How Amazon can disrupt the iPad and Android tablet market

A few weeks back, I wrote a column discussing the tablet that Amazon is rumored to introduce this fall. Since then, I have heard a few more things about this tablet that are quite interesting. In my last column on this topic, I stated that the center of its design would be on reading books. That appears to be true, as multiple sources tell me that it will have the best reading experience of any tablet on the market. But, I am also hearing that Amazon is using pretty low-cost parts and not using any of the major manufacturers that are producing most of the tablets for mainstream competitors. Apparently, the company's key goal is to make the tablet very inexpensive and then use a new business model to own the Android tablet market.

I believe that Amazon CEO Jeff Bezos knows that all of the other Android vendors are at a big disadvantage when it comes to competing with Apple. Apple has a two-year lead on them, a great app store and services program, and a soon-to-be-key technology, the iCloud, which will keep all iOS apps and devices in-sync. And it has 250 million users' credit cards and hundreds of retail stores to help people learn about the iPad and buy one on the spot. None of the other tablet vendors can even come close to matching what Apple has to offer, except maybe Amazon. Although Amazon does not have retail stores like Apple does, it does have an Appstore for Android, music and movies for downloading, the Amazon Cloud Drive for storage, and the credit cards of 200+ million users. It also has limited channel partners, like Best Buy, that it could expand as well. But, I hear that while its tablet could marginally compete against Apple, this is not the company Amazon is going after with its tablet offering. It is smarter than that. Rather, I believe Amazon's goal is to be the market leader in Android and be the top seller of tablets with this mobile OS.

The other interesting thing I have picked up suggests that Bezos and his team are thinking about deploying a radical new business model for their tablets. First, to make the tablet's price really attractive to users, Amazon may actually sell it for as much as 20 to 25 percent below cost. In this situation, think of the tablet as a razor and the Android Appstore, UnBox movie service, and music service as the blades, which can be sold to users over and over again. As I understand it, the idea is to have users' purchases applied to the their tablet through a two-year amortized program that would cover any lost physical cost of the tablet as well as give Amazon some profit. To add to that profit, it could also apply purchases through its Kindle bookstore and items you might buy from the Amazon store. And then add in any Amazon cloud service revenue and advertising and you can see how this could possibly be done. I could not confirm that this model is locked in, but it appears that it's being highly considered.

With the info I have on components from my contacts in Taiwan, I was able to do some back-of-the-envelope calculations to see how this could work. Bill of material costs along with manufacturing costs, shipping, and tariffs would most likely put the device cost at around $300, depending on its specs. This may be on the higher side of the actual costs, but for the sake of this argument, let’s use this as the baseline. Now let’s say Amazon discounts this by $51 and sells it for $249.

Say that Amazon did some research and determined that over a two-year period, a person with an Amazon tablet might buy or rent 15 movies, stream or download 50 songs, buy 18 books, and pay $5 a month for cloud storage from Amazon. Then let's say they also purchase five items through the tablet’s Amazon store; that can be counted against a two-year amortized profit curve. And lets throw in some advertising in this mix as well. Although the prices of the books, video, music, etc would vary, by my guestimates, Amazon would make back that lost $51 within six months and reap a profit of anywhere from 10 to 30 percent on the tablet over the last 18 months of the device's accounting period.

Amazon already has the trust as well as the credit cards of over 200 million users. And its “one-click” buying model would make it quite easy for an Amazon tablet user to buy often through both the Android Appstore and the Amazon store in general.

Of course, there are a lot of variables in this model, but you get the idea. The tablet is the razor and all of these apps and services are the blades, and for two years, these purchases are tied to an amortized business model to cover the cost and profit of the device.

Now imagine how this could affect the other Android vendors that are making tablets. If Amazon provides a product that is sold under cost with the goal of making up the rest of the cost and profit from apps, services, and even advertising, it could give all of the other Android vendors a serious run for their money. And, given Amazon’s deep ecosystem, other Android vendors would find it very difficult to compete against it. When measuring by units shipped, this method could make Amazon the king of Android tablets very quickly. In fact, I would go as far as to say that it could “own” the Android tablet market.

For Apple, this would be a competitive threat, but it has a pretty big lead and its own rich ecosystem of apps and services that could allow it to remain the market leader in tablets. And given Apple's history of riding down prices of the iPod once it gets to scale, you can imagine that it will also be more aggressive with iPad pricing over time. With its apps and services as well as the upcoming iCloud, it can continue to deliver high margins for a long time.

But as radical as this idea might sound, it could make a lot of sense for Amazon to take its tablets to market with this kind of business model. It would take guts, but the impact on the market for Android tablets could be significant if Amazon executes this right and the consumers buy into its version of the old razor and blades business model.

This article, written by Tim Bajarin, originally appeared on PCMag.com and is republished on Gear Live with the permission of Ziff Davis, Inc.