Friday, October 8, 2010
Posted by D. Daniel Sokol
Randy Picker (University of Chicago) has a very interesting new paper titled The Razors-and-Blades Myth(s). I highly recommend that you download it.
ABSTRACT: The razors-and-blades story offers a foundational understanding of a key area of economics and strategy: Invest in an installed base by selling the razor handles at low prices or even giving them away, then sell the razor blades at high prices to justify the prior investment. Large chunks of modern technological life - from VCRs and DVD players to video game systems like the Xbox and now ebook readers - seem to operate subject to the same dynamics of razors and blades.
At least on the paper, the competitive dynamics of this situation are straightforward and well understood. If you actually give away the handle to create the installed base, you need to recapture those loses in the blade sales. And if you are selling blades above cost, you need to be able to tie the blades to your handle or you should expect entry in the blades business to compete on the base that you have installed.
That is at least the theory. The actual facts of the dawn of the disposable razor blades market are quite confounding. Gillette’s 1904 patents gave it the power to block entry into the installed base of handles that it would create. While other firms could and did enter the multi-blade market with their own handles and blades, no one could produce Gillette handles or blades during the life of the patents.
From 1904-1921, Gillette could have played razors-and-blades - low-price or free handles and expensive blades - but it did not do so. Gillette set a high price for its handle - high as measured by the price of competing razors and the prices of other contemporaneous goods - and fought to maintain those high prices during the life of the patents. For whatever it is worth, the firm understood to have invented razors-and-blades as a business strategy did not play that strategy at the point that it was best situated to do so.
It was at the point of the expiration of the 1904 patents that Gillette started to play something like razors-and-blades, though the actual facts are much more interesting than that. Before the expiration of the 1904 patents, the multi-blade market was segmented, with Gillette occupying the high end with razor sets listing at $5.00 and other brands such as Ever-Ready and Gem Junior occupying the low-end with sets listing at $1.00.
Given Gillette’s high handle prices, it had to fear entry in handles, but it had a solution to that entry: it dropped its handle prices to match those of its multi-blade competitors. And Gillette simultaneously introduced a new patented razor handle sold at its traditional high price point. Gillette was now selling a product line, with the old-style Gillette priced to compete at the low-end and the new Gillette occupying the high end. Gillette foreclosed low-end entry by doing it itself and yet it also offered an upgrade path with the new handle.
But what of the blades? Gillette’s pricing strategy for blades showed a remarkable stickiness, indeed, sticky doesn’t begin to capture it. By 1909, the Gillette list price for a dozen blades was $1 and Gillette maintained that price until 1924, though there clearly was discounting off of list as Sears sold for around 80 cents during most of that time. In 1924, Gillette reduced the number of blades from 12 to 10 and maintained the $1.00 list price, so a real price jump if not a nominal one. That was Gillette’s blade pricing strategy.
It is hard to know what to say about that strategy. If Gillette had finally understood razors-and-blades they might have coupled their new low-end razor with higher blade prices and the two changes coincide roughly. But the other event, of course, was the expiration of the 1904 blade patents and eventual entry of Gillette blade competitors. That should have pushed blade prices down and made it difficult for Gillette to play razors-and-blades. Indeed, even with the drop from 12 to 10 blades, by 1930, Sears was selling genuine Gillette blades for the price it had been selling them prior to the packet reduction.
And all of that gets us to the final irony. No razors-and-blades during the years of 1904 patents. With the expiration of the patents, Gillette no longer had a way to tie the blades to the handles and thus, at least on paper, seemed to have no good way to play razors-and-blades. Yet with sale of razor sets to the U.S. government during World War I and the jump in handle sales with the introduction of the low-price old-style handle, Gillette’s installed based jumped rapidly and the profits followed.
And that leaves a hole in the analysis. Gillette hadn’t played razors-and-blades when it could have during the life of the 1904 patents and didn’t seem well situated to do so after their expiration, but it was exactly at that point that Gillette played something like razors-and-blades and that was when it made the most money. Razors-and-blades seems to have worked at the point where the theory suggests that it shouldn’t have. Why is that? Did Gillette succeed because of quality or were their powerful even-if-hard-to-discern-now locks - psychological or otherwise - between the razors and the blades?