Why Does this Company Sell Merchandise at a Loss?

Robby is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Amazon.com released the new Kindle Fire HD last week, and the company has been getting some heat about its profitability. As with its predecessor tablet, Amazon.com sells the Kindle Fire HD at cost, or at a slight loss. Bearish investors have been critical of the company's margins, and the launch of Kindle Fire HD illustrates their point: how can Amazon.com stay in business by pricing their merchandise too low to profit?

The Strategy of Building an Ecosystem

In the tech world, developing an ecosystem is the key to building a loyal user base.  Apple (NASDAQ: AAPL) exemplifies this tactic. The company’s operating system for desktops (Mountain Lion) integrates with its operating system for mobile (iOS), and its cloud storage service (iCloud) advertises its ability to synchronize data with every Apple device. There's serious value in cross-platform interoperability. The products communicate flawlessly with one another, creating a seamless environment and a smooth experience for the user. By designing their products to function optimally with other Apple products, the company tightens its brand and influences consumers to purchase other devices from them in the future.

Google (NASDAQ: GOOG) developed its own ecosystem, with properties including YouTube, Gmail, and Google Maps (all of which are integrated into Android phones & tablets). As with Apple, the variety of Google’s services create an inner circle around the brand, encouraging users to stay there.

Amazon.com (NASDAQ: AMZN) has been investing big in cultivating its own ecosystem. With the acquisitions Amazon’s made throughout the years, the company has evolved into more than just an online retailer; its arsenal of brands now include the Internet Movie Database, Audible.com, Digital Photography Review, and Alexa Internet.

The Significance of Kindle Fire HD within Amazon's Ecosystem

With the launch of the Kindle Fire HD, Amazon.com is solidifying its strategy to encourage sales within its subsidiaries. The tablet is designed primarily for content consumption (games, digital books & magazines, audiobooks, and digital music), and the online retailer hopes to capitalize on sales of that content. The company is also targeting college students with its Kindle Textbook Rental service, meant to alleviate the financial burden (and weightiness) that physical textbooks have on students. Amazon’s acquisitions play their parts in the seamless Kindle Fire HD experience. The tablet refers the user to Amazon brands to stream content, read trivia, download music, and buy directly from Amazon’s store.

Connecting all of Amazon.com's services is the Prime membership – a $79 annual subscription giving members access to perks and features that persuade users to stay with Amazon. Here’s a fictitious scenario of how that would happen:

If Demetri Smith wants to watch The Real Housewives of Atlanta on his Kindle Fire HD, he can easily stream it through Amazon’s integrated Instant Video service. He could use Netflix (NASDAQ: NFLX) on his Fire HD, but his Amazon Prime membership makes a Netflix subscription redundant. If he wants to read trivia about the characters’ fascinating lives, the Fire HD will use its “X-Ray for Movies” feature to access information from IMDb.com, another Amazon brand. If Demetri decides to purchase the Season 3 box set of Real Housewives, he doesn’t need to query Google to find it; he can buy the DVD directly from Amazon for a competitive price and free two-day shipping. When Demetri wants to purchase digital music, his Prime membership incentivizes him to use Amazon’s mp3 music store instead of shopping through Apple’s iTunes. And he can find audiobooks from Amazon-owned Audible.com. Or he can borrow Harry Potter as a digital book from the Kindle Owners’ Lending Library. Notice how the homepages of these services clearly tout their compatibility with Kindle Fire HD.

The Bottom Line: It All Comes Down to Price                         

In the tablet wars, Amazon is clearly intending to take market share away from Apple. In its promotional materials, Amazon.com frequently compares the iPad with the Fire HD, and the price difference is enough for consumers to decide in Amazon's favor. The lowest-end 3rd generation iPad costs $499, while the comparable Kindle Fire HD is priced at $299. Apple makes fantastic profit from the hardware it sells, and the company depends on it. Amazon isn't aiming to profit on its hardware. Instead, the company’s presence in the tablet market is intended to grow Prime memberships, propel sales of physical & digital goods, and lock consumers into the Amazon ecosystem.

Dig Deeper, Fools

If you’re a retail investor, you have to take a look at Amazon.com, the company set on disrupting the entire retail sector. Whether you’re looking to own Amazon itself or own one of the companies its taking sales from, understanding the company and its prospects is essential. That's why we've created this new premium report on Amazon, which runs through everything investors have to know about the company. Our report also has you covered with a full year of updates as key new hits, so click here now to get started.

 

 

 

 

 


robbyinvest owns shares of Amazon.com. He used to own shares of Apple a while back, but sold them too early. He has never purchased shares of Google. The Motley Fool owns shares of Apple, Amazon.com, Google, Microsoft, and Netflix. Motley Fool newsletter services recommend Amazon.com, Apple, Google, and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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