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What You Need to Know About Amazon’s New Fire Phone

It’s official: Amazon.com (AMZN) is in the phone business. Chief Executive Jeff Bezos showed off a black glass rectangle with a rubber frame called the Fire Phone. The device will be sold, starting July 25, through AT&T (T) for $199 with a two-year contract, the same price as other high-end smartphones.

The screen on Amazon’s phone is larger than Apple’s (AAPL) iPhones but smaller than phones made by Samsung Electronics (005930:KS). The processors and chips are on a par with more powerful Android phones. Sure enough, the Fire Phone includes what Bezos calls “dynamic perspective,” a feature that uses four cameras to create 3D imaging that doesn’t require glasses.

But what makes the Fire Phone truly Amazonian is the Firefly Button. By pressing it, users can use the phone’s camera to recognize (and purchase) physical products or its microphone to listen to (and purchase) songs. Bezos says that the program recognizes more than 100 million items. A Tumblr (YHOO) of accidental Firefly purchases seems inevitable.

The Fire Phone is the second space-age shopping device to come out of Lab 126, Amazon hardware division, so far this year. A wand called the Dash, available only on a limited basis, allows users to scan grocery items. The Fire Phone is the same thing, but with a chance of reaching the non-wand-buying masses.

The pressure to do something like this has been mounting for years. Without its own hardware, Amazon couldn’t create its own shopping apps without sharing the proceeds with intermediaries, such as Apple, which takes a cut of each purchases made on iPhone apps. Amazon has always survived on tiny margins—letting another company take a big cut was apparently a bridge too far.

The smartphone market has gotten too big for Amazon to ignore. There will be 1.76 billion smartphone users worldwide this year, according to eMarketer, and the number of new smartphone customers is growing rapidly. But a fast-expanding market isn’t necessarily easy to break into. Apple and Samsung dominate, accounting for about 70 percent of U.S. smartphone sales. Rival products, such asHTC’s (2498:TT) One and the Nokia (NOK) Lumia have been well reviewed without making much of a dent.

Amazon will face some of the same problems that have weighed on these companies. Like the Windows Phone Store, through which Lumia users buy apps, Amazon’s Appstore has a relatively scant selection. Amazon offers 240,000 apps, fewer than a quarter of the apps available in Google’s and Apple’s stores. When HTC released the first version of the HTC One, it had trouble striking deals with carriers, contributing to disappointing sales. Amazon is in a similar situation, since the Fire Phone is available only through AT&T.

Amazon’s advantage is that it’s not really a phone company, making it easier to reward its users with easy access to the rest of its services. Last week the companyrolled out a digital-music service, adding it to its streaming-video and e-book lending programs. All are free for people who pay $99 for a membership to Amazon Prime. “They have a ton of credit-card numbers already, they have access to a ton of digital video and music,” says John Fletcher, an analyst at SNL Kagan. “What sets them apart is the shopping.”

Nor does Amazon have to figure out how to make money solely by selling phones. The company has traditionally used hardware as a loss leader to sell more goods. When it introduced the Kindle Fire, for instance, Amazon undercut the iPad and bought itself a head start as the wider tablet market adjusted to selling smaller, cheaper devices.

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