Google is the only player in category two that's in the position to profit from the bits without stressing about the low- or zero-margin hardware business. That's its greatest advantage. Google can grow the market with reckless abandon because every new customer brings additional revenue, but not additional costs or risks.
Amazon and Barnes & Noble? Not so much.
Why Amazon's tablet business model isn't sustainable
Everyone seems to think that Amazon will continue to succeed in the tablet market. I'm not so sure.
Amazon's $199 Kindle Fire tablet launched the company into the number-two spot for tablets. It appears to be a successful product. And it is. But that success can't last with Amazon's current business model.
The big draw for the Kindle Fire was the price, which Amazon achieved by selling at a loss. Every time someone buys a Kindle Fire, Amazon loses money -- somewhere between $10 and $70. The strategy is to get new and more active customers with the tablet, then make up the difference over time through Amazon.com sales. It's the same business model as printers, which are sold at a loss with the expectation of massive profits through the sale of ink cartridges.
The idea that Amazon and Google are competitors needs to be addressed.
Amazon appears to be a partner with Google as an Android hardware maker. But remember: Neither of these companies is in the hardware business. They are competitors in the digital content and online services business. That Amazon is shamelessly exploiting the software platform of its most direct competitor doesn't change the fact.
Here's the problem for Amazon. As prices come down, Google's partners will be able to sell tablets -- without losing money -- at or below Amazon's $199 price.
To stay ahead in the race to the bottom, Amazon will need to continue subsidizing tablets. So when, say, Asus and Google are selling a co-branded $149 tablet, Amazon might sell a comparable device for $99. When the Asus-Google tablet drops to $99, Amazon would need to sell a comparable one for $69 and so on.
It's a losing proposition.
The lower prices go, the broader the audience. You get a lot more people who are unwilling or unable to spend a lot of money on things.
People who won't buy a tablet until it's really, really cheap aren't going to spend freely on Amazon.com. But Amazon still has to lose money on the tablet in order to undercut Google's dozens or hundreds of tablet-making partners.
Any discount retailer, from Wal-Mart to Costco, has to make it up on volume. But Amazon can't. If Amazon doubles the number of tablets it sells, it doubles the amount of money it loses on those tablets. Yet the new customers acquired through those losses are less likely to buy a lot of stuff on Amazon. They're either broke or cheapskates -- that's why they're buying the cheapest tablet they can find. These are not exactly the ideal Amazon.com customers.
Amazon needs a new business model for tablets, one that attracts big spenders rather than bargain hunters. ( If I were Amazon, I would start thinking about another operating system. Basing your entire tablet strategy on the platform of your most direct competitor probably isn't sustainable, either.)
Amazon can't win a tablet price war against Google because customers who don't buy a lot are expensive for Amazon to acquire, but free for Google.
Google's business model scales, but Amazon's doesn't.
Mike Elgan writes about technology and tech culture. Contact and learn more about Mike at Elgan.com, or subscribe to his free e-mail newsletter, Mike's List. You can also see more articles by Mike Elgan on Computerworld.com.