Forbes: Razor-And-Blades Pricing Strategies In The Digital Age

December 19, 2012- 

Guest post written by Craig Zawada

Marketers know they must consider the lifetime profitability of the combined offering, and the price elasticity of both upfront and ongoing products and services. But how does that change with online content and virtual goods?

Around the world, it’s the mantra that’s filled classrooms and boardrooms for nearly a century: “We’re pursuing a ‘razor-and-blades’ marketing strategy.” Heads nod knowingly, and pricing schemes are approved by executives who are confident that, over the long term, they can attract and retain a large pool of profitable, loyal customers by selling a product at or below cost and capturing profitability through steady sales of replacement consumables.

King Gillette’s marketing breakthrough rightly takes its place as one of the classic B-school case studies. For example, glucometer manufacturers will gladly sell millions of blood-sugar-monitoring devices to diabetics at negative margins to set themselves up for the multi-year revenue stream attached to the hundreds of testing strips that get used annually by each diabetic. And, with their $149 printers and $60 ink cartridges, computer-peripheral makers continually demonstrate the timelessness of this pricing model.

But as consumers move toward the digital economy, does the classic “R&B” strategy still make sense?

The short answer: Absolutely. Opportunities abound that Gillette could never envision. But, as is the case with so many aspects of e-commerce and e-goods and services, the potential rewards come with significant and amplified risks that marketers should fully appreciate upfront.

Consider, for example, the runaway success of the Amazon Kindle Fire, the 7-inch color touchscreen e-reader. Amazon has sold millions of units for $159 – a price that analysts and company watchers generally agree is below Amazon’s cost. Why? Because Amazon correctly understood that the Kindle could be a virtual store window into its collection of goods, services and content. Kindle buyers may not be totally locked in, but they’re far more loyal and lucrative than typical Amazon customers over a reasonably long term.

And then there are pure-play digital companies like Google where there isn’t even an upfront consumer cost for the physical good – the “razor.” Instead,Google takes the model to the extreme by investing billions of dollars in assembling an extraordinary portfolio of applications and services – from its flagship search to e-mail to personal-productivity apps – all for zero cost to the consumer. The reason: solely to amass an audience for its advertisers and upsell consumers to premium versions of its offerings.

It Starts With Upselling And Cross-Selling

So where are the new profits – and pitfalls – with razor-and-blades in the digital age? What lessons can we learn from the successful pioneers?

The first takeaway is that the digital incarnation of this popular pricing strategy opens up a vast array of unprecedented upselling opportunities. With its Kindle Fire, Amazon has one of the world’s largest collections of content. It starts with millions of books, of course. But the interactive tablet can also deliver millions of Android-compatible games and thousands of movie titles. By comparison, the modest approach of selling a low-cost printer to reap profits in ink cartridges seems quaint and antiquated.

Similarly, software publishers – increasingly leveraging subsidized smartphones and tablet platforms – are giving away limited or advertising-supported versions of their apps in hopes of enticing customers to shell out a few dollars for more feature-rich, unrestricted, constantly updated versions. We see this in everything from role-playing shoot-‘em-ups to tax-preparation software.

The upshot: marketing creativity matters – particularly because the lifecycles of some of these titles can be measured in weeks. Customers are now attuned to the try-before-you-buy model. However, since content generators and software developers are capturing vast amounts of “big data” as the free and trial downloads mount, they can find the correlations and commonalities that can be pinpointed with almost limitless combinations of unique and compelling offers. And that means upsells and cross-sells of related or newer products.

Caveat Marketer

Before you rush headlong into an R&B strategy for your e-commerce products and services, be aware that there are numerous traps and challenges that await. First and foremost: the relentlessness. Traditional R&B is a passive, though profitable, trap. You sell the razor and sit back for customers to break down your door to buy your blades. But in the digital space, even when you sell the proverbial razor, you still compete with other “blade” providers of content – and, unlike patented blade designs, the pricing in these new markets is highly elastic and competitive. You face significant and continuous market pressures to deliver appealing and compelling content in low-margin markets, sometimes earning pennies for each copy of a low-cost app. You’re only as good as your latest titles and services, and there’s little room for markup.

The second challenge you must address – and come to terms with – is that while you can target numerous tightly defined demographics, in this newer model, there’s an inherent loss of control that can be difficult to adjust to. In digital R&B, your two “blades” revenue streams come from upselling and advertising – two areas with significant variability that can elude your ability to control outcomes. Old schoolers can be mighty resistant – but in this market, variability is the new reality.

Finally, some consumers are starting to push back against the R&B model. For example you can purchase and use a GPS without any monthly fee. The add-on model there provides additional features like traffic alerts and map updates. And PC manufacturers are reporting stronger interest in their products that use standard, off-the-shelf batteries and cords, instead of customized designs. Marketers would be wise to account for these undercurrents of resistance.

For savvy marketers, the razor-and-blades strategy still delivers compelling revenue streams. Greater profits await those who can manage the elevated risk exposures.