are clear. The company said second quarter operating profit should increase by 79% year-on-year to KRW6.7 trillion ($5.9bn), in line with analyst forecasts, and beating the previous record profit set in Q1. Revenues should come in at KRW47 trillion, just below a KRW50 trillion forecast.
Profit from the mobile division will more than double to around KRW4.4 trillion, driven mainly by sales of about 50m smartphones, with the recently launched Galaxy SIII the highlight. "Our smartphones are flying off the shelves, with some outlets reporting 40% to 60% sales growth,” a Samsung source told Reuters, even while he also pointed to the pressures of the eurozone crisis. "Europe is our biggest consumer electronics market and we may have to initiate cost cuts and product price increases should the euro fall further from the current level," the source said. The euro has fallen around 5% against the Korean won since April, and about 8% in the past year.
By contrast, HTC’s well received new flagship smartphone, the One X, has not had the same impact on Q2 performance. The Taiwanese company said Q2 unaudited revenues were NT$91bn ($3.04bn) but net profit fell to NT$7.4bn ($247.7m) from US$585.95m the year before.
Among the factors were a shortfall in sales in the crisis-hit European region and US import delays to some key models, such as the One X and EVO 4G LTE, because of patent disputes with Apple.
Amazon challenges Apple again with GameCircle
Amazon has enhanced the gaming capabilities of its Kindle Fire tablet, as it increasingly goes head-to-head with Apple in content terms.
It has introduced GameCircle, a platform with some of the features popular in its rival’s Game Center. The new offering tracks players’ scores and compiles a leader board, and also supports a very characteristic Amazon function – syncing to the cloud, so that users can save a game-in-progress and then resume where they left off, even on a different device.
The new platform does not go as far as Game Center in its social networking features, but is likely to evolve once Amazon secures developer support. It is currently urging third parties to integrate Circle in their games, offering an API and relevant tools.
GameCircle APIs include Achievements, for tracking awards without quitting the game, and with in-game messages to keep track of accomplishments in real time. All scores and achievements are stored for free in the cloud.
Amazon is gradually integrating the Fire with more digital stores and cloud services, as well as with subscription content options associated with its Prime proposition. It will soon bring Fire video and apps stores to some European markets too, and is expected to launch a smartphone later this year, to further extend the reach of its media offerings, and of its heavily customized Android user experience.
Wireless Watch: Amazon smartphone will confirm the new mobile economics
