If You Play with Razors and Blades, You Might See Red

Monday, April 2, 2018

I've written about the razor and blades pricing method before. It's a strategy that involves selling a heavily-discounted product (razor) with the intention of making up for lost profits via sales of routinely-purchased add-ons (blades).

Many people see the strategy as a simple trade-off. One gives up short-term profits in order to create a predictable and long-lived income stream. Although most commonly exemplified in the personal care market, it is used for a wide variety of products ranging from printers to coffee makers.

When properly implemented, both buyer and seller can benefit. Shoppers are provided the opportunity to acquire the base product at reduced pricing (minimizing risk) and vendors can smooth out their income streams and enjoy financial stability.

As a general rule of thumb, the cheaper the base item (razor), the more interested shoppers will become in purchasing it. The dirty secret, known only to advanced mathematicians and readers of my blog, is that the size of the discount is mathematically insignificant to the vendor. The longer a consumer buys the add-ons (blades), the more revenue the vendor will receive. Over a long enough timeline, any margin on the blades will surpass the discount on the razor.

Unfortunately, the choice to use the razor and blades model is not so much a decision as it is a wager. Not only does the vendor bet that consumers will be eager to purchase its razors, but (more importantly) it also bets that consumers will continue to purchase its blades for a significant period of time.

So what happens when the bet goes wrong? What happens if customers buy the subsidized razors in record numbers but, for some reason, decide not to purchase blades in significant quantity?

Let's take a look at a recent example.

Cell phone vendor Verizon thought it had come up with the perfect plan. The firm decided to offer a heavily discounted Motorola cell phone to potential customers. The deal seemed to be the prototypical example of razor and blades pricing. After all, cell phones (razors) don't offer much value without monthly cell phone service plans (blades).

Verizon's current marketing slogan cuts to the heart of it: When it really, really matters, we're right there with you. In other words, owners of Verizon phones need Verizon service.

There is just one problem. Many cell phone buyers don't want to be right there with Verizon. As a relatively high-priced option for cell phone service, customers have an incentive to "cheat" and purchase service from a less expensive vendor - one that does not have to make up for the subsidy on the phone.

Fortunately for shoppers (and unfortunately for Verizon), clever hackers soon figured out how to "unlock" Verizon's prepaid phones so that they could work with cheaper vendors' service plans. Although Verizon should have planned for this possibility, its managers may have forgotten that the particular phone in question lacked any hardware limitations (such as GSM vs CDMA that once limited cell phone compatibility).

Soon, instructions suitable for non-technical shoppers started showing up online, and a mad dash ensued to buy out the entire stock of subsidized devices.

Although it took some time, Verizon eventually got the message, and the firm began to take steps toward locking down their subsidized phones.

While Verizon might be moving in the right direction, its response is like closing the barn door after the horse has bolted.

Let's take a look at what happened as a result:

• Verizon almost certainly lost money by subsidizing cell phones.
• Verizon's competitors likely gained new subscribers, thanks to the availability of Verizon's subsidized phones.
• Verizon established itself as a provider that can and should be gamed. Future buyers will be on the lookout for such opportunities.
• Verizon anchored future phone prices against a price that they had subsidized (thus limiting their future pricing power). Who would want to buy a similar model for a high price today, when it was so inexpensive just a short while ago?

Verizon really shot itself in the foot with this one, but that's not all. In fact, something quite worse occurred: I missed out on the deal. Next time I hope Verizon lets me know when it wants to take a loss via poor pricing strategy - I'd be happy to help them out. Of course, if you'd like to improve your profits through better pricing, I'd be happy to help you out, too.

P. S. In an interesting twist, companies within the shaving industry may be moving away from the razor and blades model. Yes, Dollar Shave Club, a firm that sends razors and cartridged blades to club members, continues to subsidize initial purchases. It was purchased for one billion dollars in 2016, but the increasing consumer interest in safety razors may point to a future in which razors regain their place as high-margin items, with blades relegated to a mere commodity, sold at razor-thin margins.