Amazon Can Afford Losses on Tablets due to E-Commerce Opportunity

Amazon (NASDAQ:AMZN) could become Apple’s (NASDAQ:AAPL) most formidable competitor in tablets as analysts at Forrester expect it to sell 3-5 million units of its own tablet in Q4 alone. ^[1] With the iPad having a clear advantage as a first mover in the market as well as Apple’s reigning brand consciousness, competing tablet makers have realized that slashing prices could be the only way to capture market share in this fast growing market. Previously, many companies have tried to counter the iPad, including HP (NYSE:HPQ), Research in Motion (NASDAQ:RIMM) and Motorola Mobility (NYSE:MMI).

We currently have a price estimate of $240 for Amazon’s stock, which is about 15% above the current market price.

Why is Amazon Willing to Sell Its Hardware at a Loss?

With the iPad 2 carrying a starting price of $499, Apple relies on the high margins on its hardware business, which fuels the bulk of its business. In order to gain any significant market share, competitors have had to sell their tablets at dirt cheap prices, which effectively means selling their hardware at a loss.

A recent example is HP’s TouchPad, which slashed its prices to the $99 and $149 price range from $399 and $499 respectively (According to reports, a 16 GB Touchpad costs $306 to make, while a 32 GB one costs $318). ^[2]

However, Amazon is in a much better position to cushion these losses on its tablet. With a speculated price of below $300, the company can pretty much count on taking losses on the hardware. The profit however comes through Amazon’s extensive range of eBooks and other content-based applications, which has sales that should more than compensate for any hardware loss the company is willing to concede.

The Kindle Model

A similar example is Amazon’s Kindle. Amazon accounted for more than 90% of all eBooks sold globally, ^[3] for which the online sales of content easily compensated for the losses Amazon incurred on making the Kindle. Apple sold almost 30 million iPads since its launch in April 2010, and it all depends on whether Amazon can reach the predicted scale of over 3-5 million tablets in a quarter, which would definitely make it a challenger to Apple.

See Our Full Analysis for Amazon’s Stock

1. Amazon may sell 3-5 million tablets in Q4: Forrester, Reuters, August 29th, 2011 [↩]
2. The Inquirer: HP Could Lose $400m on TouchPad Price Cuts [↩]
3. Kindle’s Market Share Losses Shouldn’t Ding Amazon’s Revenue Much, But Analysts Are Still Way Too Optimistic [↩]