Will an Amazon Smartphone Be a Game-Changer?

The rumors were true. After weeks of speculation, Internet retailing giant Amazon.com (NASDAQ: AMZN  ) unveiled its first smartphone ever on June 18 at a highly publicized event.

Amazon shares rose 3% on the day of the announcement, implying a sense of optimism that the phone will provide a boost. While it's understandable to get excited about a new product release, the success of the smartphone is far from guaranteed.

First, Amazon is going up against some established and intense competition. In addition, hardware itself is not a highly profitable business. In addition, one of Amazon's biggest criticisms over the past several years has been the inability to generate profits from its rising sales. A smartphone isn't likely to change that.

It's going to take time and cost a lot of money for Amazon to take on the industry competition and also change its brand connection with consumers, who haven't associated it with phones. As a result, at first glance it seems unlikely that the phone will be a home run for Amazon.

Amazon sets the smartphone market on Fire
Amazon's phone, called Fire, will be exclusively available on AT&T (NYSE: T  ) , and does have some interesting features. It has a 4.7-inch screen, a high-definition LCD display, and some 3-D functionality. Pricing starts at $199 for 32 gigabytes, or $299 for 64 gigabytes with a two-year contract with AT&T. Without a contract, the Fire phone will cost $650.

Source: Amazon.com

But Amazon's phone is pricey if you don't opt for a contract with AT&T. It might be getting ambitious on pricing.

AT&T looks like a winner from the announcement, as it has yet another product it can sell and an exclusive arrangement with Amazon. And of course, AT&T will rack up revenue from contracts and data usage on its 4G LTE network.

The smartphone represents Amazon's first foray into smartphones, but it already has a well-established presence in devices. Amazon's Kindle Fire tablet is now complemented by a smartphone, making it abundantly clear that Amazon wants a piece of the hardware pie. Whether that's a good decision, though, isn't as readily clear.

The hardware side of the business is essentially a duopoly, with Apple and Samsung controlling the lion's share of industry profits. Hardware is a low-margin product as it is, which won't exactly silence Amazon's critics.

For years, Amazon's valuation has steadily expanded, despite the fact that its profits haven't kept pace. To illustrate, consider that even though Amazon's revenue has tripled since 2009, from $24 billion to $74 billion, its diluted earnings per share have collapsed 71% during this time. Put simply, Amazon has an amazing ability to rack up sales, but it has to spend increasing amounts of money to obtain these sales.

Amazon is hoping that putting a phone in the hands of consumers is yet another way to build its brand connection, with the goal of eventually integrating its other services. For instance, for a limited time Amazon will offer a 12-month subscription to Prime along with the smartphone.

Plus, Amazon presumably thinks it can offer users something the industry stalwarts can't. That's likely to be the 3-D technology which Amazon calls "Dynamic Perspective," which supposedly will allow you to make commands with gestures without having to touch the screen. This could indeed be a differentiator.

But again, success if far from guaranteed. And if you're concerned about profitability, whether a phone will cure what ails Amazon is by no means a sure thing.

Amazon had better be prepared for a fight
The battle for global smartphone supremacy has a new entrant in Amazon. While Amazon has undoubtedly conquered the Internet retailing business, it might be in over its head when it comes to smartphones. This is uncharted territory for Amazon, and it's about to go up against some stiff competition in the forms of Apple and Samsung.

Amazon's share price rose after unveiling its first-ever smartphone, and there is reason for optimism since the phone will include some interesting features such as 3-D technology. At the same time, the smartphone business itself is extremely difficult. Hardware isn't a highly profitable venture, which will only add fuel to the bearish case against Amazon that the company can't turn solid profits from all its sales.

The smartphone graveyard is littered with companies that couldn't keep up with Apple and Samsung. Amazon management needs to be prepared for a fight.

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