How Does Amazon Profit From The Kindle? 


The Kindle is more than simply a product for Amazon: it's an entire ecosystem. 


It's not only an e-book reader; it's also a tablet, a media shop, a digital media sales platform, and even a publishing imprint.


Amazon's fastest-growing product, the Kindle ecosystem, could contribute to more than 10% of the company's revenue next year. 

As a result, Amazon watchers are naturally intrigued:



What is Amazon's income model for the Kindle ecosystem?

Is there any money coming in yet?

Will it ever be profitable?

How much is it? 


Because Amazon exposes so little (essentially nothing) about the Kindle environment, and because the business is still so new, answering these issues is difficult.
However, because the Kindle is critical to Amazon's future, we must work with the knowledge we have.


hat said it's most likely a major corporation.

According to Citi analyst Mark Mahaney, Kindle ecosystem revenue will account for 10% of Amazon's overall sales by 2012, a $6 billion industry (see chart at right).

The Kindle ecosystem is made up of two main components:

Hardware sales (e-readers and tablets) and software sales (media). 


Most observers agree that Amazon sells Kindle hardware at a loss to subsidize media sales, using the well-known "razor/razor blade" paradigm.
As it grows in size and efficiency, it passes savings on to customers, resulting in extremely low prices (see chart). 


We believe Amazon is almost probably losing money on the Kindle Fire, its newest and most expensive Kindle.
According to the analyses we've seen, the other Kindles are probably closer to breakeven.


So, while the Kindle hardware business is likely to generate several billion dollars in revenue, Amazon is likely to break even on these sales at most. 


So, how about the media—software?



Kindle was once solely dedicated to books.
This is no longer the case with the Kindle Fire.
Despite Amazon's denials, it's safe to assume that with the Kindle Fire, all of Amazon's digital media sales are now part of the Kindle ecosystem.
They are as follows:


Digital books MP3s Streaming video Apps Advertisements

Because the economics of each of these are distinct, it's worth briefly discussing them all. 


Amazon began by losing money on e-book sales by using the "wholesale model," which involved purchasing books from publishers at regular print wholesale pricing and then selling them at a discount to set reader expectations of a lower price for e-books.


However, the publishers were alarmed by this, fearing that it might stifle print-book sales.
(Which is unavoidable, but that's another story.)
After losing a high-profile dispute with publishers, Amazon agreed to transition to an "agency model," in which publishers determine e-book rates and Amazon receives a modest commission.
Publishers usually charge the same amount for e-books as they do for traditional books. 


As a result, Amazon is probably not making a lot of money off these sales right now.
However, it is unlikely to lose as much money as it once did.


However, Amazon will eventually make more money from Kindle books, in part because it is transitioning into a publishing firm.


Amazon already allows authors to self-publish books on its Kindle platform, keeping 30% of the sale price.
By avoiding established publishers and selling fewer books at lower prices and in greater volume, some authors have already become billionaires. 


Amazon has also launched its publishing label, led by New York editor Larry Kirshbaum, to take on conventional publishers head-on.
These novels are not only available on Kindle, but also as paperbacks, which Amazon sells on its website.


Self-published and Amazon-published books are still likely to make up a modest percentage of total ebook sales, but that percentage is likely to climb.
Amazon should generate considerable money from e-books as it rises up the value chain in publishing, as the possibilities of self-publishing on Kindle attract more and more writers to bypass the traditional publishing process, and as Amazon obtains extra negotiation clout over publishers. 


Overall, according to Citi's Mark Mahaney, the number of ebooks available on the Kindle platform is rapidly increasing, approaching a million (see chart at right).


This is a positive signal for the Kindle ebook platform because we believe it has network effects: as the Kindle becomes the dominant sales channel for books, it will draw more consumers, who will attract more publishers/authors, and so on. 


As a result, Amazon's negotiation power will increase.
Publishers will eventually grow so reliant on Amazon for distribution that they will have no choice but to grant it better terms.


Amazon MP3: Likely, Amazon isn't making any money off of music sales just now.


Because Amazon has a much smaller market share and attracts customers with aggressive pricing, Amazon MP3 is similar to Apple's iTunes Music Store, which is thought to be close to breakeven (most of the money goes to record companies; Apple's cut goes to running the service); and Amazon MP3s tend to be lower-priced than Apple's. 


Amazon Instant Video, on the other hand, is unlikely to make much money.
Amazon Instant Video is provided at no additional cost with Amazon Prime, Amazon's $79/year two-day free shipping package.
Although Amazon Instant Video is included with the Kindle Fire, non-Prime members will have to pay to rent or buy the material.


Apps are also likely to be profitable at the moment.
Apps have never been a huge moneymaker for Apple and Google, and they are unlikely to be for Amazon. 


Then there's the matter of advertising.
Ads are now available on some Kindle devices.
At the moment, Amazon is unlikely to profit from adverts because it sells ad-free Kindles for a higher price.
Amazon, on the other hand, should profit from Kindle ads in the long run because it has a monopoly on them.
Advertising for Amazon Local, Amazon's daily bargain service, is now available in Kindle ads.


Tablets, in general, are simply a large canvas for advertising creatives to work with, and Amazon knows a lot about Kindle owners, so advertisers should be willing to pay a lot of money for Kindle ads.


So, to summarize how Amazon profits (or does not profit) from the Kindle ecosystem:

Hardware: no books: possibly a few MP3s: no streaming video: no apps: no ads: some, presumably minor at this stage


So, why did Amazon enter into this business in the first place if the Kindle ecosystem isn't profitable?


There are two main reasons for this:


Media accounts for 45 percent of Amazon's income, and the industry is undergoing a secular revolution as physical media is being replaced by digital media; Amazon will almost certainly profit from the Kindle ecosystem in the long run.
Let's begin with the most basic.


Physical media sales, such as books printed on dead trees, DVDs, and the like, currently account for 45 percent of Amazon's revenue.
This method of media distribution is slowly but steadily becoming extinct (or at least the tiger).
Nobody knows when or how it will happen, but it will. 


Instead of being disrupted, Amazon must drive the disruption.
A good example books.
Amazon pioneered the sale of digital books with the original Kindle, and it now controls over 90% of the market.
Although Amazon may not make much money from digital book sales right now, it is in a better position to do so in the future than if digital book distribution was controlled by Sony, Barnes & Noble, or Apple.


The same is true in the case of music and movies, where Amazon is defending itself against Apple and Netflix: to avoid being displaced, Amazon simply needs to have its distribution channel for these types of media, even if it isn't profitable right now.


And here's where the second reason comes in: Amazon will almost certainly profit from the Kindle ecosystem at some time in the future.

It's clear to see how Amazon will profit from books and advertisements in the long term.
In a few years, Amazon will be able to economically or breakeven sell media tablets with greater specs than the Kindle Fire for $99.
And if consumers start using these tablets, which have Amazon's video offerings as well as an Amazon-mediated web via its revolutionary browser Silk, this will result in a significant increase in both physical and digital product sales.


However, if Amazon can sell millions or tens of millions of low-cost media tablets, it will be in a strong position to profit from other forms of media, as it will have the kind of distribution that will allow it to negotiate better agreements with content owners.


One thing to keep in mind about Amazon is that it thrives in margin-constrained circumstances, winning by passing savings on to customers.
It's excellent for Amazon if the Kindle ecosystem grows thanks to low prices and has, say, 5% profit margins overall in a few years. 


If there's one thing you can say about Amazon, it's that it's a long-term thinker.
For seven years, the company's core commerce division was losing money.
It's now extremely profitable.
In 2002, Amazon launched its cloud services.
It is now one of the industry's leaders.


Kindle is the result of a decade of research and development into a media consumption and distribution ecosystem.
Because Amazon needs to disrupt itself, it can't afford to ignore it.
And it's something that will pay off in the long run.


As a result, Amazon is unlikely to profit from the Kindle ecosystem today, next year, or even in a few years.
However, it is still a fantastic long-term investment.


Disclosure: Jeff Bezos, the CEO of Amazon, is a Business Insider investor.