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Amazon Trashes Its Fire Phone: Here's Why Investors Shouldn't Care

By Jamal Carnette, CFA - Sep 10, 2015 at 4:00PM

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Scaling back its efforts in smartphones should be replaced by spending money in this division.

Happier days for Lab126. Source: Amazon (AMZN -7.16%) can't catch a break when it comes to employee treatment. In a recent article in The New York Times, the company's intense work culture was chronicled with the article going as far as claiming "workers who suffered from cancer, miscarriages, and other personal crises said they had been evaluated unfairly or edged out rather than given time to recover." On balance, The New York Times painted a harsh picture of Amazon's work environment.

In response, CEO Jeff Bezos issued a staff memo refuting the article by writing: "[t]he article doesn't describe the Amazon I know or the caring Amazonians I work with every day." While the truth is probably somewhere in between Bezos' statement and the Times article, one thing you can't argue with is Amazon's operational success -- the company's shares are up more than 1,000% in the last decade, propelling owner Jeff Bezos to the world's 15th richest person according to Forbes.

To say the company is succeeding in all facets would be a falsehood, however. According to a new article in The Wall Street Journal, the company is quickly shedding hardware-related jobs and discontinuing the ambitious (but disastrous) Fire Phone project.

Amazon's secret lab is becoming smaller
Specifically, the Journal's article centers on Lab126, Amazon's secretive hardware-development laboratory located in Silicon Valley. According to the article, the company has parted ways with dozens of engineers and has curtailed plans for future projects. And although the company has recently boasted of a few technologies Lab126 has bought to market -- the Echo speaker system and the on-demand ordering Dash Button -- none of these have been as well-received as the Kindle series of e-readers.

As previously mentioned, the impetus behind this abrupt change has been Amazon's Fire Phone. After coming to market with high hopes, both as a deep-pocked manufacturer to compete with Apple's iPhone and Samsung's Galaxy and as an alternate operating system to compete with iOS and Google's Android, which it forks, the device was widely considered a flop.

Instead of using the business model that propelled its Kindle to initial success -- a low-margin, on-demand shopping and content consumption device -- Amazon brought an expensive smartphone with a limited ecosystem and differentiating features. And those differentiating features -- Dynamic Perspective's 3D user interface and Firefly's shop-friendly product recognition -- weren't enough to justify the $650 (off contract) cost. Even after quickly cutting the price, the phone never quite caught on in a meaningful way, and was recently discontinued. The company is rumored to avoid the fate of the Fire Phone by returning to market with a $50 tablet, but perhaps the best investment Amazon could make isn't in devices.

For Amazon, perhaps cloud is the answer for its hardware woes
So while Amazon appears to be curtailing investment and devices in its hardware business, there's certainly an area where the company should be investing: the cloud. Or, more specifically, its cloud-computing based Amazon Web Service. After years of not releasing any numbers related to the business unit, Amazon reported the service was profitable in its first fiscal quarter and followed that up by reporting a year-over-year revenue increase of 81% in the recently reported second quarter.

And even better for investors -- AWS is a higher-margin business than the company's core retailing business. Last quarter AWS netted $400 million in segment operating income on $1.8 billion in net sales whereas the rest of Amazon reported operating income of $684 million on total revenue of $21.4 billion. As the fastest-growing division, and the one with the highest profit margin, it makes perfect sense for Amazon to commit more resources to Amazon Web Services at the expense of its struggling hardware counterpart. Amazon's been faulted for years for producing very little profits, investing more money in AWS could change that ... and quickly. 


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