Can Amazon Make a Cheap iPad Challenger?

on August 29, 2011
Reading Time: 3 minutes

Developments in the tablet market in the past couple of weeks, especially Hewlett-Packard first killing the TouchPad then successfully disposing of tens of thousands of them in a $99 fire sale, has led to some very strange commentary on how competitors can take on Apple. All they have to do is sell a tablet that’s as good as the iPad–or at least nearly as good–for a lot less.

Kindle iconFor example, in a Cnet post, Brooke Crothers quotes analyst Roger Kay as saying the TouchPad “wasn’t really a product failure, it was a pricing failure.” That’s self-evident as far as it goes. The TouchPad at $500 was priced higher than people were willing to pay,  and when the price was cut 80%, they flew off the shelves.

The problem is that in the real world of business, pricing has to bear some relationship to cost. No one is going to beat the iPad by building a product of equal performance and quality for less. Apple has mastered the supply chain and, with sales of the iPad in the area of a million units a week, achieves considerable economies of scale. It’s in the rare and wonderful position of offering a premium product while actually enjoying a cost advantage over competitors.

That means that no one can hope to compete with Apple simply by offering a product similar to the iPad for less. If Apple were to perceive it as a threat, they could underprice the interloper while feeling less pain than the competition. It’s a game that only Apple can win.

Another alternative is a subsidy model. Both my colleague Tim Bajarin and Kevin C. Tofel at GigaOm suggest that Amazon could afford to subsidize the hardware and cover the subsidy cost either through advertising on the tablet or through sales.

The one place where the subsidy model has succeed in in mobile phones, including the iPhone. But wireless carriers are in a unique position. Because they sell the phone on a contract, which gives them a revenue stream of known amount and duration, they can be certain of recovering the subsidy and making a profit besides. (Those early termination fees take care of most of the contingencies.) The carriers, however, have shown little interest in extending the subsidy-plus-contract model to tablets.

An Amazon subsidy would be a lot more problematic. Amazon’s operating margin runs less than 4% of sales. On a crude calculation, that means that every $100 in subsidy would require $2,500 in incremental sales just to break even. Maybe tablet customers buy higher margin goods, but the math of the subsidy model seems truly daunting.

All the signs point to Amazon doing a tablet of some sort, though the company itself has remained silent on the subject. But I don’t expect that it will offer an iPad-like product at a substantially lower price. One possibility is a tablet that competes with the iPad not on price but on a distintive feature set. (What might that be? If I knew, I’d design it myself instead of speculating about it.)

The other, which I think is a lot more likely, is a sort of super-Kindle: A 7″ tablet more capable than the Kindle or Barnes & Noble Nook, but simpler and cheaper to make than the iPad. It would primarily be a book reader, casual game console, and media player with, of course, an optimized Amazon shopping experience. A product like that could probably be sold for $300 without much subsidy. (B&N is selling the color Nook for $249, apparently without subsidy.)

Another, bolder approach, would be for Amazon to come up with its own subscription-based revenue model. The company has been steadily diving deeper into online services. It currently sells a somewhat odd bundle of movie streaming and free shipping on Amazon purchases for a $79 annual fee. The trick is finding enough other services to roll in to provide enough revenue–and profit–to pay for substantial subsidies. Book rentals are an intriguing one, but would be a tough sell to publishers. It’s a difficult proposition, but amazon has shown itself to be nearly as creative a company as Apple, and if any one can do it, they have the best chance.