At first I didn’t get it. But Erik Brynjolfsson says we should think of it basically as a loss-leader:
Of course, Amazon knows this and makes a healthy, but not unreasonable, margin on every media sale. What’s more, they avoid having to pay 30% commission that Apple extracts when Amazon sells ebooks via the iPad. Because the profit stream from Amazon’s media products is boosted every time another customer buys a Kindle, Amazon can afford to price it at very low, or even negative margins. That gives them an advantage over standalone competitors. What’s more, Amazon can skimp on memory in the Kindle Fire—only 8 gigabytes – because owners can store an infinite number of books, songs, movies and documents on Amazon’s cloud servers at no cost. They even throw in a 30 day trial of Amazon Prime, the two-day delivery program that boosts loyalty among customers of Amazons non-digital goods.
If you go to the supermarket, they let you use a shopping cart for free. Not because the supermarket has access to a magical supply of free shopping carts, but because they want to sell you more groceries. Gillette makes its razors pretty cheap, then sells blades at a high margin.
That said, this seems arguably upside down as a business model. The marginal cost of distributing a digital copy of a book, song, TV show, or movie is $0. A company with a lot of confidence in its tablet could acquire the copyright of media, treat that as similar to the fixed R&D costs involved in developing new products, and then make its money by selling high margin tablets (rivalrous physical objects) that come with streaming “cloud” access to the firm’s entire library of content. It would then be in a position to pay writers, musicians, etc. to create new content that would be available to tablet owners.