BUSINESS 2.0:

Amazon's New Direction

Wall Street has not been kind to Amazon in 2006. But as always, Jeff Bezos has a plan. Here's where the world's largest store is heading next.

By Kevin Kelleher, Business 2.0 Magazine

(Business 2.0 Magazine) -- Even for someone as optimistic as Jeff Bezos, 2006 is turning out to be a hellish year. The Amazon.com founder and e-commerce pioneer saw his second-quarter profit plunge 58 percent, due largely to increased competition.

For the year as a whole, earnings are expected to be cut in half. And one of the worst reports in Amazon's short history, released in August by Caris analyst Tim Boyd, said the Seattle business offered "nothing truly unique."

But just as he did in 1997, when an analyst dubbed his company "Amazon.toast" on the eve of its battle with Barnes & Noble (Charts), Bezos is fighting back. Amazon (Charts) has increased its spending on programming and technology this year by 62 percent, more than twice the pace of revenue growth.

And while Bezos (who would not comment for this article) is almost as tight-lipped about future plans as Steve Jobs, Amazon is clearly focusing on two major areas: content and technology services.

The company's worst-kept secret is that it's about to launch a digital download service. In August bloggers trawled the Amazon site and uncovered pages touting a service called Amazon Unbox, apparently in beta. Business 2.0 was able to download the Unbox software before the pages were taken down.

According to the terms of service, customers will be able to stream movies and TV shows or burn them to DVD and keep them for good. In return, customers will apparently have to let Unbox police their hard drives, deleting expired rentals and delivering unsolicited previews of coming attractions.

Bezos is gunning for video downloads with good reason: They offer far higher margins than DVDs. Capturing even 5 percent of total U.S. DVD revenue would hand an Amazon service $1.2 billion a year in sales.

Because Amazon already sells so much video, the company has good relationships with the studios. "They're just ironing out the business model, the way the profit would split," claims Bob Peck, an Internet analyst at Bear Stearns. As a bonus, Unbox may help Bezos steal some of Jobs's music business. "The labels are frustrated with Apple (Charts) being the only game in town," Peck says.

Amazon is even trying its hand at content creation. In April the company promoted an unknown novel, The Stolen Child, which quickly became an Amazon best-seller. Now the online retailer has optioned a feature film based on the fantasy tale and is looking to partner with a studio.

Thanks to its troves of data, Amazon has great insight into what people will pay to see. But does it have what it takes to become a Hollywood player? "If it's like Starbucks (Charts) selling music on the side, it's OK," says Piper Jaffray analyst Safa Rashtchy. "A serious venture would be very risky."

Less risky, but further from Amazon's core retail business, is its growing roster of tech services: S3, which offers digital storage at 15 cents a gigabyte; EC2, which rents computing capacity to smaller Web developers; and Mechanical Turk, which pays humans to handle intelligent repetitive tasks, like identifying performers on CDs.

Meanwhile, 180,000 developers are tinkering with new uses for Amazon's Web services, including its e-commerce code; it benefits because any site with features created with the code will direct shoppers to Amazon.com.

"I believe a company should stick to its knitting, and this is very much a part of Amazon's knitting," says Adam Selipsky, an executive with Amazon Web Services. "Amazon has always been fundamentally a technology company."

These side businesses are part of a strategy to build relationships with startups like SmugMug, a photo-sharing site that chose to use S3 instead of raising funding for more storage.

"S3 is like a gateway drug," says SmugMug founder Chris MacAskill, who's saving $400,000 a year by using S3 and is now considering other Amazon services.

Sure, it might not be enough to pull Amazon out of a ghastly year for earnings. But in the long run, new services and new content should help Bezos prove the naysayers wrong yet again.

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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.