Exclusive: Amazon Wants To Offer Its Smartphone for Free. Who Will Follow?

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By Amir Efrati and Jessica E. Lessin

UPDATED: This story has been updated to reflect a comment from Amazon, saying if it were to launch a phone in the future, it would not be free.

Which technology giant will be the first to offer a free smartphone? Amazon.com Inc. is making a play.

In a previously unreported move, the online retailer and Kindle maker is considering introducing its long-planned smartphone for free to consumers, according to people familiar with Amazon’s effort.

There are many unanswered questions about the plan and what strings will be attached for customers. One of them is whether Amazon would require its  smartphone owners to pay for services such as Amazon Prime, the company’s loyalty program. But the people familiar with the matter said that Amazon wants the device to be free whether or not people sign up for a new wireless plan at the same time. (Wireless carriers typically discount the price of devices if customers sign up for a one- or two-year wireless contract.)

One person familiar with the effort said the company has talked to wireless carriers about offering its phones, though it is expected to offer them directly to consumers through its website. A launch date also is unclear.

The pricing strategy is a big departure from the strategies of incumbents like Apple Inc. and Samsung Electronics Co., whose new flagship phones retail at around $200 with wireless contracts in the U.S. Those companies also offer some older high-end models for free or for just $1, with contracts.

The free strategy isn’t set in stone and depends on several factors, including Amazon’s ability to work out financial arrangements with hardware partners, said one of the people who is familiar with Amazon’s smartphone effort. This person and others expressed skepticism about Amazon’s ability to pull off a free device.

On Sunday, an Amazon spokesman said in a statement: “We have no plans to offer a phone this year, and if we were to launch a phone in the future, it would not be free.”

Still, Amazon’s pricing ambition is the clearest indication of its phone playbook: undercut rivals and grab meaningful market share.

Apple’s Nightmare

It is also shows that Apple’s worst nightmare may be coming true: prices could fall not just for cheap phones in developing markets but higher-end ones too.

Indeed, for years, Apple and Samsung have been packing their flagship phones with more bells and whistles in order to justify premium prices. And they have been pretty successful. In the past five years, the average price a consumer paid for smartphone that is not subsidized by a wireless carrier dropped just 20% to $343 from $430, according to IDC.

But the game is changing. New smartphone entrants Amazon and Google generate revenue primarily through e-commerce sales and online advertising, respectively. As such, they are more willing than their competitors to sacrifice profit for market share.

Even upstarts like Chinese handset maker Xiaomi, which sells its phones at razor-thin profit margins, says it plans to make money off software like apps and games.

It’s a strategy suited for penetrating developing markets where the iPhone is still too expensive for many people. Such markets, including China and India, will account for about two-thirds of all smartphones shipped this year, up from 43.1% in 2010, according to IDC.

While companies are responding by offering different devices at different prices, it is unclear how long the high end can hold up; today, even smartphones priced around $150 without a contract sport fancy features like powerful cameras and high-resolutions screens.

It’s a far cry from 2007, when the iPhone came out. The device was coveted around the world as a luxury item and started at $499. (That model had a quarter of the memory of the cheapest iPhone 5 you can buy from Apple today.)

But the market has changed and continues to do so. Here’s our take on the major players in the race to lower smartphone prices.

Amazon

Amazon has been working on a smartphone for at least two years, according to media reports dating back that far. Most recently, the Wall Street Journal wrote that the company was developing two smartphones, including a high-end one that could render three-dimensional images.

One reason it has taken so long: the company struggled to find manufacturing partners that haven’t committed to only producing Android devices approved by Google. And in some ways, packing hundreds of electronic components into a small device like smartphone is more complex than making a tablet.

Like its Kindle Fire tablet, an Amazon smartphone would be powered by a “forked” version of Android, which means that it uses the open-sourced version of Google’s mobile-operating system but doesn’t preload any Google apps. Numerous smartphone manufacturers based in China and elsewhere have signed agreements with Google to only manufacturer Google-approved Android devices, which often include preloaded Google apps.

Offering a phone for free would be a daunting proposition. Amazon would have to find a way to make up for the cost of manufacturing — on average, $200 per smartphone — by steering device owners to shop for goods through Amazon.com and to purchase digital media and apps through its app store. It also sells digital ads and could show them to device owners, something it already does on the lowest-priced model of the Kindle Fire tablet.

Amazon’s smartphone strategy would be similar but perhaps more extreme than the one it used when it entered the tablet market in 2011. However, it’s difficult to determine whether to call the Kindle Fire, which is priced as much as $200 less than some iPads, a success. Some research firms say the Kindle Fire represents double-digit percent of U.S. tablet sales but it doesn’t appear to have slowed down rivals. It has far fewer apps that Google’s Play store and Apple’s App Store. It’s also difficult to determine how much it has juiced Amazon’s sales of digital books and movies and other online goods.

Apple

Don’t expect Apple to start offering free phones anytime soon. The company generates 51% of its revenue from iPhone sales. And the planned announcement of a new iPhone next week, including a gold-colored model, show how it is trying to maintain its premium image.

But Apple, the second-biggest smartphone maker after Samsung, is hardly ignoring the trend. Next week, it is planning to announce a new, less expensive iPhone model in addition to a new high-end version. That’s a big change from its approach to less-expensive markets today, which has involved keeping older models on sale for a lower price.

Google/Motorola

Google also is trying to cut smartphone prices and is considering a number of ways to do so.

Google’s Motorola unit is building a cheaper version of its flagship Moto X device for emerging markets and the fast-growing “prepaid” market in the U.S. And Motorola CEO Dennis Woodside has repeatedly said he wants to push down smartphone prices.

When it comes to Android, Google is trying to ensure that most features of the upcoming “KitKat” version of the mobile operating system will work well for lower-end phones, according to people familiar with the effort. That would be in contrast to recent Android software releases, which have tended to work better for high-end devices, developers say.

Further out, Google has been looking at developing its own microprocessors and low-cost Android smartphones that could connect to next-generation wireless networks, which Google hopes to fund or build in emerging markets, people familiar with the matter have said.

Microsoft

With its plans to acquire Nokia’s handset business, Microsoft’s mobile strategy is getting a reboot. But what Microsoft has done with its existing partnership with Nokia to date might provide some hints of the strategy ahead.

Microsoft’s mobile operating system, Windows Phone, which has a tiny 4% market share globally by some estimates, is making some headway in the lower end of the smartphone market: Low-price “Lumia” smartphones made by Nokia and powered by Windows Phone software have gotten traction in the top five European markets including the U.K., where Windows-based phones surpassed 8% market share during the second quarter, according to Kantar Worldpanel. There also are some positive signs in emerging markets such as Mexico, where Windows Phone devices made up 11.6% of all sales during the same period, the firm said. It noted that the low-priced Lumia devices were particularly attractive to first-time smartphone buyers.

After Microsoft closes the Nokia acquisition, it will put significant marketing resources behind Nokia to boost sales, similar to Samsung’s strategy to outspend rivals in promoting its line of Galaxy smartphones, according to a person with knowledge of Microsoft’s plans.

Samsung

The global leader in smartphone sales has never ignored the lower end of the market, hence its strong position. It has numerous Android smartphones that are priced below $150 without a contract, and its high-end Galaxy S3 — which launched last year and is one version behind its latest S4 — is available for free with a contract and other promotions through at least one U.S. wireless carrier.

Expect the portfolio approach to continue. Samsung will try to keep a foot in the high-end market as long as it can, while also being very aggressive on the low end.

Huawei, ZTE and Xiaomi

China-based hardware makers have been undercutting Samsung and gaining some market share with phones that cost $130 or less. But some of these companies, including Huawei and ZTE, are trying to expand into higher-priced devices.

One low-price phone contender to watch: Xiaomi. The Chinese manufacturer has exploded with a suite of phones that it sells essentially at cost. That translates to about $130 to $300, without a carrier subsidy. The company, which describes itself as a “mobile Internet company” on its website, says it plans to make money from software and services. Sound like Amazon?

Spokespeople for the phone makers declined to comment, referred us to publicly-disclosed information, or never got back to us.

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