Amazon Faces The Cost Of Competing With Apple

09/11/2011 09:44 | Updated 26 December 2011

Amazon has announced its third-quarter profits have fallen by 73% on last year, missing Wall Street estimates and sending its stock price down as much as 19% in after hours trading. Not a rosy picture, but the high cost of taking on Apple.

There is a sea change occurring at Amazon, a change that has a cost, but one that will secure the long-term future of the company. Founded in 1994 it is one of only a few survivors of the dot-com bubble. Its peers Yahoo!, AOL and eBay are suffering mixed to woeful fortunes as they grapple with changes in how people are using the web. But in Jeff Bezos, Amazon have a CEO who isn't flapping, who has a clear vision needed to handle the upheaval needed to turn the retailer of physical goods into a major digital player.

It is very much a case of the hunter becoming the hunted. In every territory they operate there are stories of how Amazon has caused book and entertainment retailers to go out of business. Big or small, no one was at the mercy of Amazon's model of lean warehouse distribution. But we've moved on, or at least, we're in the process of moving on from buying physical entertainment products, and this is the threat Amazon is facing.

Apple had an advantage with iTunes in that it had no legacy in entertainment retail. It had no warehouses full of CDs and DVDs, no large scale shipping operations. Amazon has all of these, which it will eventually have to phase out, or diminish, in order to compete digitally. Their shipping charges in the third quarter 2011 generated $360 million, but cost them $918 million. Now is a really good time to get out of physical distribution game.

The Kindle was Amazon's first big play in digital and was built on their core business, selling books. People think of Kindle as an e-reader, but it's not, it's an ecosystem. Buy a book from the Kindle store and it can be read on the Kindle device, on a mobile phone, on a desktop PC, on an iPad or Android based tablet. This says something very important about Amazon's philosophy - they're not in the business of making hardware, they want to sell you content. And they want to sell you much more than just e-books as the launch of the Kindle Fire shows.

Amazon won't make any money selling their new $199 device (no UK price confirmed). Analysts have speculated that Amazon is either selling it at cost or loses $10 per device. What they're banking on is the purchase of content through their ecosystem. Though the device is built on Google's open source Android operating system, Amazon has locked down the device so all content purchases are via them. The perfect analogy is razor blades. They're giving you the handle for next to nothing, they make the money on the disposable blades.

This where Amazon and Apple are philosophically opposed. Apple sell content as a reason to buy their hardware, Amazon sell hardware so you'll buy their content. The two sides have taken their stance and they are asking a question of consumers, is it the device you own that's important, or the stuff on it?