(AMZN) A Smartphone from Amazon?

Rumor has it that Amazon.com (AMZN) will be launching a smartphone late next year. Well, may not be a rumor exactly, since the Citigroup (C) analyst reporting the development mentioned that his supply chain checks suggested that such a device was in fact being developed in collaboration with Foxconn International Holdings.

However, the largest contract cellphone maker may not be the one to ultimately make the product for Amazon, which may rely on its tablet maker Hon Hai Precision for the purpose. The phone is expected to use Texas Instruments’ (TXN) OMAP 4 processor and Qualcomm (QCOM) baseband chips.

The question that comes to mind is, what could Amazon possibly be thinking? The company is no more a smartphone maker than a tablet maker. So this is not its core competency. How would it ever compete with the Apples (AAPL), Googles (GOOG) and Research In Motions (RIMM) of the world?

We really have a lot of faith in Jeff Bezos and doubt that the man would suddenly jump so far away from Amazon’s core retail expertise. We have therefore been thinking of the move more in terms of a retail strategy.

We believe that Amazon is trying to protect its share in the online retail space, which is a Herculean task, considering the fact that the company is a leading player in an extremely fast-growing market. Consumer markets are, by their very nature, given to stiff competition and almost invariably, share losses for the market leader as new players enter the market. There is really no reason for Amazon to be any different.

At a minimum, Amazon would need to stay on par with developments in the industry or lose its customers. Not so much because these companies are its direct competitors, but because customer requirements are essentially calling for convergence technologies.

For example, Apple Inc. sells hardware and software, either in the form of iPods, iPhones or iPads. The company’s interest in peddling entertainment or other products is with the intention of boosting its device sales.

Google Inc. is mainly interested in advertising revenue, so it needs people to stay on its pages and consume the ads it serves them. For this purpose, it is partnering with hardware makers to ensure that there are enough devices in the market running its operating systems. The need to create customer loyalty in the phone segment is pushing Google toward digital entertainment, daily deals and what not.

Amazon, on the other hand, is selling goods and digital entertainment as its primary products. If the company does not get on the mobile bandwagon, it obviously has a lot to lose. These companies, which so far could have been its partners, would increasingly encroach on its core market.

But a position in the mobile segment could be useful. Amazon is already an online retail giant. It has a huge customer base, a lot of customer loyalty and a lot of insight into customer behavior. The new phone could increase the stickiness of Prime for one.

If Amazon offers the phone free to Prime subscribers who would be able to use the inbuilt near field communication (NFC) technology to buy goods from Amazon, this would be value addition. It could also be used to woo new Prime subscribers.

Of course, Amazon has a ways to go. It is nowhere near Apple and Google in terms of its software. The Kindle Fire is only selling because its so cheap and the smartphone could be a similar play.

However, we doubt that buying WebOS from Hewlett Packard Company (HPQ) is going to solve its problems. That is like throwing good money after bad. Amazon would do better to tie in with Google and use Android instead. But there could be competitive issues involved, so we’ll wait and see what happens.

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