Amazon.com Could Dominate the U.S. Smartphone Market

If it releases a phone, Amazon could threaten both Apple and Google.

Jan 26, 2014 at 10:45AM

If the U.S. is anything like China, Amazon.com (NASDAQ:AMZN) could become a major force in the smartphone market. Xiaomi, a company that some have dubbed the "Apple (NASDAQ:AAPL) of China," has risen to become the top selling smartphone vendor in the world's most populous country.

Like Amazon, Xiaomi powers its popular smartphones with a modified version of Google's (NASDAQ:GOOGL) Android, and like Amazon, Xiaomi sells its devices near cost, making money from services rather than on hardware. Reports have indicated that Amazon is thinking about entering the U.S. smartphone market; if Xiaomi is any indication, investors should take an Amazon-made phone very seriously.

Xiaomi's overnight success
Last quarter, Xiaomi overtook Samsung to become the largest seller of smartphones in China, according to Kantar Worldpanel. The data is particularly noteworthy, given that Xiaomi is a new company -- it was founded less than four years ago.

Xiaomi is known to be an innovative company with excellent marketing, but most of its success likely originates from the cost of its phones. Xiaomi's flagship, the Mi3, retails for $327 in China -- less than half of what Apple's iPhone 5s costs. Despite its price, the Mi3 is a powerful phone, with a full-HD, 5-inch screen and a fast, quad-core processor.

Amazon's rumored handsets
Amazon could do something similar in the United States. Rumors of the Internet retailer's impending handset have been floating around for some time. Most recently, last October, TechCrunch reported that Amazon had not one, but two smartphones in the works, one of which featured a radical 3-D interface.

An Amazon-made smartphone wouldn't be too surprising, given the company's foray into tablets -- pairing a Kindle smartphone with its Kindle Fire tablets seems like an obvious move. Given that Amazon has consistently offered its tablets at or near cost, it would be shocking if Amazon's phones were expensive.

Changes in payment plans support an Amazon model
Assuming they're priced aggressively, they could take a large chunk of the U.S. smartphone market. In years past, Amazon's pricing policy might not have made a difference, but ongoing shifts have made cheaper smartphones far more attractive -- and set Amazon up to dominate.

Say Amazon had brought an unlocked Kindle smartphone to the market two years ago for a retail price of $350. Even if it was equally as powerful as Apple's $649 flagship iPhone, most U.S. consumers on the major carriers would have little incentive to buy the cheaper Amazon phone -- with their monthly bill fixed, the price difference between Apple's iPhone and a less-expensive Kindle phone would be limited strictly to the down payment -- a small fraction of the total cost of a standard, two-year contract.

But smartphone plans are rapidly changing. Last year, T-Mobile abolished smartphone subsidies in favor of a no-contract, no-subsidy policy. If a T-Mobile subscriber purchases a smartphone outright, that customer can reduce his or her bill significantly -- by as much as 50%. Naturally, the customer is inclined to choose a cheaper handset; indeed, T-Mobile's subscribers buy fewer of Apple's expensive iPhones than their counterparts at other major carriers.

If smartphone subsidies fall out of favor -- and it seems that they will, given T-Mobile's rapid growth -- a high-powered, low-cost Amazon handset could be attractive to many U.S. buyers.

Google could be hit hardest
That could weigh on Apple's market share, but Google could be most disadvantaged. Amazon's FireOS, the mobile operating system it uses to power its tablets, is based on Google's Android, but is heavily modified.

Gone are Google's services, replaced with alternatives. Bing is the default search engine on FireOS, and app downloads and purchases are made through Amazon's own store -- not Google Play. Google offers Android for free, using it as a platform to get people onto things such as Google Maps, Gmail, and Google search -- by cutting Google's services out of the operating system, but still using the underlying technology, Amazon's FireOS is really the worst sort of competitor for Google.

Amazon remains a force in the tablet market
Although Amazon remains primarily a retailer, the combination of high-end hardware and low prices has proved to be highly effective in the tablet market. Apple's iPad remains dominant in the U.S., but Amazon's Kindle Fires come in second. According to Chitika, Amazon-made tablets generate more Web traffic in the U.S. than any of the ones made by Google's hardware partners.

Given the shift away from subsidies in the U.S. smartphone market, the same could eventually prove true for smartphones. Reports of Amazon's forthcoming smartphones remain speculation at this point -- but if Amazon does unveil a phone, investors should expect big things.

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Sam Mattera has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Amazon.com, Apple, and Google. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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