The Value of Advertising on the Kindle

Amazon recently announced they would sell a new Kindle with “Special Offers”version.  Kindle with “Special Offers” has the same specs as their WiFi-only Kindle but will include advertisements as the screen saver and on the home screen bar.  In exchange, Amazon will only change $114. 

In all likelihood Kindle hardware will one day be free (or close to free) because of cross subsidization (give away the hardware and monetize the content). The Kindle app for other devices is logically already free.  And of course, this go-to-market approach is common for other technology categories like gaming.  Gaming hardware doesn’t drop to zero likely in part because of the retail relationships that must be maintained by the OEM, but it isn’t uncommon to see it sold below cost at different times. With Amazon’s Kindle in other retail channels, this might be the approach Kindle takes.  You also don’t want consumers taking more than they’ll use.  With a registered Kindle account this becomes less of a concern.  I won’t be surprised if the Kindle with “Special Offers” remains exclusively available through Amazon because of the confusion it might cause in other retail chains which might help drive volume back through Amazon. 

A key element in the process of driving the price to zero is of course at what rate of decay the price drop towards zero. (ie how soon until it is nearly free).  The current approach by Amazon is an interesting way of getting the price closer to zero while enabling other items to cross subsidize the hardware  costs.     

The $25 discount offered by Amazon allows us to estimate what Amazon thinks they’ll make in offsetting advertising dollars. The math on this is a pretty straight forward.  The present value of an annuity for n periods is a follows:

$latex PV=\frac{c}{r}+[1-\frac{1}{(1+r)^n}]$

We can now solve for the formula above.

PV: The Amazon discount is the present value or PV.  $25 is a nice round number so Amazon might have picked it somewhat arbitrarily. This might mean they are uncertain about the full amount of revenue they’ll achieve through advertising or they aren’t concerned with fully cross subsidizing the discount. 

N:N resents the number of periods Amazon will receive advertising revenue for a given device.  This is synonymous with the lifespan of the device which is probably around three years. 

r: r is the discount rate.  If we use OMB’s rate we are looking at effectively zero percent (given the low inflationary environment).  We could assume something slightly higher in the 1-3% range.

With these we can now solve for C which is the annual advertising revenue per device. Depending on the parameters you ultimately choose, you arrive at about $8.5 annually if the device is in service for three years and just under $13 annually if the lifespan is a shorter two years.