Amazon's (NAS: AMZN) new line of Kindle tablets were announced recently, and reviews across the Internet gave the company two thumbs up. According to fellow Fool Evan Niu, Apple (NAS: AAPL) better watch its back and, frankly, I don't disagree.

What intrigued me about the announcement, though, was the company's strategy to continue subsidizing devices in hopes of making the money up on the back end. Jeff Bezos sold the original Kindle below cost to get into the market, which made sense at the time, but even these new devices won't make Amazon a profit unless users buy things on them.

The notion of only making a profit only if customers use the product is admirable, but is it wise? Apple makes a profit every time you buy an app, a song, or a movie on its devices, but it also makes a profit on every device that is sold. And it's a hefty profit at that. So can Amazon make money on these devices by making it up on the back end? I did some back-of-the-envelope calculations to get an idea.


How much do you spend on apps and books?
Since Amazon is cryptic about how much it makes from apps, movies, e-books, or anything else it may sell on the Kindle, I used the best comparisons -- the iPad and iPhone. Here's how I came up with a rough estimate for monthly revenue and profit that Amazon can expect from the Kindle.

First, I looked at how much revenue Apple generated from iTunes, the App Store, and the iBookstore. The company reported revenue of $2.06 billion in the most recent quarter for these items, including some accessories, which will skew the number slightly higher; but, because it's the best-reported number, and it will increase the numerator and help make the case for Amazon, I'll go with it.

Now, how many iPads and iPhones are floating around out there to generate that revenue? I assumed that devices sold in the last two years would be active, so I used iPhone and iPad sales from the calendar second quarter of 2010 through calendar first quarter 2012. The total came out to 166,901,000 iPhones and 67,084,000 iPads, for a grand total of 234 million devices. This doesn't account for new devices but, again, it should lower the denominator, helping the case for Amazon.

Now, if we divide the revenue generated by three, we get average monthly revenue of $686.7 million, divided by 234 million devices, which brings us to average monthly revenue per user of $2.93. Now, take Apple's 30% cut of developer revenue, and we get a revenue of $0.88 per month per user (not including infrastructure or overhead costs).

Making money on the Kindle Fire
If my assumptions above are correct, there isn't a lot of money to be made on the Kindle Fire HD, but there are reasons to think that the Kindle Fire HD will make more money for Amazon. Kindle users are book readers, and books are generally more expensive than apps that sell well in Apple's App Store.

Earlier this year, RBC Capital estimated that each Kindle Fire generated $136 in additional revenue for Amazon. If we assume a two-year estimated life, that's about $5.67 per month, or about a $1.70 profit. RBC also estimated that Amazon lost about $18 on each Fire it sold, when including marketing and free shipping. These estimates may be in the right ballpark for the new devices and, if they are, it doesn't make the device a moneymaker for Amazon. Amazon, like Apple, takes a similar 30% of sales -- meaning it makes about $40.80 in additional revenue for each device after the initial sale, leaving just over $20 of potential profit.

What I haven't included is advertising revenue from Kindle ads. I don't have good estimates for what this revenue would be, but it will likely add a few dollars to Amazon's case at the very least.

Even if we assumed a slight loss in manufacturing costs for new devices, and nearly $6 per month in recurring revenue, Amazon is going to be lucky to make a profit on the new Kindle Fire HD when accounting for costs like the cloud, and other infrastructure costs.

Crushing the competition
Amazon has created  a device that will likely be a winner in the tablet market. Google's (NAS: GOOG) Nexus 7 doesn't have as much memory for the same cost, the iPad is more expensive and, therefore, less compelling for many consumers, the Microsoft (NAS: MSFT) Surface tablet follows a number of flops for the tech giant in the mobile space, and Barnes & Noble's (NYS: BKS) Nook looks dead in the water.

If Amazon is able to take a big share of the tablet space, then what? Tablets don't exactly require brand loyalty and, with quality increasing, I think it's safe to say that consumers won't require a new device every year or two. I'm just wondering how a dominant position in tablets helps make Amazon money.

The bottom line matters
For years, Amazon has been building a business that's more about making sales than making profits. The company's margins are down since the first Kindle Fire was released, and I have no doubt that they'll be down again once this product is released. The company's model of making money on the back end just doesn't lend itself to making money the way Apple's does, and that's why I'm negative on the stock. Until Amazon can prove its model can make a significant profit, I'll stay bearish. Even in the short-term, it's left me feeling like the curmudgeon that just doesn't understand this newfangled business model.

For an extremely in-depth look at Amazon, you should check out our premium report on the stock. It comes with a year of updates, so find out more by clicking here.

The article The Biggest Question About the Kindle Fire HD originally appeared on Fool.com.

Fool contributor Travis Hoium is short Amazon and manages an account that owns shares of Apple. You can follow Travis on Twitter at @FlushDrawFool, check out his personal stock holdings, or follow his CAPS picks at TMFFlushDraw.The Motley Fool owns shares of Microsoft, Amazon.com, and Apple. Motley Fool newsletter services have recommended buying shares of Amazon.com, Google, Microsoft, and Apple. Motley Fool newsletter services have recommended creating a bull call spread position in Apple. Motley Fool newsletter services have recommended creating a synthetic covered call position in Microsoft. Motley Fool newsletter services have recommended writing puts on Barnes & Noble. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.


Increase your money and finance knowledge from home

Investment Strategies

What's your investing game plan?

View Course »

Investing Like Warren Buffett

Learn from one of the world's best investors.

View Course »

Add a Comment

*0 / 3000 Character Maximum