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Why Is Amazon Dropping Kindle Fire Prices?

Sunday - 3/24/2013, 10:00am  ET

Last week, Amazon.com announced that it was reducing the price of its Kindle Fire HD 8.9-inch tablet from $299 to $269, while also cutting the price of the LTE version from $499 to $399. In the press release, Amazon stated that the launch of those tablets in Europe and Japan allowed the company to increase production volumes and therefore lower prices. However, this announcement should be taken with a grain of salt. It is much more likely that weak sales of the 8.9-inch Kindle Fire devices led to the price cut. While Amazon has generally tried to sell its tablets at cost, the 8.9-inch devices were previously priced to be profitable. With the failure of that strategy, Amazon seems to be reverting to its primary strategy of pricing tablets at cost and hoping to sell content at a profit.

Who wants a $500 Kindle Fire?
Other vendors, such as Motorola (Xoom), BlackBerry (Playbook), and Hewlett-Packard (TouchPad), have previously tried to compete with Apple in the upscale tablet market. Each of those would-be iPad competitors flopped at the $499 price point. Even at greatly reduced prices, none of these tablets were able to come close to the iPad's sales volume.

Despite this harsh lesson, Amazon decided to attempt a $499 tablet last year. The highlight of Amazon's high-end tablet was a 4G LTE modem, and an option for customers to buy a discounted $49.99 basic data plan for the first year. Amazon also introduced an 8.9-inch Wi-Fi version of the Kindle Fire HD for $299. The Kindle Fire HD 8.9-inch began shipping on Nov. 15, with the LTE model shipping the week thereafter.

As early as December (one month after the launch of the Kindle Fire HD), analysts began warning that demand for the 8.9-inch Kindle Fire models was very weak. One analyst estimated that Amazon sold 6 million tablets in the holiday quarter, with most of those being the $199 Kindle Fire HD 7-inch. (Amazon has not released official sales statistics for the Kindle Fire tablets.) While some analysts had expected the new Kindle Fires to steal market share from Apple, the reverse seems to have occurred. Apple introduced the iPad Mini shortly after the Kindle Fire HD launch, with a starting price of $329. With a 7.9-inch screen, the iPad Mini is in between the two Kindle Fire HD size options. Apple reportedly expects to sell 55 million iPad minis in 2013. The iPad Mini's runaway popularity suggests that customers comparing it to the Kindle Fire HD 8.9-inch are overwhelmingly willing to sacrifice on screen size (and pay an extra $30) to get the iPad's superior overall experience.

Enter price cuts
By cutting its prices to $269 and $399 for the Wi-Fi and LTE 8.9-inch tablets, Amazon will put a little more distance between itself and Apple, price-wise. As analyst Colin Gillis of BGC Partners recently argued, the price cut may be designed to stimulate demand in the seasonally weak first half of the year. More broadly, it confirms that demand was either weak all along, or fell off dramatically after the holiday season. By contrast, Amazon's claim that the addition of new markets is allowing lower prices does not make very much sense. Tablet sales peak in the seasonally strong fourth quarter, so the launch of the Kindle Fire HD 8.9-inch in Europe and Japan will (at best) offset seasonally weak demand in the U.S. Worldwide sales of the Kindle Fire HD 8.9-inch will be flat to down sequentially.

Only iPads earn a profit
There may be a grain of truth in Amazon's explanation for the price cuts: It probably can break even (or even earn a small profit) on its tablets at their new, lower prices. According to a bill of materials estimate by TechInsights, the components for the Kindle Fire HD 8.9-inch may cost as little as $179, or $218 for the LTE version. These estimates do not include the manufacturing cost or logistics costs, but should otherwise be roughly accurate (Amazon is also probably subsidizing the data plan for the first year). For comparison, TechInsights estimated the bill of materials for the base model Kindle Fire HD 7-inch at $148.

These cost estimates imply that if Amazon was breaking even on the Kindle Fire HD 7-inch, it was earning a significant per-unit profit on both versions of the Kindle Fire HD 8.9-inch. Last week's price cut probably wiped out most of that profit margin. Once again, we are learning that while vendors other than Apple can sell tablets in respectable quantities, only Apple can earn a significant profit in the tablet business.

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