Is Amazon's Kindle Unlimited the First Step in Unbundling Prime?

Amazon loves the bundle, but is it missing out on a huge revenue opportunity?

Jul 28, 2014 at 4:02PM

Earlier this month, Amazon.com (NASDAQ:AMZN) unveiled a new service, Kindle Unlimited, which offers voracious readers the ability to read any of the 600,000 books in its library for $10 per month. It's a beefed-up version of the Kindle Lending Library that comes with Amazon Prime, and it may indicate the next direction for Amazon's digital services.

Amazon Prime may be the most valuable bundle of services ever -- if you use all it has to offer. At the beginning of the year, the company raised the price of the bundle to $99 per year from $79. It also added a limited music streaming service as well as hundreds of new high-quality titles from HBO to its video streaming library to justify the price increase and compete with Netflix (NASDAQ:NFLX).

Kindle Unlimited may be Amazon's first step in unbundling Prime and increasing its revenue.

Why unbundling works
Unbundling works for one simple reason: People want the best. It's easier to be the best if you do just one thing. Netflix does one thing. Amazon does everything.

Even if Amazon Prime is about the same price as Netflix, its library can't compete with Netflix's. For people uninterested in two-day shipping, Amazon Prime isn't worth the price when Netflix is available. Amazon uses bundling to make up for its limitations, but its competitors continue to grow in spite of the added benefits of Prime. 

With more people using their tablets and smartphones for listening to music, watching videos, reading, and shopping, Amazon is certainly a jack of many trades when it comes to mobile activities. The company has already figured out that it can unbundle its services into separate apps and boost engagement. It has a shopping app, a Kindle app, a music app, and a video app, among others. To get the most out of any of those apps, however, you have to buy the Prime bundle.

We live in an economy where specialization is valued. If Amazon doesn't offer specialized services, another company will. Considering Amazon has a stake in just about everything, specialized competitors will be a detriment unless Amazon offers its own specialized services.

Although Prime Instant Video is closing the quality gap between its library and Netflix's, it's still a second-tier video streaming option. Strong competitors are popping up in the ebook subscription space as well, and music streaming has seriously cut into its digital downloads business. The Prime bundle is unable to service those customers as well as competing specialized services.

Why unbundling doesn't work
Amazon relies on consumers getting sucked into its ecosystem and using all of its services. Surveys have shown that Amazon Prime subscribers purchase more from Amazon on average. Of course, correlation doesn't mean causation; someone who uses Amazon a lot is probably interested in unlimited two-day shipping, but may be less interested in the movies, music, and books that come with the subscription.

Being a jack-of-all-trades is great, but Amazon Prime provides the most value to people who actually shop on Amazon. That fact is probably not unintentional on Amazon's part, but it's also not lost on most would-be subscribers. That's why Amazon has failed to make a dent in Netflix's subscriber growth, which now stands above 50 million, and it's why people will continue to subscribe to other streaming music services, cutting into Amazon's digital music store.

But Amazon faces a similar unbundling problem to the cable industry. Its movie, music, and free e-book library are all supported by the fact that Prime subscribers are the Amazon customers who buy the most stuff. In other words, sales of merchandise on Amazon's Web store all subsidize the price of Prime's digital streaming services.

Going a la carte would mean much higher prices. (Kindle Unlimited actually costs more than a Prime subscription.) If the price comes with quality on par with that of top-tier competitors, however, it may effectively increase Amazon's subscriber base and revenue. On the other hand, that also means added investments in content in markets where it appears difficult to break even. So, even if it adds revenue, it may reduce profitability.

Risky business
Unfortunately, Amazon has put itself in a situation where if it unbundles its services now, it's almost certain to cause an uproar of Prime subscribers. It must tread lightly considering those are its most valuable customers.

When Netflix unbundled its DVD and streaming services, there was a huge backlash, and the stock was pummeled. Amazon wants to avoid a similar fate, even though Prime subscriptions represent a much smaller percentage of revenue compared to Netflix's previously bundled subscribers.

Kindle Unlimited will be an interesting experiment to see if Amazon can offer a premium service compared to what's available to Prime members. If successful, Amazon may be able to branch out from there, unbundling music or movies, and maximize its digital media revenue.

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Adam Levy owns shares of Amazon.com. The Motley Fool recommends and owns shares of Amazon.com and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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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