16 September 2010

Razors, blades and business models

One of the classic stories that relate to business models involving compatibility standards is that of Gillette. The story goes that Gillette built a proprietary standard for safety razors and handles. To profit from this strategy, they gave away handles (or sold them at low cost), with the idea of selling higher priced razor blades on which they had a monopoly by virtue of the standard.

This, by the way, is the model that HP uses with ink jet printers ... you purchase a printer at relatively low cost (and below production cost) and HP will recoup this "investment" by selling you ink cartridges above production cost ... they NY Times wrote:
H.P.’s printing group has long been one of the company’s star performers. It accounts for nearly a quarter of overall revenue. Printer ink remains one of the most expensive liquids on the planet — more valuable than expensive perfumes — providing H.P. with far higher profit margins than PCs and other types of computing hardware provide.

This came to mind because of this paper by U. Chicago law school Professor Randall Picker. In it he writes:
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.

So another good story is shattered by facts ...


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This is one of the reasons that Gillete is very successful brand today.

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