How Does the Razor-and-Blades Model Work?

You may have heard that Procter & Gamble doesn't make its money when it sells razor handles -- instead, it makes most of its profits from the blades. This model has become popular across a variety of industries, and in this Industry Focus: Financials clip, host Jason Moser and Fool.com contributor Matt Frankel, CFP, take a closer look.

A full transcript follows the video.

This video was recorded on Sept. 17, 2018.

Jason Moser: We're taking a listener question today from Jenny on Twitter who asks, "Can you explain what you mean by razor and blade model? That's new to me." This is a question that popped up late last week on an investment that I recently made, Matt, an investment in a company that's not necessarily financials, but I think it brings up a good question for all investors. It's an interesting business model, that razor and blade business model. I was talking about Idexx Laboratories. They are in the pet diagnostics equipment business.

Essentially, when we're talking about razor and blade models, these are companies that are selling a durable product, a piece of equipment, or what we would call the razor, at a fairly low cost, sometimes even below cost, because they are going to drive sales of higher-margin proprietary consumables that that equipment uses. That's the blades. So, we have the razor and the blade. It's a great business model because it gives you a pretty predictable revenue stream. Typically, the longer that people use that equipment, you can exercise a little bit more pricing power. Certainly, Idexx Laboratories is a company that has done a lot on the R&D side in growing out their offerings. My veterinarian that we take our three dogs to actually uses Idexx equipment. He really could vouch for how good their products and services are.

Matt, you and I were talking a little bit before taping about a company in the financial market that is kind of a razor and blade model too, right?

Matt Frankel: Right. There's a ton of examples of this outside the financials space that that most of our listeners probably use. Just to name a couple of quick ones, how you buy a Keurig machine, and then you have to buy the K-cups. That's how they make most of their money. Amazon sells Kindles for like $30. They make their money on the actual books that you're buying. There's a bunch of these. My printer, you could buy a printer these days for $20.

Moser: I hate to interrupt, but you brought up Amazon Kindle. It reminds me of the quote from Jeff Bezos, it's just stuck in my brain forever. Bezos always says, "We want to make money when you use our devices, not when you buy our devices." I think that really encapsulates that razor and blade notion.

Frankel: Absolutely. Going back to the financials space, Square, one of our favorite stocks, we talk about it frequently on Industry Focus: Financials, everyone's seen it at their local craft markets and things like that, the little Square card readers. A lot of local coffee shops, things like that, use Square hardware. Square doesn't make much money on the hardware. In fact, they probably lose money on it. Where they make money is the recurring transaction revenue every time that that's used. That's a good example of a razor and blade model. They pretty much give away a product in the hopes that that product will generate a consistent revenue stream, as Jeff Bezos said, when the customer uses it.

There's examples of razor and blade models in pretty much every sector of the market. It's a very effective business strategy when done correctly.

Moser: Yeah, I agree. I think the interesting thing with Square, from the perspective of their razor, is really the blades. It's not going to be card specific. Whether it's a Visa, MasterCard, American Express, whatever card you swipe. It doesn't have to be any particular card or proprietary technology, which really opens up that market opportunity for Square the company and for Square investors. I'm a Square investor, a very happy one. I know you are, too. Those who are familiar with me whatsoever probably have heard me mention more than once the war on cash basket of stocks. Square is a very important part of that collection of stocks there, as well. I'm sure we'll talk a lot about the war on cash here on future episodes. But that's for another time.