Thursday, September 29, 2011

Why is Amazon willing to sell the Kindle Fire for $50.00 below actual cost?

Short answer.  The value they get per purchaser will far exceed the $50.00 shortfall. 
Amazon's goal is to make it affordable and easy for people to give up (in addition to printed books) cable TV for streaming video.  

Cutting the Cable TV Cord

In 1990, I was a legal intern at Viacom International. It was one of the largest owners of cable television systems in the United States.  It was a great job. My main “clients” were Heckle & Jeckle, Mighty Mouse, and the company's library of classic television shows from the 50s and 60s.  The library included the iconic Twilight Zone, I Love Lucy and The Honeymooners.  My focus copyright and trademark issues -- and sending default notices to television stations that stopped paying license fees. Down the hall from from me lived the cable television attorneys.  In the early 90s, they spent a lot of time buying and selling cable television systems.  When valuing a cable system, they looked at multiple of cash flow and value per subscriber. In the early 90s, the price you paid for a subscriber when you acquired a cable system was in the $2,000 to $2,500 range.    

If the price Viacom was willing to buy and sell subscribers was $2,500, then to acquire a Fire user for $50.00 is a steal. 

Unlike cable, launching a tablet is not (relatively speaking) capital intensive.  No laying of cables.  No tough federal regulations.   $50.00 is Mr. Bezos’ advance on the right to sell you and I – and our families – books, magazines, music, movies and video content his proprietary platform.        

Curbing Cable & Book Publishing's Power

Recently, Eric Schmidt, Google's chairman, was grilled over similar issues.  One of the concerns voiced at recent Senate hearings was whether Google (and by implication, Amazon and Apple) should own the content that flows through their virtual cables. Ironically, Viacom was formed in 1971, when the FCC issued consent decrees preventing the big three television networks (the Amazon, Apple and Google of their day) from owning a stake in the prime time programs they broadcast. 

Under what were called the Fin-Syn rules, the networks were forced to divest themselves of programs they had a financial interest in.  The FCC's goal was to encourage more diverse and innovative television content.  From my point of view, it is unlikely that the regulators will get in the way of Amazon, Apple or Google. Why? We live in an era of abundance. Amazon, Apple and Google are fueled by an endless supply of user generated content, and unlike broadcast television, the Internet pipes can support an endless supply of content.    

Just as content providers like HBO are a threat to cable system operators, book publishers and motion picture studios are a threat to Amazon. At the end of the license term, content providers can raise their fees, and squeeze the platform for more money.  Amazon and Google are wise to that. 
What if HBO Wasn't Beholden to Cable?

What’s next for Amazon?  To compete with its distribution partners in the gaming, music, movie, publishing and television industries, Amazon will continue to develop its own content -- original books, co-branded magazines, as well as exclusive transmission rights to music and sporting events.  You don’t need a weatherman to know which way the wind blows.  Who knows, maybe they’ll even start a channel dedicated to original family programming.  Acquiring an interest in Viacom's Nickelodeon to keep the lid on the price of content makes sense.  Or, perhaps, J.J. Abrams will option the rights to produce a new Twilight Zone series (from Viacom), and license Amazon exclusive  first-run rights.   

Unlike the 70s, today, the concern is control of production, distribution and dissemination of not just television programming, but books, , games, music and video.  
Will the Internet giants use their power unfairly?  Will Amazon, Apple and Google evolve in such a way that they undermine the role of independent content producers?  Or, do we applaud Amazon, Apple and Google, and their ability to endure short-term losses while creating innovative business models we all benefit from?  

The potential of Amazon's multi-function tablet is a mystery. What’s no mystery is why Mr. Bezos is willing to sell a Kindle Fire for $50.00 below cost.  

Big cable and big publishing are bleeding.    

If I were seeking an internship today, I know where I’d send my resume. Under Mr. Bezos’ leadership, Amazon is doing Amazing things.  

[revised 8/30/12]

*Footnote.  By 1991, the FCC relaxed the Fin-Syn rules.  Shortly thereafter, Viacom acquired CBS Corporation.  Viacom, once CBS’s child, was now, to quote the old Willie Nelson song, "it’s own grandpa."

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