Amazon (AMZN -3.03%) has introduced two new lines of smart TVs designed in-house. Instead of partnering with manufacturers like it and rival Roku (ROKU -9.25%) have for years, it's taking more control of the product. Direct control over the television line gives Amazon the ability to set its own price and provide deeper integration with its other products and services.
But there's really just one fundamental reason why Amazon wants to make its own televisions: Advertising.
A bigger opportunity than competitors
Connected-TV advertising is growing quickly, and Amazon is well-positioned to capitalize on that market with its 50 million existing Fire TV users.
Connected-TV ad spending in the U.S. will surpass $13 billion this year, according to eMarketer. It's one of the fastest-growing segments of digital advertising. Spend will reach nearly $25 billion by 2024.
That's what makes companies like Roku promising for investors. But Amazon's advertising business goes well beyond the connected-TV space. It has a whole retail website chock-full of advertisements.
A TV is a lot more than just another surface for Amazon to display ads. It can collect a lot of valuable data about viewers. But Amazon's ability to crack the smart TV market has been limited. Most of its Fire TV users come from its plug-in player devices. Meanwhile, Roku accounts for one-third of all new smart TVs sold in the U.S.
Roku uses audio content recognition (ACR) to determine what content its smart TV users are watching and which ads they've seen on linear television. It can then use that data to tailor its digital ads and improve content recommendations.
Amazon can take it a step further. If you see an ad for a product on broadcast television, maybe you'll see that product pop up in your recommendations when you open the Amazon app or navigate to its website's homepage. While Roku has an ad-buying platform that can place ads all over the internet, Amazon can also offer the premium ad inventory on its own websites, making it a more attractive ad platform for cross-platform advertisements.
Amazon can undercut the competition
Amazon doesn't have to profit from the sale of its TV sets if it can generate recurring revenue from their active use instead. The company has relied on that model to sell its Fire TV sticks at prices well below Roku's streaming sticks. And considering Roku's player gross margin was -5.9% last quarter, it's likely Amazon's losing money on the sale of every Fire Stick.
The slim margins on TV sales are what's kept big-name tech companies from entering the market. For example, Vizio generates gross profits of around 10% on its device sales, which is a substantial improvement over 2018 when its gross margin was just 5%. Still, there's a lot of room for Amazon to undercut pricing before its margins dip into red-ink territory.
Roku would much rather license its operating system than spend heavily on producing television sets itself. However, Roku's a much smaller company than Amazon, and it's focused on doing one thing and doing it extremely well.
Since Amazon has the capital and capabilities to develop its own brand of smart TVs, it can offer a better television at a lower price than the competition. Of course, it'll lose money, but when you can generate additional revenue from the platform business, that difference is easily recouped.
Roku took in revenues of $36.46 per user over the last year. Thanks to its unique advantages, Amazon can generate much more than Roku's average in high-margin revenue per television set.
Undercutting the competition's pricing can help Amazon penetrate the smart TV market and get its hands on the valuable data of people's viewing habits.