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“Amazon and Google are undermining mobile pricing, and that may hurt everyone” by Jon Fingas
Jon Fingas argues that the pricing war initiated by Google and Amazon, as regards to determining the low price at which tablets are sold, “don’t bear their full costs”. The fact that two of the biggest players have decided to start selling tablets with no profit margin, might be a good thing in short term perspective however, it might prove detrimental for the industry in the long term, as it may derail the industry's’ focus away from providing quality devices and steer it to selling cheap, minimum capabilities ones.
It is generally accepted that competitive markets fail for four basic reasons; market power, incomplete information, externalities and public goods.
Inefficiency arises when a producer or a supplier of a factor input has market power and both
Google and Amazon undoubtedly have power. Currently, they are the two biggest market players after Apple, and Amazon is the biggest online retail and content provider. Both have decided on the output quantities of devices and at which marginal revenue to sell and have conceded that the marginal revenue is going to be equal to the marginal cost. Therefore they have squeezed their profit margin for these devices near zero, projecting that the high profit margins will come from selling content and services to consumers.
As a result, they succeed in making competitive products appear overpriced to the consumer, even if they are costly to produce. Secondly, they force other producers to lower their selling price and subsequently their profit margins. Further, they lead producers in the forced dilemma of choosing between quantity and quality when designing and producing new devices.
Google is aiming to both make a profit and broaden the reach of its Android operating system, while Amazon is looking to restore the profit gap when customers buy movies, books and magazines from its store. Andrew Rassweiler, an IHS senior director, said Google’s tablet is also clearly aimed at Amazon.com, which shook up the tablet market last year by offering its own version at $199. “Google’s Nexus 7 represents less of an attempt to compete with Apple Inc.’s market-leading iPad, and more of a bid to battle with Amazon’s Kindle Fire,” he said in a statement. While the two are “similar in many regards,” he added, the Nexus 7 “has superior specifications to the Kindle Fire, giving it a more attractive feature set that may make it more desirable to consumers.” Amazon and Google don’t care to monopolize the market but they do care to achieve a monopsony. Amazon and Google appear to be simultaneously trying to establish a wholesale monopsony and a retail monopoly in the e-book and content/ advertising sector. At the same time, it is important to note that Google and Amazon are in effect trying to apply a predatory pricing practice into the market of tablets and content. By selling a Nexus or a Kindle at rock bottom prices, they intend to drive competitors out of the market and/or create entry barriers to potential new competitors. What is even more important to realize/acknowledge is their attempt to establish in buyers’ mind the conviction, that well-known products such as the iPad mini are by default overpriced. If competitors, like Asus, Nook. Samsung or Rim, or potential competitors, cannot sustain equal or lower prices without losing money, they are eventually driven out of business or discouraged from even attempting to enter it. In essence, Amazon and Google have chosen to undergo short-term pain for long-term gain. Therefore, for both to succeed, they must have sufficient strength (financial reserves, guaranteed financial backing or other sources of offsetting revenue) to endure the initial lean period. In our case, it is really interesting to follow Amazon’s steps, since Google seems to have all the strength required to endure the initial period . Since Amazon had some rough quarters regarding revenues and profitability, this strategy may fail if competitors (like Apple or Samsung) are stronger than expected, or are driven out (like RIM, HTC or Acer) only to be replaced by others. In either case, this will force the Amazon and Google groups to either prolong or even abandon the price reduction policy. Their strategy may fail, if both Amazon and Google prove unable to sustain the short-term losses, either because they last longer than expected or simply because they did not estimate the loss accurately. Therefore it makes the whole situation inefficient because at the end of the day there is a short term better off for Amazon and Google, a worse off for other competitors like ASUS and RIM. In the long Term, it is questionable whether Amazon can endure while practicing the predatory pricing and should be interesting to see how this would affect Apple and its ecosystem. Tablet makers selling a complete range at that break-even level could ultimately whittle down the market to those who either produced a winning formula at the right time (Apple) or have deep enough content stores and bank accounts to willingly give up large parts of their potential hardware profit (Amazon and Google)
Consumers do not have accurate information about market prices or product quality. As most consumers are price driven , they tend to ignore the fact, that it is difficult for companies who lack the proper profit margins, to access the funds required to develop new technologies and provide the market with innovative products. It is important to stress, that devices sold by Google and Amazon gain their value from content which has to be purchased. So it is quite possible that people who actually buy a device, because it is significantly cheaper than the competitions’, find out that either the app ecosystem is not very safe or well developed or worse still, that in order to have the proper experience using the inexpensive device, they have to spend more money on different kinds of content purchases.
In our case, market prices do not reflect the activities of either producers or consumers.
Prices are kept artificially low, as the producers try to earn market share and gain revenues from content sales. This has an indirect effect on other consumption or production activities that is not reflected directly in market prices. There is an externality, because the price tablets which are sold by Amazon and Google, do not bear the true cost of producing them or having a reasonable profit margin. The profit margin allows producers to spend funds on Research and Product development so that they can provide consumers with well designed, well made devices able to improve and optimize the experience of consuming content or services through them. This causes an input inefficiency driving other competitors to push their profit margins lower, to be able to sell at matching low prices like Amazon and Google and force on them the dilemma between money, potential market share and quality. They are basically trying to equate profit margin in the table market segment, with sin. Because Google and Amazon are the two biggest players in the market of tablets after Apple, it is possible that the externality will prevail throughout the industry and the price of tablets will be lower than it would be if the cost of production reflected the effluent cost. As a result, competitors who struggle to remain in the market, and which will affect the experience of users will produce too many low quality tablets. There will be output inefficiency.
Criticism First, it is obvious that in the short term, lower prices for tablets are only beneficial to consumers. By setting the price around $200 for a pretty decent and well made tablet branded by Amazon or Google, consumers become able to access more content and to get a tablet much cheaper. The downturn is that people start to expect or demand products to be sold in such low range prices, forcing producers to focus in providing cheap products over quality ones.
Amazon and Google, by applying predatory pricing practice might get an advantage in the short term, but at the same time are opening a Pandora’s box. Selling with no margin or at a loss, as Amazon did with the first Kindle Fire , might be a good practice if you are a wealthy company but it can easily derail even the strongest plan if unexpected things happen, or markets start to ask for something more advanced or pricy than what producers are able to offer. Furthermore, a situation like that can easily turn against you when buyers expect to be able to buy more products without profit margin and cost. Amazon and Google might lean on content sales where they can still retain margins, but consumers can as easily leave them for someone who will come up with an even more disruptive idea on how content can be sold or distributed. (similar to when Apple almost pushed out of the content industry, the mobile providers with the app store). From the consumers ’ point, there is an important question to be answered: what is the right price for a tablet? Or what is a fair profit margin for producers to sell? In both cases the answer is conceptually Straightforward: the right price or the right profit margin will drive tablets’ price where all negative externalities, like R&D costs, design, market development, are fully reflected on the tablet’s price. This point is not pegged where Apple sells its own tablets but for sure it is not the point Google and Amazon priced theirs. Finally, in the long term, producers even the strongest ones, will face major difficulties to keep the pace of innovation and technology development, when they will struggle to find the necessary money to fund research and development.