Razor Blade or Subscription Based Which is a Better Business Model?

Introduction

Having a definite business model is essential for any business. But what is a business model exactly? Many have attempted to define the concept and formulate theories around it, but for the purposes of understanding in this essay, a business model is an underlying principle or a structured roadmap based on which the company decides to do business and meet its goals. This essay explores in brief the trajectory of the business model concept development and provides a subjective take on what appears to be a better business model out of innumerable options available in business model literature. And while doing so, the essay also pits this chosen model against another which appears to be relatively less successful. Although it is true that a business model effective in one company may not be just as effective in another. Therefore, adding value to one model over others is not fully justified and can only be contextual within the real-life examples used in the essay.

Business Model Trajectory — Theories & Concepts

There is no common or universally accepted definition of the concept ‘business model’. However, many researchers and scholars have tried to define the idea in their publications. According to Chesbrough & Rosenbloom (2002), it is the “heuristic logic that connects technical potential with the realization of economic value“, whereas for Amit & Zott (2001), it is “the content, structure, and governance of transactions designed so as to create value through the exploitation of business opportunities” and for Shafer et al. (2005), a business model is “a representation of the underlining core logic and strategic choices for creating and capturing value within a value network“. Simply put, as Michael Lewis said, a business model is a plan to make money (Ovans, 2015).

It goes back as long as in 1998 when Timmers and then Rappa in 2001 attempted to define and categorize the types of business models in the market. The defining and classifying stage was taken over and enhanced by Linder & Cantrell (2000); Petrovic, Kittl et al. (2001); Chesbrough & Rosenbloom (2002); Magretta (2002). They led to the next stage of business model concept development by adding components to the models. In the third stage, Hamel (2000); Weill & Vitale (2001); and Afuah & Tucci (2003) further defined and consolidated the concept in a more detailed manner. Then came the fourth stage marked by Gordijn (2002) and Osterwalder (2004) who worked on business model ontology and contributed significantly to business model concept development through evaluations and practical testing. At the last and fifth stage of business model trajectory, Gordijn, Osterwalder, Linder and Cantrell applied the developed concepts to real-life situations.

According to Johnson (2010), there could be 19 basic business models, namely: affinity club model, brokerage model, bundling, cellphone, crowdsourcing, disintermediation, fractionalization, freemium, leasing, low-touch, negative operating cycle, pay as you go, razor blade, reverse razor blade, reverse auction, product-to-service model, standardization, subscription and user communities model.

A study of these models and from the understanding of literature, it seems that the razor blade model is highly effective as a business model, but it may not be enough in certain situations. What seems to be the most effective form of doing business today is the subscription based model.

Subscription-based Model & Razor-Blade Model: A Comparison

The razor blade model is also known as the bait and hook model and is based on the simple analogy of selling a razor (bait) at low profit margin and gaining from high margins on sale of blades (hook). This model has been quite successful in many industries, starting with ink and cartridges, to Smartphone and gaming consoles. In essence, the success of this model lies in the fact that profit is made from the recurrent sale of subsequent refills and accessory item purchases to complement the master product or service, which acts as the bait and is usually offered at a low price.

Over the years, many companies have used this model successfully to make money. For example, the printers (bait) and ink cartridges (hook); cell phones (bait) and airtime (hook); gaming consoles (bait) and games (hook); etc. This razor blade model works on the premise that consumers are enticed by freebies and discounts offered by companies so much so that they make a purchase and then they are hooked to buying the associated products, which are sold at higher margins. The idea is to make up for the low or zero profit through sale of subsequent products.

Companies like Sony, Microsoft or Nintendo, all of whom are forerunners in the gaming industry, work with this razor blade model and have made great strides in terms of revenue generation and customer loyalty base. However, baiting and hooking cannot work if innovation stops. Consumers want more novel gaming experience from time to time. To cater to that, all three companies have constantly innovated and improved their gaming consoles with more features and functionalities.

Even then, in an existing market, Nintendo adopted a different approach and outran Sony and Microsoft at one point with 100.3 million units of WII sold, as compared to 80 million each of Playstation3 and XBox 360. This was possible owing to the blue ocean strategy (Kim & Mauborgne) that Nintendo adopted, keeping competition aside and increasing value with decreasing costs. Therefore, the razor blade model may have its limitations in certain situations. What appears to be a better business model choice today, is one that is subscription-based.

In subscription-based models, the customer pays a certain fee for availing a service or product. This has been the model for magazine and newspaper companies, but have trickled to other industries as well in today’s world. Since most of the world operates digitally today and every company has an online presence, it makes sense to adopt the subscription based business model which will give a company a passive recurring revenue (the backbone of online businesses). A subscription based model can also be targeted towards specific market segment, thereby increasing chances of more revenue generation. A recent success story of this subscription model is Adobe’s transition of the creative suite to the creative cloud.

 

Subscription Model: The Adobe Success Story

In 2012, Adobe Systems switched to a subscription based business model in a smart move that yielded remarkable results for the company. It transitioned its creative software suite to the cloud. This meant that customers were then able to buy the Adobe tools online for a subscription fee. Since the subscription model has a lesser upfront cost to customers, the latter is attracted to make a positive buying decision. Therefore, the move won the company many new customers who were not even Adobe users before.

Initially Adobe’s decision to switch from Creative Suite to the Creative Cloud and deliver tools online was unwelcome. Some customers expressed their discontent with the decision over the social media. But the senior management at Adobe maintained that the decision would bear fruit in the long run, the discontent notwithstanding. They were not wrong. The subscription model paid off soon. By the second quarter of 2014, Adobe recorded better-than-expected revenue, owing largely to the subscription sale of Creative Cloud software (Lev-Ram, 2014). The switch in business model is giving the company’s bottom line a tremendous boost year-on-year. In early 2015, Adobe gathered 517k new Creative Cloud subscriptions and the company aims to achieve about 6 million paid subscribers by the 2015 close (Wilhelm, 2015).

The income statement of the company illustrates the steady financial growth quarter by quarter (see below):

 

The revenue and profit both grew steadily at every stage. The switch to Creative Cloud gave the company recurring incomes and helped it generate more revenue than what the market expected. Evidently then, this business model can be a good option for many more companies in today’s digital world.

Conclusion

Business models are many and it is difficult to pinpoint any one as the ‘best’. The idea of a better business model, however, is relative only to another in a particular context and time and also depends on the kind of product and service the company provides. The understanding of business model literature applied in the present day context signals that the bait and hook model is effective and sustainable, but better still is the subscription-based model as it ensures recurring company revenue and little upfront cost to customers. There have been many companies who have benefitted from having a subscription model. The Adobe Systems success by transitioning from the cardboard box software delivery model to the online software selling model is a perfect example of turning a business unexpectedly profitable with an appropriate business model. In this case, the subscription model definitely appears to be more effective than the razor blade model.

 

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