Clever new companies are cutting up a classic business model, writes Phil Young
Have you heard the story of the razor and the blade? It’s a classic model economists use to describe the business model where a company provides one element of its product at an average or below-average gross profit margin while making a much higher margin on the items that go with its usage. Typically, a company makes and sells both the razor and the blade. I’m sure readers can think of other examples.
Two that immediately spring to mind are printer and ink cartridges; and coffee machines and pods. Of course, such companies always have the risk of competitors offering a compatible version of the higher-margin consumable at a lower price. I just discovered a coffee pod that works on my Nespresso machine at a lower price than the genuine Nespresso units. Internet shopping is truly a wonderful thing!
The digital world enables companies to offer interesting variations to the traditional razor and blade model. For example, a company can earn a high gross profit margin on both their ‘razors’ and their ‘blades’. Apple is perhaps the epitome of this. Its devices (the razors) command margin well above the industry average, while its i0S platform and Apple Store are ready-made distribution channels for its apps (the blades). Apple extracts fees from app developers. And such fees have a very high margin.
Another variation, of which I recently learned, has taken the razor and blade model as a starting point, but disrupted it to dramatic effect. I am an amateur jazz guitarist. For most jazz guitarists, the instrument of choice is a handmade, arch-top guitar. This can be quite expensive to own – a performance-standard model ranges in price from about $7,000 to upwards of two or three times that amount. Still, learning the art has become more accessible. In recent years, an increasing number of jazz guitar professionals have begun offering free videos, as well as paid lessons on YouTube. Live lessons on Skype are also available.
Just recently, one of the better-known performers with a very popular online course announced that he had been “secretly” working with several top guitar makers to build a high-quality, but more affordable, handmade arch-top. What caught my attention was the offer he made to a prospective buyer of this guitar. First, the price seemed to be quite reasonable for such an instrument: $4,999. But, second, buyers of this guitar would automatically become members of his guitar club. This would entitle his customers to various digital products – podcasts, videos and factsheets – free of charge. They are said to be worth $1,500 if purchased from him separately. In this example, what is the razor and what is the blade? It is not clear. Perhaps the ‘mass customization’ of his production team reduces the unit cost to less than the one that individual, small-volume luthiers can achieve. But one thing is for sure: digital technology is what makes this particular bundled offering feasible. First, thanks to the internet and YouTube, this jazz musician is able to provide lessons to a large number of students. Second, he is able to promote his guitar and membership into his club to a very targeted audience by using the email addresses of past and present students and those inquiring about lessons. And third, he is able to offer digital products with a high retail-value for free, because there is no significant cost associated with the making or distribution of these products.
Apparently, his business model and marketing effort are working well. While drafting this column, I received an email from him saying that the demand for his guitar was overwhelming. So much so that he was forced to suspend the taking of any more orders. It seems his new take on the razor and the blade is cutting through.