Amazon investors should look beyond the phone

With Amazon.com (AMZN) on the cusp of entering the smartphone market, investors shouldn’t get too caught up in the razzle dazzle of the new handset.

Sure, it’s rumored to include a cool new 3-D display, along with cutting-edge specifications. But it’s also likely to be sold at a price that is merely breakeven, doing little or nothing to directly improve Amazon’s bottom line. And most of Amazon's prior hardware offerings have taken little or no market share away from leaders such as Apple (AAPL) and Samsung (005930.KS).

The real story for investors is more likely to be what else is announced at Amazon's event in Seattle on Wednesday. Will the phone be accompanied by a new kind of cheaper monthly data plan, an innovative mobile payments system or a wider expansion of the company’s “Mayday” personal assistance service? Appealing new offerings could attract a lot more customers – and profit – than the phone itself.

A crowded market

The existing smartphone market isn’t all that appealing. The field is crowded with competitors, led by Apple and Samsung at the high end and low-cost Asian manufacturers such as Lenovo at the bottom. Unlike the tablet market when Amazon made its entry a few years ago, the smartphone market is rapidly maturing and sales growth is slowing.  And by announcing the phone now but not putting it on sale right away, Amazon CEO Jeff Bezos risks being left behind when Apple reveals its new models later this summer.

But, as with Amazon’s other hardware offerings, the new phone doesn’t need to catch on with everybody to be a success for the company. It just needs to help Amazon identify and connect more closely with its top customers, who will end up buying lots of other stuff from Amazon. Only 10% to 20% of Amazon’s regular customers subscribe to its Prime service, for example, but they tend to buy far more than other customers.

Keeping those kind of customers close via Amazon-branded tablets, set-top boxes and now phones is much more important to the company’s success than capturing high market share among device owners overall. Amazon has never revealed the numbers, but it could be a classic example of the 80-20 rule, also known as the Pareto principle, which suggests that a majority of profits often come from a small portion of customers.

Beyond that, the phone could help generate some new revenue streams, such as a piece of the recurring monthly fees from mobile carriers. AT&T (T) will begin as the exclusive carrier of the new Amazon phone, according to a report by the Wall Street Journal. That gives the carrier a greater incentive to market the phone to its customers and possibly share more revenue with Amazon on the back end.

News of the deal wasn’t welcomed by all in the industry. T-Mobile’s (TMUS) CEO John Legere, for one, shot back on Twitter:

Whew! @Amazon doesn’t know what they just signed up for. Remember the Facebook phone? #yikes

— John Legere (@JohnLegere) June 17, 2014

The price of the phone itself isn’t going to be that important. Perhaps Amazon will offer the phone free to Prime members or sell it for a low price without requiring a two-year contract. But that hasn’t made a hit out of other companies’ low-cost models. U.S. consumers appear rarely to think much about the true cost of their phones and are satisfied with “free” and low-priced phones that do require a two-year contract.

The new phone will help expand Amazon’s growing Kindle ecosystem of books, video, apps and games to a new platform. That should give content owners and app developers a bigger incentive to include the Kindle devices in their future plans. Prior Kindle devices run a modified form of Google’s (GOOGL) Android operating system that’s separated from Google’s vast app and media offerings.

Finally, there are the possibilities of expanding Amazon’s “Mayday” personal help service. Owners of recent Kindle tablets can tap on a button and, in just seconds, get help with their device from a live human. The new phone could include “Mayday,” helping make customers even more loyal to Amazon, as well as providing new routes for future expansion.

So investors following Wednesday’s phone announcement should probably pay more attention to everything but the phone.

 

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