Amazon

The next phase of smartphones

It’s now 7 years since the iPhone reset the phone business, and indeed the entire computing and internet businesses. But it was pretty clear at the time that the first iPhone was an MVP, and Google’s first Android… homage, the HTC G1, was even more so. It feels rather like the last 7 years have been spent adding all the things that really needed to be there to start with, both in hardware and software. For iOS and Android these have come in different orders, since their opening assumptions were very different, but they’ve ended up at much the same place in terms of the user experience and interaction model. There are small differences in how you interact, and there are always things that are on one platform before the other, but the basic user flows are very similar, and almost all the obvious gaps have been filled. 

Along these lines, my colleague Steven Sinofsky makes the point that for any new ‘thing' in computing, at the beginning everyone is doing roughly the same stuff because the stuff you need to add is pretty obvious and undifferentiated - you might deliver different things in different orders but you’ve got basically the same wish list. It’s once you’ve finished building out that stuff that things start to diverge. 

This, I think, is what we started to see at this year’s WWDC and Google IO - the end of the first 7 years and the start of a new phase, with the fundamental characters of Apple and Google asserting themselves. As Jean-Louis Gassée put it, iOS 8 is really iOS 2.0

Hence, WWDC was all about cloud as an enabler of rich native apps, while the most interesting parts of IO were about eroding the difference between apps and websites. In future versions of Android, Chrome tabs and apps appear together in the task list, search results can link directly to content within apps and Chromebooks can run Android apps - it seems that Google is trying to make ‘app versus web’ an irrelevant discussion - all content will act like part of the web, searchable and linkable by Google. Conversely for Apple, a lot of iOS 8 is about removing reasons to use the web at all, pulling more and more of the cloud into apps, while extensions create a bigger rather than smaller gap between what ‘apps’ and ‘web sites’ are, allowing apps to talk to each other and access each others’ cloud services without ever touching the web. 

Unlike the previous differences in philosophy between the platforms, which were mostly (to generalise massively) about method rather than outcome, these, especially as they evolve further over time, point to basic differences in how you do things on the two platforms, and in what it would even mean to do specific tasks on each.The user flows become different. The interaction models become different. I’ve said before that Apple’s approach is about a dumb cloud enabling rich apps while Google’s is about devices as dumb glass that are endpoints of cloud services. That’s going to lead to rather different experiences, and to ever more complex discussions within companies as to what sort of features they create across the two platforms and where they place their priorities. It also changes somewhat the character of the narrative that the generic shift of computing from local devices to the cloud is a structural problem for Apple, since what we mean, exactly, when we say ‘cloud’ on smartphones needs to be unpicked rather more. That's a subject for my next post. 

Meanwhile, this sort of divergence is why I’m a little skeptical about the other two big reveals in the last couple of months: the Fire Phone and Facebook’s mobile announcements at F8. Facebook is trying to build essential plumbing to connect the web and apps together, in particular with its deep linking project. But this is like building the plumbing for a building that’s still going up, and where you don’t know what it's going to look like. Making tools to connect apps and the web together when Apple and Google are shifting the definitions of those terms is going to be challenging. 

Amazon has a bigger problem. Most obviously, more and more of what it means to be ‘Android’ will come from the closed Google services that aren't part of AOSP and that it doesn’t have access to. If Amazon wants to free-ride on the Android app ecosystem, it will need to spend more and more time replicating the Google Android APIs that the apps it wants are using, or the apps just won’t work - presuming that Amazon even has the sorts of search-led assets to do that. But more fundamentally, AOSP is being pulled along by Google’s aims, and will change in radical and unexpected ways. This isn’t like building on Linux - it could be more like taking a fork of DOS just before Windows 3.1 came out. Are we quite sure (to speculate wildly for rhetorical effect) that we won’t be running Android apps in a sandbox on our ChromeOS phones in 5 years? Where would that leave Amazon’s fork? AOSP is not necessarily a neutral, transparent platform for Amazon to build on. 

Amazon and Android forks

The general reaction to Amazon's Fire Phone has been a puzzled shrug. It's a good but unexceptional device with entirely conventional high-end and high-margin pricing - a move as out of character for Amazon as the purchase of Beats was for Apple (and probably driven in part by the way the US pricing structure makes even $400 phones ’free’). There's an interesting quasi-3D UI feature and a big flashing BUY button, in line with Amazon's role as the Sears Roebuck of the 21st century, but little that really changes anything or couldn’t be done on any other smartphone anyway. And that leaves people wondering why Amazon bothered. The most productive line of thought, I think, is to look at Prime, Amazon's whale service, and the role that the Fire Phone plays in securing that relationship. 

To me, though, the interesting thing is less the phone than the platform and what it it represents - that is to say, the first real attempt to sell phone that forks Android outside China*.  

Android itself is open source, and anyone is free to take the code (AOSP) and build whatever they want. Android is the new Linux, in this sense. But AOSP doesn't give you Google's own smartphone apps and it doesn’t give you all the system services Google has built. So if you make an Android device without reference to Google, and change a bunch of things ('fork Android') your device won’t have the app store and the maps, and it won’t have the Google services APIs that lots of third-party apps need, most obviously push notifications, in-app payments, location and embedded maps. There are lots of other things Google makes as well, but those are both the important and the hard parts. 

Without this Google layer you really only have a featurephone, and to get Google's layer you need to submit to Google's control over what you make, which amongst other things means that you have to use Google's interface and you have to take the whole package - whatever Google wants on the phone goes on the phone. (The core mechanic here is that you have to pass the compatibility test). Hence, Google uses access to its apps and services as a lever to control Android. This is pretty similar to the way that Microsoft used Office and Windows: selling an Android phone without Google's services is like selling a Windows PC that doesn't have Office and can't run it. 

In China all of this works differently. Google services are either blocked or weak or both (the Chinese unaccountably didn't let Google send its mapping cars down every road in the country), while the Chinese internet giants Baidu, Alibaba and Tencent ('BAT') and scores of others have built lots of great Android services of their own. So the vast majority of Android phones sold in China (even from Samsung or Motorola) come with no Google apps and integrate these instead. 

Outside China, though, if you want to use Android as a platform but do something different, you need to build or buy those core functions yourself, and that’s what Amazon has tried to do. It has licensed Nokia’s HERE mapping platform, it has built an app store for Android, and it has built its own versions of the key enabling APIS - location, push notifications etc. 

The problem is that the maps and the app store are not commodities. Adding them is not just a matter of spending the money. Google's Maps platform is very good and HERE, at least in western markets, is not as good. As with Apple Maps, it works, mostly, but the gap is clear and there is no roadmap that points to that gap closing. For apps, though an app store itself is perhaps a commodity, Amazon has only persuaded a minority of Android developers to load their apps into its store, partly since this means they have to swap out Google’s APIs (for maps etc) for Amazon’s, and that is not necessarily trivial. Amazon has done just about as good a job as one could expect anyone to do at this stage, and there are very few other companies that could get this far - perhaps only Microsoft. But it hasn’t, remotely, reached parity with Google. 

And so Amazon is testing the proposition that you have to have Play (or iTunes) and Google Maps to sell a smartphone outside China - or, rather, it is testing just how good the app store and maps have to be. How many of the latest cutting-edge apps do you have to have, if you cover the basics? How close do you have to get to Google Maps’ coverage? We know Windows Phone does not have enough apps, but can the Amazon store get there?

These same questions apply to any Android OEM that might be thinking of asserting greater independence from Google (such as Samsung), with a further complication. Google’s agreements with OEMs have been leaked several times, and they include clauses that prevent you from having a foot in both camps: you cannot sell a forked device and carry on selling official Google Android devices. So you can’t experiment on the margins (Samsung can't sell a phone running Amazon's Fire software) - you have to walk away from Google entirely, or not at all. That's really no choice at all at the moment. 

All of this takes us to the elemental question - why, exactly, are you forking Android? What important problem do you solve that’s worth reinventing the wheel, while taking on the risk of building on someone else’s platform, open-source or not? Why are you asking people to buy a phone with second-rate maps and a second-rate app store? Are you offering them something you couldn’t otherwise do in return, or just addressing your own strategic concerns? Are you solving a user problem or your own problem?

Both Xiaomi and Cyanogenmod (an a16z portfolio company) have built their own very custom versions of Android that do none the less pass the compatibility test. And though Xiaomi differentiates on software, Xiaomi phones outside of China ship with Google Apps. Hugo Barra called it 'a compatible fork'. After all, it’s not as though you’re not allowed to change Android at all. Google describes the compatibility test as follows: 

"Enable device manufacturers to differentiate while being compatible. The Android compatibility program focuses on the aspects of Android relevant to running third-party applications, which allows device manufacturers the flexibility to create unique devices that are nonetheless compatible."

Generally, Android OEMs have been no better at differentiating on software than were PC OEMs, even though Google allows you to change more than Microsoft did. But it doesn’t follow that you can’t make Android visibly better without forking it if you bring the right skills and culture - Xiaomi and Cyanogenmod (and a number of other Chinese companies) show that. 

Hence, it seems to me that the forking question really flows not from a specific feature that you want to implement but the fundamental principle of controlling your destiny - you want a platform that’s 'yours'. 

That is, a central strategic problem for both Amazon and Facebook, amongst others, is that their businesses have moved from the essentially neutral platform of the web browser, where there has been no real change in the user interaction model in 20 years, to the much messier, mediated and fast-changing platform of smartphones, where the web is just one icon and platform owners are continually adding new ways for users to discover and engage with content, such as iBeacon or Google Now. They didn’t need to make browsers because browsers had become transparent commodities, but smartphones aren’t. This of course is why Google itself made (or rather bought) Android - to make sure that it would not be shut out in this new environment. Making an entire new OS is not an sensible option for Amazon or Facebook at this stage, but building on top of a free, open-source one is worth at least thinking about. But, again, in doing that you need to solve the users' problems, not just your own. 

Facebook is also poking away at this issue (such as with the abortive Home), but as Mark Zuckerberg pointed out, even a really successful Facebook Phone would only be used by 5% or 10% of Facebook’s users, so would really just be a distraction. Instead, faced with a very different set of competitive dynamics on mobile, Facebook is exploring the unbundling of its product with a 'constellation' of different apps. That is, Facebook is embracing this new and more complex environment. With the Fire Phone Amazon is going the other way - greater bundling rather than less.

I do wonder what might appear if Facebook's strategy was applied to Amazon's product - if there were half-a-dozen different interesting and useful Amazon apps for finding and buying products. But Amazon has never been a user experience company in that sense - it thinks about user experience the way Fedex does, as something to focus on ruthlessly, but not as a playground for new experiences. That means it's going to be very interesting to see how it can enchant and delight people who buy its phone. 

 

*Note: when I wrote this on a Sunday evening the fact that Nokia (and hence now Microsoft) has been selling a forked Android phone for the last 6 months passed completely out of my mind, even though I played with one at MWC and rather liked it. It's done rather well in emerging markets, apparently, and is on sale in parts of  Europe) but isn't even for sale in the USA. The main driver is that Windows Phone doesn't fit well into the hardware required of that price. The points in the blog post all remain, though. 

The Amazon Rorschach blot

I've written several times about Amazon and its profits, which tend to be the topic of a polarized debate. Either it's a brilliant company investing every penny of cash in building the future, or it's a Ponzi scheme doomed to collapse. The great thing about this chart is that you can use it to support either view. It's the Rorschach Blot of charts. One thing is easy to agree on, though: competing directly with a company like this is very hard. 

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(If you look very closely, you can see that in 2010 the company accidentally made a profit. )

Amazon's PR genius

Amazon is pretty much the most secretive company in consumer tech. Apple gives almost all the operating metrics you could reasonably ask for, but Amazon has never disclosed unit sales for Kindle and is systematically opaque about every aspect of the business. It generally refuses even to comment on news stories, which can sometimes be rather funny, as in this quote from a New York Times article about this issue: 

“Every story you ever see about Amazon, it has that sentence: ‘An Amazon spokesman declined to comment,’ “ Mr. Marcus said.

Drew Herdener, an Amazon spokesman, declined to comment. (Link)

However, there is one area where Amazon doesn't stonewall: the warehouses and logistics operation. There's a steady flow of informative and interesting press pieces on this topic. This is partly because it is more interesting to a general audience and partly because you can get raw material without going through Amazon - you can ask the workers and local people about a huge fulfilment centre. But it's also because Amazon gives access: photographers and journalists are allowed in. And the warehouses make for great pictures.

If the only thing Amazon is happy to see talked about is its logistics platform, this is probably deliberate. All the coverage supports two narratives: 

  • Amazon offers very good value
  • Amazon is impossible to compete with

Price is obviously a large part of the consumer story, but talking about logistics is a competitive weapon just like not talking about Kindle sales. Every story about how Amazon has built an amazing, incredibly efficient, incredibly low-cost distribution platform is another ecommerce start-up that doesn't get funded, or even started. Jeff Bezos famously said that he was happy for Amazon to be misunderstood for long periods of time, but no-one is in any danger of underestimating the scale of Amazon's distribution. 

Even apparently negative stories, for example about how hard the workers are driven, benefit Amazon, much like a mobster's reputation: 'don't try competing with these guys'. Hence, one could suggest that even if a journalist sets out to make Amazon look bad, the result is generally something that looks and feels negative but still actually helps the company. 

The same of course applies to stories about how Amazon deals with partners. It's pretty clear that the pleasantness of dealing with Amazon as a customer is quite opposite to the experience of dealing with it as a supplier. Amazon named a project for dealing with small publishers 'Project Gazelle' because Jeff Bezos said Amazon “should approach these small publishers the way a cheetah would pursue a sickly gazelle.” The lawyers renamed it the "Small Publishers Negotiation Program". (Link) Publishers get outraged by this sort of thing, but to consumers these stories can often read as "Amazon squeezes fat lazy industry to give me better prices".

All of this leads to the question; is there any company more successful at controlling the public narrative than Amazon? Nothing it cares about ever leaks. Almost all of the press coverage, even the negative stories, runs to a script that Bezos could have written - "We do amazing things to get low prices to customers" and "it's incredibly hard to compete with us". Of course, both of those things may well be true. 

Simplicity

Unlike most other industries, tech companies are often very secretive about their product plans. Apple is the obvious example, but rivals like Google or Amazon are often even more closed-mouthed. And in parallel, there is often somewhat frantic speculation about what they’ll announce next.

Yet at the same time, these are often fairly simple companies with pretty predictable strategies.

Apple sells devices - circuit boards in boxes at a 30-50% gross margin. It makes them with a certain kind of experience, where it can add significant value in the software and hardware integration. It wants to control as much of the experience as is possible. It will not sell devices below a certain quality of experience just to hit a price point.

Amazon is an ecommerce platform - a warehouse with a search engine. As every new category goes online - as buyers and sellers become willing to buy and sell that product online - Amazon is there with the best logistics and the best selling platform. Meanwhile, it continually reinvests profits in infrastructure and new businesses to drive further growth - taking profit now is just wasted investment.

Google is a search engine and an advertising business, powered by a a decade-old machine learning engine that it feeds with as much data as possible, and it needs reach, in every sense - to feed the machine with data and to deliver search results (and advertising).

One could certainly quibble about how I’ve phrased these, and perhaps add or subtract things. Nor is any of it especially insightful. But that’s the point. These companies do actually tell you what they’re trying do to. Apple and Amazon in particular are very public and explicit about their strategies: Tim Cook (and Steve Jobs before him) and Jeff Bezos say variations of these things over and over again.

Yet somehow, people don’t hear them, and come up with ideas about what these companies will do that are totally at odds with their actual strategies. For example, Google wants Motorola to be a rival to Samsung. Apple will build a global pay TV network or a mobile operator, or an MVNO. Apple will make a mind-blowing new product every six months. Amazon will never be profitable. And so on, and so on.

In truth, though, the best way to understand these companies is to listen to what they say.

Amazon's profits

The problem with Amazon is not that it doesn’t make a profit, but that you don’t actually know what the profits are. 

On the face of it, this sounds like an absurd statement - it doesn’t make any profits. After all, look at this chart - massive revenue growth, zero profit. 

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If we’re going to do this properly, of course, we should look at free cash flow, or rather (to smooth out the seasonality) trailing 12 months free cash flow (which is also Amazon's preferred metric). 

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But, of course, this doesn’t show any profits either - in fact what (relatively) little FCF there used to be has now been reduced to close to zero by capex (though this also includes a one-off $1.4bn for purchasing Amazon's headquarters building in Seattle in Q4 2012). Amazon is, very obviously, reinvesting every penny that it can squeeze out of the business back into growth, in pricing, market expansion and capex. 

This leads to two views of the company. One, to put it crudely, is that at some point, when it has gained enough market share to get away with it, it will ‘flip a switch’, put up prices or cut capex and start making a return. 

The other view is that this isn’t actually possible - that Amazon is a sort of Ponzi scheme. It can only grow by running at zero profit - as soon as it puts up prices or cuts capex the business will collapse, and as soon as the share price stops going up all the staff will leave. 

It is certainly true that you can’t just decide to change your business model to be be profitable, as Horace Dedui points out with some precision here. But there's another angle to the Amazon story - it isn’t actually one business. 

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This chart shows the revenue segments that Amazon reports. These are in different industries, at different stages of development, and in different markets. It seems pretty likely that their underlying economics are different too. Not, that is, the FCF or net incomes that Amazon reports after all that re-investment, but the underlying performance of the divisions.

Moreover, even this isn’t the full story, since Amazon is actually a lot more atomised. Most separate product lines have their own internal owner and P&L by country or region (with a lot of internal transparency, incidentally). Some of them fail and get killed, some have only just started and some are doing very well. 

Meanwhile, Amazon is constantly creating new business lines. When they start, like any new business, they're loss making. But they don't 'flip a switch' to get to profitability - they just grow and execute, like any other business. 

This means that Amazon's earnings are actually driven a mix of four overlapping factors: 

  • Capex in new distribution
  • 'Artificially' low prices
  • Operating losses at new ventures
  • Offsetting profits at established ventures

We have very little idea, from outside, what the mix is. All we know is that Bezos diverts any profit that arrives at the bottom of the P&L back into these to keep the final result at zero. But at least two offer a switch that can be 'pressed' for profit without any damage to the business or any conceptual problem. 

To put this another way, Amazon is LOTS of different startup ecommerce businesses on one platform. All the profits from the ones that work are spent on new, loss-making ones. 

This prompts two analogies. The first is GE, which also managed its earnings with great care, so that it was hard for anyone outside really to tell what was going on. 

The other is Marxism. As Karl Popper pointed out, the problem with the Marxist theory of historical materialism was that you couldn't disprove it. Any scientific theory is susceptible to disproof: something could happen that would show it to be untrue. But there isn't anything that would disprove Marxism - the Marxist can always say 'the conditions for revolution weren't right, but just wait, it will come next century'. 

Equally, the problem with saying 'we can't tell from outside how Amazon is really doing, but it will become profitable, just wait and see' is that you could be waiting for ever without ever knowing if you're wrong. 

Amazon is not a media company

Amazon is not a media company; it's a leveraged play on the conversion of the entire economy (or as much of it as possible) to ecommerce. Amazon is the Sears Roebuck of the 21st century. 

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If you don't know this by now you're really not paying attention.

Falling interest in Kindle and Nook: the decline of ereaders?

I'm a big fan of Google Trends. It's partial, and you need to think carefully about what you're actually looking at, but used properly it can be very revealing of market trends.

So, caveats aside, this chart shows US search volume for Kindle, Kindle Fire and Nook. Three things stand out: 

  • A large and unsurprising spike at each Christmas
  • A really substantial decline for 2012 versus 2011 - close to 50%
  • The Kindle Fire, supposedly the future-proof successor to the Kindle, appears to be falling, not growing

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Amazon, of course, tells us nothing tangible about how the Kindle is doing, but Nook's numbers (as reported by Barnes & Noble) are looking terrible, which is consistent with this.

It seems to me that several things may be going on here:

  • General-purpose tablets (mainly the iPad) are more proving more compelling to consumers than special purpose tablets like the Nook and even the (rather more capable) Kindle Fire
  • Cheap general purpose tablets (which are very hard to capture in Google Trends, as an aside) have removed or reduced the price advantage the Nook and Fire had last year
  • These devices have quite long lives - especially ereaders (i.e. the Kindle). Maybe most of the addressable market bought one in 2010 and 2011 and those people didn't come back to the market in 2012

There's a broader story here, of course, in the way that the growth rate of ebooks seems to be slowing as they reach a third or so of the market.

The UK data shows a trend that's slightly different: Nook is MUCH weaker (reflecting the absence of real distribution or brand) and Kindle Christmas interest held up better in 2012, probably reflecting the later UK date - ebooks seems to be about 1 Christmas behind the USA. However, the drop-off seems to be sharper in the beginning of 2013 than in the beginning of 2012, just as in the USA.  

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The same point is even more clear if we look at search volume for 'ebooks'. The deceleration is clear.

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