Let's put the 5m fire units into some buckets:
- Existing prime users (I'm in this bucket) - We are part of the Amazon ecosystem (Kindle, video, music, Prime) and the Fire is a must have as it gives us more+better access to our content.
- Non-prime users, that will become prime users - You are a light part of the Amazon ecosystem - you have some Kindle books, you have the $2 GaGa album and some free cloud storage.
- Non-prime users, that won't become prime users - You are new/light to Amazon and just want to use Fire as a low-end Tablet. You'll browse, email and maybe shop, maybe read some Kindle books, but don't join Prime because you hate free 2-day shipping and access to thousands of streaming videos.
If you agree with me on these three use-cases, then here's what I think the economic impact of each of these is:
- Existing prime users - The cream of the Amazon customer crop and Amazon is already making a killing on these folks. Their spend is 4X non-prime. To be conservative let's say that economically from a Fire perspective, we actually get the least amount from these guys - let's even say their spending habits increase 0. In reality, I could see them maybe going from 4X to 5X, or decreasing any Prime churn, but let's say 0. Think of this as a customer loyalty program.
- Non-prime users, that will become prime - This is the lucrative group. The Fire will bump them over the hump and get them into Prime. They'll spend $80 for the video and 2-day shipping, then their average Amazon spend will go up 4X. Let's say they spend $100/yr on Amazon and that becomes $400 @ 10% margin - that's $30+80 in incremental margin or $110.
- Non-prime users that don't become prime - Getting the Fire will naturally cause this group to consume more Amazon digital content - kindle ebooks, VOD, and even physical products. Let's say these guys spend $0 today, and they bump to $200 - $200*30% = $60 incremental margin (digital goods have higher margins).
Finally, if you generally buy into those economics, the real key to this whole thing is the mix of each bucket. Rest assured that Amazon completely 'gets' this and it's the clear reason why they are packing so much new content and benefits into Prime and will continue to do so. I believe they will make Prime so compelling you will see this mix:
- 33% - Existing prime users - 1.65m units - $82.5m in cost, no offsetting margin.
- 45% - Non-prime that become prime - 2.25m units - $110m in cost, and $247m in margin for a net positive contribution of $135m
- 22% - non-prime users that become prime - 1.1m units - $55m in cost, and offsetting margin of $66m for a net positive of $11m
Bottom line, you have $250m in costs and $313.5m in revenue bump for a net positive of $63.5m. Think of this as a first year analysis. For year two, you have NO COST (because they already have the fire) and in year two you make $313.5m (which has upside as some of the third group move up to group 2). Now you may argue, ok I get what you are saying, but all the cost will be incurred in Q4 and the revenue will come over the following 12 months - into 2012. Perhaps, but I actually think the most high margin events (prime sign-up and digital goods) will actually come right after the device is opened and that component alone ($66m+180m = 250m) will offset my $50 unit costs and if the unit costs are actually $10: $250m (revenue bump) - (5m*10=50m) = $200m incremental profit that is actually upside on Q4.
Now, Amazon is notoriously a) tight lipped on these kinds of things and b) conservative on guidance, so I think what we'll hear in Q3 is that they are conservative here and then in Q1 when they announce, we'll hear -surprise, surprise, the amount of content consumed was amazing and we not only filled the margin dip from the device, but created a handy surplus.
What do you think?
Do you think Amazon will be conservative on guidance? Do you think my numbers are totally off? Sound off in comments.
SeekingAlpha Disclosure - I am long Amazon and Google and eBay is an investor in ChannelAdvisor.