Razors vs Razor Blade Businesses
Reuben is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Selling razor blades is a great business. It's so good that razor companies frequently give away or heavily subsidize the razor itself, focusing instead on making money off of the sale of razor blades, which have to be frequently replaced. This “device” and “consumable” relationship is prevalent throughout the business world and can be a great money maker.
The Razor Blade Example
Modern razors, like those manufactured by Gillette, which was purchased by Procter & Gamble in 2005, are made in two parts, the handle and a disposable razor. While the razor often costs a few dollars, the real money is in selling the consumable razor blades. It is so profitable, in fact, that some razor manufactures will practically give the handles away. The hope is that customers will be locked into the handle for years, thus creating an annuity like revenue stream from the sale of razor blades.
More “Razor” vs “Razor Blade” Businesses
Selling discounted “devices” that use “consumables” isn't unique to razors. In fact, there are many industries that can be seen through this lens. Here are a few worth noting:
If you have ever owned an ink jet printer, you are well aware of how much ink these handy devices use and how much the ink costs. This is why a printer can be bought for as little as $50 to $100. Although digital documents are taking a toll on the sale and use of printers and ink, that doesn't mean the business is dead. It just means that profitable printer ink provides a cash cow to fund other initiatives.
Hewlett Packard (NYSE: HPQ) has been looking to move away from its hardware businesses, including the manufacture of computers and printers, to a more services based model. It's been stymied by poorly executed purchases and strife in the executive office. While there have been discussions of jettisoning the legacy hardware businesses, they are highly profitable despite relatively low margins. In fact, it's businesses like printers and ink that have allowed HP to make such a mess of its transition and still remain viable.
Lexmark International (NYSE: LXK), on the other hand, is pretty much a pure play printer company. Although it is shifting out of the consumer market, it still has a material position in the business sector, which is more profitable than the consumer sector but is also very competitive. It is the uptick in competition of late that has hampered Lexmark. Still, with a material installed base of printers around the world all continuing to use Lexmark supplies, the company appears to have a solid core business that will keep it profitable for years to come.
There's a reason why Apple's iPhone can be had for just a couple of hundred dollars, despite the fact that it actually costs more like $500. The cell phone companies, primarily AT&T (NYSE: T) and Verizon (NYSE: VZ), subsidize the cost to get people locked into a contract.
AT&T and Verizon pretty much have a cell phone duopoly in the United States. This gives them annuity like revenue streams. The best part for these two companies is the continuing shift to smart phones, like the iPhone, that are capable of streaming music and video. Such data usage is set to increase further as more and more people become accustomed to accessing the Internet through mobile devices.
The medical field is filled with devices that use proprietary supplies. This includes testing machines and surgical equipment. One notable company in the space is Intuitive Surgical (NASDAQ: ISRG), which is best known for its da Vinci robotic surgical system. The system allows for surgery to be performed by a doctor using just tiny incisions and a complex robot. Like all surgical equipment, you can't just cut into one person and then use the same tool on the guy in the next room.
So while the sale of da Vinci machines is an important metric for investors to watch, so, too, is the sale of the consumable products that Intuitive sells. This company, unlike many of those noted above, is a pure play on the razor/razor blade model because it only sells this one product.
Business Models that Work
It's important to understand the way in which a company makes money. The razor/razor blade model is a classic and very profitable model. It's so powerful, in fact, that even companies that appear to be in a dying business can remain profitable for a long time, like printer manufacturers.
AT&T and Verizon, however, are in an industry that is set to see demand increase, making them good options for income investors. Growth minded investors might be interested in Intuitive, though its shares are a bit pricey.
Reuben Gregg Brewer has no position in any stocks mentioned. The Motley Fool recommends Apple, Intuitive Surgical, and Procter & Gamble. The Motley Fool owns shares of Apple and Intuitive Surgical. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!