In recent years the old razor-blade model has returned in different sectors. This model is based on the idea of selling cheap razors and profiting from the highly priced blades. This concept isn’t new, but it’s interesting to see more companies basing some or all of their business on this model. Is this model profitable? What are the perils companies may face when using this model? How can companies sustain this model over time? Let’s try to answer these questions by analyzing several companies that have implemented this model.
Kindle and E-books
During the past several years Amazon.com, Inc. (NASDAQ:AMZN) has been slowly augmenting its market share in the tablet market by selling its Kindle fire brand. Before Kindle fire, the company used Kindle to hook its customers to buy its E-books. The prices of Kindle and Kindle fire aren’t high compared to other tablets. This move may have helped increase its E-books sales and perhaps even take on other competitors, such as Barnes & Noble.
Despite the low price of Kindle, Amazon’s market share was only 3.7% in tablets in the first quarter of 2013 (based on IDC). In the first quarter of 2012, its market share was 3.6%. Nonetheless, sales continue to grow as worldwide shipments grew by more than 157% (year-over-year).
The company’s near dominance in the E-book market is enabling Amazon to make its profits from E-book sales. Moreover, the shift to E-books has also enabled Amazon.com, Inc. (NASDAQ:AMZN) to become a self publisher and by doing so eliminatted the role of publishers. Since it’s easier to purchase an E-book from a tablet than a regular book, this could partly explain the rise in the number of e-books Americans read compared to books. According to one survey, Americans who read E-books read 24 books a year, compared to 15 books for non-e-books readers. One of the reasons for Amazon.com, Inc. (NASDAQ:AMZN)’s success is its dominance in the book market that helped the company compete with other E-readers such as Barnes & Noble’s Nook. So it seems that Amazon is benefiting from its business model. Let’s see how other companies have done with this razor/blade business model.
Turning to beverages
Sodastream International Ltd (NASDAQ:SODA) has also been implementing the razor-blade model. The company has been selling its soda maker kit at almost no profit but its soda supplement products, such as refill gas canisters and flavor packets, at a high profit. How is the company doing?
So far, Sodastream International Ltd (NASDAQ:SODA)’s financial results are impressive with steady growth in revenues and a reasonable profit margin of over 10%. The company isn’t facing direct competition (for now) from the big players such as Coca-Cola. And unlike Amazon, if SodaStream will face strong competition this could result in a knock out for this company.
This means if a company is using the razor-blade model and doesn’t have competition (such as SodaStream) or has a strong market share to begin with (such as Amazon) the model works fine. Because these companies aren’t selling something unique that others can’t sell (as oppose to Pharma companies that sell non-generic treatments) the business model relies on market conditions to determine its success. But if Sodastream International Ltd (NASDAQ:SODA) will face competition down the line, it could face big problem in maintaining customers. On that note let’s turn to another company that uses this model: Green Mountain Coffee Roasters Inc. (NASDAQ:GMCR).
The coffee maker
Many criticized Green Mountain for relying on its K-Cup patent that expired last September. Green Mountain’s “razor” is the coffee maker and the “blades” are the K-Cups. Since the expiry, generic companies were able to sell cheap coffee packs and thus eliminating the high profitability of the company. Nonetheless, in the first quarter of 2013 its profit margin grew to 21%. In comparison, in the first quarter of 2012 its profitability was only 17%. The company’s collaboration with Starbucks, which was extended to a five-year agreement, is likely to further insure GreenMountain’s standing. Therefore, up to now, the company’s business model is still maintained.
The Foolish Bottom Line
The razor/bladed business model is an interesting strategy that could be profitable over long period of time if the company has a strong hold on the market (as Amazon.com, Inc. (NASDAQ:AMZN)) or collaborates with big partners (as Green Mountain). Finally, if a company such as SodaStream isn’t able to protect its business from competition by the above mentioned measures, its business model might not sustain over time and its core business could fall to stronger competitors.
Lior Cohen has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, Green Mountain Coffee Roasters, and SodaStream. The Motley Fool owns shares of Amazon.com and SodaStream.
The article The Return of the Razor-Blade Model – Is it Working? originally appeared on Fool.com.
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