When you order something from Amazon, it comes in a box.
Let's say you browse the Amazon.com website looking for a book, a wristwatch, or a muffin pan. When you find the object of desire, you click an Add to Cart button. Amazon already has your credit card and address, so it's easy for you to buy and for them to sell. The cardboard box your item arrives in is the physical manifestation of Amazon's fulfillment of your order.
Boxes are important to Amazon's business. But they're not in the box business. They don't make money on boxes. Amazon is happy to lose a little money on boxes because it enables them to profit from what's inside the box.
To Amazon, a tablet is just another kind of box.
Electronic products like music, movies, e-books, and digital publications are part of Amazon's business. An e-book is an item for sale, just like a paperback. And Amazon wants to control the order-fulfillment experience just like it does with cardboard boxes. So it makes tablets.
You can divide the tablet universe into three categories:
- Companies that are in tablet hardware and online content and services businesses
- Companies that are in the online content and services business only
- Companies that are in the tablet hardware business only
The first category has two players: Apple and Sony. In both cases, Apple and Sony have business models that depend on making revenue and profits from the sale of tablet hardware, as well as from digital content and online services.
The second category are those companies involved in selling digital content and online services, but which use tablets as boxes. They're happy to make no money on tablets -- or even lose money -- as long as they can give their digital offerings an advantage over competitors. This category includes Amazon, Google, and Barnes & Noble.
The third category includes companies that sell tablets for profit, rather than as containers for digital content and online services. This category includes Samsung, Asus, Research In Motion, Acer, Motorola, Toshiba, Archos, and many others.
All three categories will continue to exist side-by-side indefinitely, but there will be winners and losers within each category.
Why Apple will dominate the first category forever
In any standards-based, network-effects-based, application platform-based, or aftermarket-based business, the rich tend to get richer. The more customers and partners any company has, the more attractive that company is to additional customers and partners.
The tablet market is all four. Apple is by far the richest and is therefore in the enviable position to keep dominating.
Apple has by far the most tablet customers. These customers are by default embracing Apple's standards, which are part of services like iCloud and iTunes. For example, people who have uploaded personal content to iCloud and invested in content on iTunes have a strong incentive to buy future Apple tablets, because only Apple's products participate in those standards.
Apple has network effect advantages. A network effect is when the value of a network increases with the number of people using it. Apple networks like iMessage and FaceTime are more valuable as more people get on them.
Apple has a huge lead in tablet-specific apps. More apps draw more people who want apps, and the size of that app market attracts more app developers.
Finally, because Apple has one basic tablet size and shape (as well as the biggest share of the market), it's a no-brainer for makers of cases, accessories and other aftermarket products to favor iPad. Having more accessories makes the iPad even more attractive to additional users, which draws more accessory makers and so on.
The biggest advantage of all for Apple is less appreciated: Apple has staked out the high-end "sweet spot" of the market. As a very well-established premium brand, Apple attracts a much higher concentration of deep-pocket big spenders. These are the people who buy Apple's content and services, as well as apps (of which Apple gets a third of the revenue). In other words, Apple has not only more customers, but better customers.
As you can see, Apple not only has a tremendous lead, it has insurmountable advantages going forward.
Apple's only category contender, Sony, doesn't at present have any prospects of significant revenue in either tablet hardware or online content and services.
Why Google has the long-term advantage in the second category
As Moore's Law, economies of scale, and other cliches bring down the cost of tablets, the distance between premium tablets like the iPad and average-priced tablets will grow. As non-iPad tablet prices go down, more people will buy tablets. As such, over time, Apple will make the most money per tablet, but the majority of tablets will eventually be sold by companies other than Apple. The tablet market will resemble the smartphone market in that respect.
Google's biggest advantage is that it doesn't make or sell the hardware.
Yes, Google will probably acquire Motorola (the deal is awaiting approval from the Chinese government), but that's likely to be run as a separate and independent business. The Wall Street Journal reported this week that Google plans to sell co-branded tablets made by several category-three companies in a new online store.
But buying Motorola for patent protection, co-branding tablets, selling them in a store and even the existence of the Android mobile platform are all means to an end, which isn't big bucks from the hardware business, but revenue from Google Play digital content, online services, and advertising.
Google is the only player in category two that's in the position to profit from the bits without stressing about the low- or zero-margin hardware business. That's its greatest advantage. Google can grow the market with reckless abandon because every new customer brings additional revenue, but not additional costs or risks.
Amazon and Barnes & Noble? Not so much.
Why Amazon's tablet business model isn't sustainable
Everyone seems to think that Amazon will continue to succeed in the tablet market. I'm not so sure.
Amazon's $199 Kindle Fire tablet launched the company into the number-two spot for tablets. It appears to be a successful product. And it is. But that success can't last with Amazon's current business model.
The big draw for the Kindle Fire was the price, which Amazon achieved by selling at a loss. Every time someone buys a Kindle Fire, Amazon loses money -- somewhere between $10 and $70. The strategy is to get new and more active customers with the tablet, then make up the difference over time through Amazon.com sales. It's the same business model as printers, which are sold at a loss with the expectation of massive profits through the sale of ink cartridges.
The idea that Amazon and Google are competitors needs to be addressed.
Amazon appears to be a partner with Google as an Android hardware maker. But remember: Neither of these companies is in the hardware business. They are competitors in the digital content and online services business. That Amazon is shamelessly exploiting the software platform of its most direct competitor doesn't change the fact.
Here's the problem for Amazon. As prices come down, Google's partners will be able to sell tablets -- without losing money -- at or below Amazon's $199 price.
To stay ahead in the race to the bottom, Amazon will need to continue subsidizing tablets. So when, say, Asus and Google are selling a co-branded $149 tablet, Amazon might sell a comparable device for $99. When the Asus-Google tablet drops to $99, Amazon would need to sell a comparable one for $69 and so on.
It's a losing proposition.
The lower prices go, the broader the audience. You get a lot more people who are unwilling or unable to spend a lot of money on things.
People who won't buy a tablet until it's really, really cheap aren't going to spend freely on Amazon.com. But Amazon still has to lose money on the tablet in order to undercut Google's dozens or hundreds of tablet-making partners.
Any discount retailer, from Wal-Mart to Costco, has to make it up on volume. But Amazon can't. If Amazon doubles the number of tablets it sells, it doubles the amount of money it loses on those tablets. Yet the new customers acquired through those losses are less likely to buy a lot of stuff on Amazon. They're either broke or cheapskates -- that's why they're buying the cheapest tablet they can find. These are not exactly the ideal Amazon.com customers.
Amazon needs a new business model for tablets, one that attracts big spenders rather than bargain hunters. (If I were Amazon, I would start thinking about another operating system. Basing your entire tablet strategy on the platform of your most direct competitor probably isn't sustainable, either.)
Amazon can't win a tablet price war against Google because customers who don't buy a lot are expensive for Amazon to acquire, but free for Google.
Google's business model scales, but Amazon's doesn't.
Mike Elgan writes about technology and tech culture. Contact and learn more about Mike at Elgan.com, or subscribe to his free e-mail newsletter, Mike's List . You can also see more articles by Mike Elgan on Computerworld.com.
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This story, "Why Amazon can't win a tablet price war against Google" was originally published by Computerworld.