Sunday, August 22, 2010

The Razor Blade Strategy

I was talking today with a friend about the razor blade strategy: give away the razor itself and make money on the refill cartridges. It's a play to reduce up-front purchasing costs for customers in order to generate revenue (usually at phenomenally high margins) on the recurring sales required to keep the originally purchased goods useable. Check out the price of a Gillette razor, the check out the price of the refill blade packs and do a little math...any guesses as to where Gillette makes their profit on the deal?

Although todays' discussion had nothing to do with ERP software, I'm always struck by how effectively the razor blade strategy works in the ERP market. Talk to the applications sales reps from any of the major players: Oracle, SAP, whoever...doesn't really matter. All those sales reps will negotiate discounts on the purchase price of software (potentially huge discounts, even to the point of giving the stuff away, if you're talking in the fourth quarter of their fiscal year). But they won't budge an inch on the recurring maintenance/support's a percentage of list price. Not the price you paid for the software, but the price at which it was listed. Why? Because they're leveraging the razor blade strategy: anything made on the original purchase price is nice, but the real value of the deal for these sellers comes in the very-high margin recurring maintenance fees.

There's nothing unethical or dishonest about the razor blade strategy. I'm just fascinated by the way it plays out in different markets...razor blades, ERP software, and many others. Nothing like building up a massive annuity. And everybody has to shave, right?

1 comment:

editor said...

Yes, it's how many software vendors make their money, on the backend via this annuity. Once the application is in production, the customer is unlikely to migrate to another platform or application, so they keep paying the maintenance/support.