Amazon's big bet: How a smartphone intensifies war with Apple, Google

The online retailer treads into new territory that will test its strategy of selling products at cost.

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The Amazon logo is projected onto a screen at a Kindle Fire tablet launch in 2012. David McNew, Getty Images

Amazon CEO Jeff Bezos is rolling the dice once more with his riskiest wager yet.

When the Seattle e-commerce giant introduces its smartphone -- which is widely expected to happen ata company-hosted event on Wednesday -- it will be only Amazon's fourth device in the last seven years.

But where its first three products have skirted the edges of mainstream consumer electronic devices -- an e-reader, a budget-priced tablet, and a streaming Internet TV box -- Amazon is now jumping straight into the heart of an industry with the most personal and critical of tech gadgets. In doing so, Bezos is escalating Amazon's fight against Apple and Google for control of the hearts and minds of consumers by combining a branded smartphone with a set of services available through its Prime premium membership.

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Amazon's anticipated foray into the smartphone world comes as its fellow tech titans have steadily expanded their own reach beyond devices such as PCs and smartphones, with Apple and Google -- as well as Microsoft and Samsung -- introducing an array of services. Their common goal: to power everything from thermostats to medical equipment to automobiles.

"The great ecosystem war has begun," said Ben Schacter, an analyst with Macquarie Research. "This is going to be a long, hard war with many battles."

For Amazon, it comes back to the smartphone, the one device many people won't leave home without, and its potential to be the remote control for all the other devices in our lives. The company likely sees it as the ultimate hook for its $99-a-year Prime service, which offers members two-day shipping, e-books, movie, and as of last week, a streaming music service. Bezos' bet is that Prime is more effective in keeping customers coming back to Amazon than any single device.

Here lies the company's main weapon. Bezos is more focused on making money off digital content and physical items shoppers buy through its hardware than actually making money off selling the devices.

Yet the e-commerce pioneer is treading into unfamiliar territory. The smartphone world is brutally competitive, with Samsung and Apple at the top of the market.

Amazon's phone is expected to feature 3D technology, enabled by four front-facing cameras, and to come with a service called Prime Data to encourage video and music streaming through the device. But it will take more than a gimmicky technology that hasn't worked in the past for other handset makers to win customers. In line with Amazon's usual hardware strategy, the phone is also expected to have a low price tag, which it needs to compete.

It will go up against the popular, and likely more expensive, Apple iPhone and Samsung Galaxy S franchises at the high end, and an increasing array of affordable, but high-quality smartphones including the Motorola Moto X and Google Nexus 5 for the more budget conscious.

The unique dynamics of the smartphone business will test the company's strategy of selling its products at cost to gain a price advantage.

Still, Amazon has as good a shot as any. The company has spent years turning its Kindle devices into a trusted brand, and it boasts the world's best digital storefront in the Amazon.com homepage.

The man behind the devices

Amazon's ability to break into the smartphone business comes down to Dave Limp, publicly named vice president of devices in April.

While Bezos spells out the vision for the company, Limp's job is to execute upon that vision.

"Every day, when I wake up, I read customer feedback," he told FastCompany, reciting a common mantra among Bezos' top employees. "Some days it's hundreds of emails; others, it's thousands. We get ideas from all of it. The feedback leads to rapid iteration."

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A tech veteran who has worked on the Kindle business for the last four years, Limp joined Amazon in 2010 after serving as the chief operating officer of Limbo, a mobile entertainment company. He's worked with hardware before. Prior to Limbo, Limp was the chief strategy officer for Liberate Technologies, a pioneer of using TVs for additional services, like shopping or checking email, and even further back, he was chief strategy officer for Palm's PDA business.

Like Bezos, Limp has both technical expertise as well as business smarts. A graduate of Vanderbilt University and the Stanford University Graduate School of Business, Limp holds a B.S. degree in computer science and mathematics, and a masters in management.

During his time at Amazon, the company moved from e-readers to Kindle tablets and streaming TV boxes with this year's release of the Fire TV and, now, presumably, to smartphones.

"Our philosophy, which hasn't changed even as we add a third category of devices, is we try to effectively break even on our devices when we sell them," Limp told The Seattle Times at the launch of the Fire TV in April. "We want to make money when customers use the devices."

All about Prime

Getting more customers to subscribe to Prime has been the primary reason behind Amazon's array of products. Amazon doesn't disclose how many Prime members it's garnered, saying only that the official tally of the service is in the "tens of millions."

The original Kindle e-reader drove e-book sales, and it has nearly dismantled the physical book retail industry. Amazon's line of Kindle Fire tablets, which run an altered, or "forked" version of Google's Android mobile operating system that omits key Google apps and services, presents Amazon services up front and even includes its own app store. The $99 Kindle Fire TV box also runs Amazon's variant of Android, and it's designed to take advantage of streaming video and downloaded media from Prime.

Amazon's smartphone is rumored to include a feature that displays images in 3D, which would make sense if the company views the device as an extension of its online store. 3D product images might entice more buyers to buy from their smartphone.

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While Prime started as an option for fast, free shipping, Amazon has slowly layered more on top of the service, adding online movies, free e-books, and most recently a streaming music service, in a bid to secure the loyalty of its customer base. The company is highly motivated to sign up more Prime customers, who tend to shop more with the site.

"Every user that buys that device becomes your customer and then you own them," said Topeka Capital Markets analyst Victor Anthony. He estimates that of Amazon's 244 million active customers, roughly 25 million are Prime members.

Amazon's tactics in hardware show that Bezos is willing to bet big. While Apple boasts margins of more than 20 percent on its iPhone and iPad, and Google makes money from the advertising it delivers through its Android mobile OS, Amazon says it's happy to break even -- or even take a loss -- on its gadgets for the chance to win repeat customers who will keep coming back to the company's ecosystem and ultimately spend more money at its store.

Macquarie analyst Jeff Su called this the "Trojan Horse" approach to luring in customers.

Analysts say Bezos' strategy works. Kindle owners spend 30 percent more on Amazon than non-Kindle owners, according to a recent survey of 2,000 Amazon customers conducted by RBC Capital Markets. The results are even better for the company's main attraction: Amazon Prime members spend almost twice as much as non-Prime members.

Risks abound

A key dilemma for Amazon is what the company typically counts as an advantage: price.

Unlike other devices, smartphone pricing is skewed by the subsidies the devices enjoy. In exchange for a two-year contract with a carrier, what would be a $650 iPhone 5S ends up costing the consumer $200.

Even off-contract, there are a number of smartphones that offer plenty of bang for a reasonable buck. Both the Nexus 5 and the Moto X costs $349 unlocked. The Huawei Ascend Mate 2 phablet is available without a contract for $300 at GetHuawei.com.

The rumored Prime Data plan may offer customers an attractive way to save money in step with the growing popularity of streaming media, a service that increases the need for data. But it won't be easy.

Other non-telecom companies, such as ESPN and Disney, have released their own branded phones and services, but ultimately couldn't win enough customers to justify the devices or networks.

"There's a lot of corpses buried in the ground of companies who have tried and failed," said Julie Ask, an analyst with Forrester Research.

Still, there's room for growth in the smartphone market, and Amazon could capture some of the 70 percent of cell phone owners globally who haven't yet switched to a smartphone, according to Anthony, the Topeka Capital Markets analyst. In the US, however, that figure is less than half, with more people snapping up smartphones everyday.

Ultimately, it's not about selling more devices than Apple, or even getting Apple's customers to jump ship. It's about providing consumers with an affordable alternative, Anthony said.

And that goes back to Bezos' game plan: At the end of the day, Amazon doesn't care if it makes money off its devices as long as people shop more on its site.

"Amazon, no matter what ecosystem you use, they want you to buy their products," Anthony said. "Amazon wants you to shop no matter what device it is."

 

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