Daily: implications of Amazon selling mobile hardware at cost

By Edward Harrison On Oct 12, 2012

There are a lot of different threads in today’s links to choose from for the overarching theme. So I will just choose one and run with it. Let’s look at the Amazon selling at cost issue from Apple’s perspective.

What Amazon CEO Jeff Bezos told the BBC is that “we sell the hardware at our cost, so it is break-even on the hardware.” This is what technology analysts have long said in analysing the actual cost of the components used for Amazon’s Kindle tablets. On the other handle, Apple is just above break-even on iTunes, the software, but makes a huge amount of money from hardware sales. Separately, Bezos told AllThingsD that “our approach is our approach, and we don’t even claim it’s the right approach. It’s not something that’s new, but it’s something we’ve done since the founding of the company.”

When you put this all together, you come up with a few conclusions:

Apple’s model is more profitable if you have some sort of temporary pricing or cost advantage, which Apple does. Look at iPods, iPhones and iPads. In each case, Apple was first to market and decided to sell into the premium-priced space. Before iPods, there were only flash-based mp3 players, so they weren’t really competition for Apple’s new disk-based hardware system that had much b=higher storage capacity. Apple was unique in similar ways in the other two spaces as well. The result was enormous margins that commodity producers cannot have.
High margins invite competition. This is axiomatic in the world of business when markets are relatively free. So from day one, Apple’s high margins in each space in which it operated invited competition, meaning that it was in other companies’ interest to enter those markets and sell at lower margins to take some market share from Apple.
Apple understood the margin/share trade-off from the beginning and opted to maintain margin and minimise share erosion by successfully tying iPod/iPhone hardware and iTunes/Appstore software. The point was to make the sale an integrated solution controlled by Apple. To the degree Apple had first-mover advantage and high market share, network effects would then allow Apple to maintain extremely high margin and share for longer than anticipated.
Apple is now losing so much share that margin erosion is inevitable. The key here with Android and Amazon now in the mobile space is that the firewall Apple built in tying hardware and software has now started to crumble. Apple has been forced to move down market in price in all of its markets in order to maintain sales growth. To date, this has not really dented the huge earnings potential that Apple has built. But, Amazon represents a new threat because it is not a hardware manufacturer but rather a service retailer that sells hardware at cost. To the degree Amazon gets traction, this can only be negative for Apple. Apple’s only saving grace here is that Amazon has somewhat balkanised the Android market with it’s highly customized hardware product. However, software that runs on Amazon hardware will almost always run on other Android hardware – and that builds network effects and platform stickiness for Android.
The question then is whether Apple’s share price reflects the fundamentals. Much of this is known. After all, Apple doesn’t sell at a huge earnings multiple, whereas Amazon does. Apple and other large cap technology stocks sell at the lowest multiples in decades relative to the general market. Nonetheless, Apple’s multiple is based on modest earnings growth – and that begs the question whether earnings erosion is something that would severely dent Apple’s share price.

On the whole, I think Bezos is right to say his model is just his model. Amazon is an idiosyncratic organisation. For me, the more interesting question is what impact the Amazon model will have on Apple. And my sense is that it will have the same impact on Apple’s margins that it has had in other markets, namely putting significant downward pressure on margins. For Amazon, it’s all about services and volume. That’s a low-margin business model. And now that Amazon is a mobile competitor, that’s trouble for Apple. I anticipate an Amazon phone, perhaps as soon as September 2013. By the time this happens, it will be clear that Amazon has been a threat to Apple’s profitability and share price will be down.

BBC News – Kindle Fire HD and Paperwhite sales make Amazon no profit

“”We sell the hardware at our cost, so it is break-even on the hardware,” chief executive Jeff Bezos told the BBC.

It is a stark contrast to the strategy of best-selling tablet-maker Apple.”

US Vice Presidential Debate

Your VP Debate Summary: Ryan Did Well, Biden Did Better – James Fallows – The Atlantic

I saw the debate and I thought Ryan was more measured stylistically but that Biden put more meat on the bones substantively. As far as moving the dial, I expect this to be a non-event. Fallows gives his viewpoint in this post.

Ryan Solid, But One Major Mistake – The Daily Beast

“On radio, Biden was … what’s the word? … Oh yeah: terrible. Impatient and dismissive, punctuated by forced, faked little laughs and peevish demands for more airtime. Ryan’s voice, by contrast, had a timbre of sincerity, even when he was being evasive, as for example when he sought to escape Martha Raddatz’s demand for more specifics on how the Romney tax plan would work.

When he demanded that the “folks” trust him, he sounded a corny old pol.

But on TV, Biden seemed somehow much better: impassioned rather than impatient, aggressive rather than dismissive. Ryan’s superior poise and courtesy – the sincere timbre of his voice that resonated so nicely on radio – seemed suddenly defensive and weak: the indicators of a competitor who doesn’t want to take and hold the center of the arena.”

Poll: By Wide Margin, Democrats Want Biden in All Remaining Debates : The New Yorker

This is pretty funny.

Americans’ Views of Obama More Polarized as Election Nears

“Thus far in October, an average of 90% of Democrats, and 8% of Republicans, approve of the job Barack Obama is doing as president. That 82-percentage-point gap in approval ratings by party is on pace to be the largest Gallup has measured for a recent incumbent president in the final month before Americans vote on his re-election. George W. Bush had an 80-point party gap in approval, while the October gaps for other presidents were less than 70 points.”

In Polls, Biden Gets a Hold – NYTimes.com

“Instant polls conducted after the debate are suggestive of something between a tie and a modest win for Vice President Joseph R. Biden Jr.

A CBS News-Knowledge Networks poll of undecided voters who watched the debate found 50 percent giving the advantage to Mr. Biden, 31 percent to the Republican, Representative Paul D. Ryan, and 19 percent calling the debate a tie.

A CNN poll of debate-watchers, however, had 48 percent giving the debate to Mr. Ryan, and 44 percent to Mr. Biden.”

Other articles

BBC News – Lance Armstrong: Tyler Hamilton on ‘how US Postal cheated’

“Hamilton started off on testosterone, a “red egg” as the cyclists referred to the pill, but soon graduated on to the more powerful EPO – erythropoietin – which he and his US Postal Service team-mates dubbed Edgar, after Edgar Allen Poe.

This stimulates the creation of red blood cells, boosting performance by about 5%, or, as Hamilton puts it “roughly the difference between first place in the Tour de France and the middle of the pack”.”

Nederlandse woningmarkt verkeert in zware crisis – De Standaard

Dutch housing bust continues apace

Wells Reports Record Profit, but Revenue Misses Views – Deal Journal – WSJ

“The nation’s largest bank by market cap earned $4.9 billion or 88 cents per share, in the third quarter, up 22% from the year-prior period.

Revenue came in at $21.2 billion in the third quarter, compared with $19.6 billion in the third quarter of 2011.

Analysts polled by Thomson Reuters expected Wells Fargo to earn 87 cents per share on revenue of $21.56 billion.”

J.P. Morgan Reports Record Earnings – Deal Journal – WSJ

“The nation’s largest bank by assets reported a $5.7 billion profit, or $1.40 per share, in the third quarter, a 34% increase from the same period a year ago.

Revenue came in at $25.1 billion up 6% from a year ago.”

Argentina: cozying up to Chavez | beyondbrics

“Cristina Fernández, Argentina’s president, has reason to be thankful for Hugo Chávez’s re-election triumph. Beyond her genuine emotional congratulations to a fellow leftist who has dared to subvert what both see as the market-driven, neoliberal world order, friendship brings big trade rewards.”

Lagarde calls for caution on austerity – FT.com

“Her call for slower adjustment is a boost to Athens, which is trying to persuade its eurozone partners to give it more time. However, slower deficit reduction in Athens would mean Greece’s international creditors giving it extra help in a politically fraught overhaul of Greece’s €174bn bailout programme.”

Spain keelhauled by Germany and AAA chicanery – Telegraph Blogs

Evans-Pritchard uses the same kind of language I did when I wrote that “Rajoy was hoodwinked and now Spain faces a debt deflationary spiral”

“A key reason for Standard & Poor’s two-notch downgrade of Spain to near junk last night is the refusal of premier Mariano Rajoy to bite the bullet on a rescue. His “hesitation” is “potentially raising the risks to Spain’s rating”.
By contrast, Moody’s said earlier that it will cut Spain to junk if it DOES request a bail-out. What a marvellous mess.”

The harmful myth of the balanced budget – FT.com

“I have no doubt Oliver Cromwell could balance the UK budget with sufficiently draconian measures. But there are such things as conflicts of objectives. The aim of the macroeconomic side of a national budget should be to help balance the economy. George Osborne’s comparison, when he took office as chancellor, of the national budget to “every solvent household in the country” was wrong, wrong, wrong. Around the same time Sir Mervyn King, governor of the Bank of England, called for a grand bargain in which lower domestic demand in deficit countries was offset by an increase in domestic demand in the surplus countries. Predictably there was no such bargain and the half- million increase in UK export sector jobs he hoped for did not materialise.”

Merkel says planned tax cuts to revive European economy | Reuters

“Germany’s planned tax cuts could stabilize domestic demand and help stimulate the European economy, Chancellor Angela Merkel said on Thursday, noting the country was feeling the effect of economic collapse in southern Europe.”

Greek unemployment reaches new record in July, at 25.1 pct | Reuters

“Greece’s jobless rate rose for the 35th consecutive month in July, scaling a new record of 25.1 percent from an upwardly revised 24.8 percent in June, the country’s statistics service ELSTAT said on Thursday.”

Golden Dawn’s Popularity Rising Rapidly in Greece – NYTimes.com

“Just a few months ago, the name Golden Dawn was something to be whispered in Greece.

But three months after the extremist right-wing group won an electoral foothold in Parliament, talk of Golden Dawn seems to be on everybody’s lips.”