How The Razor Blade Model Is So Successful

Many of us consider the purchase price as the most important expense, but few take the time to calculate the lifetime cost...

According to Mint.com, the average monthly spending on all food and dining for Americans is $1,169.

On average, savings accrued from buying groceries in bulk at a Sam’s Club (instead of a Walmart, Target or other traditional grocery store) amounted to 31%—which more than offsets the annual $45 membership fee if you shop regularly. However, the amount of savings did vary based on the type of item.

While cereal, bread, cooking, baking, and snacks averaged nearly 40% savings, raisins, syrup, bottled water, and sandwich bags can save an average of 66%. If you’re still not impressed, generic household items such as aspirin and hand sanitizer result in savings of up to 83% when bought in bulk.

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Most people shrug off these savings because it’s for inexpensive items. Frosted Flakes costs $0.14/oz at Costco in a larger quantity and $0.32/oz at Walmart in smaller boxes. If we compare the two at a standard 33oz box, this makes a box of Frosted Flakes at Costco $4.62, and $10.56 at Walmart.

If John Doe finishes one box of Frosted Flakes every week, he would save $308.88/yr and $3,088.80 in a decade by buying his cereal in bulk at Costco instead of at a typical supermarket like Walmart. And this is only for cereal. Imagine the savings accrued from all your groceries over time when you buy bulk.

Paying 40% less for a box of Frosted Flakes seems insignificant, but the issue is that people fail to calculate the lifetime cost effect. A person who eats cereal every morning for breakfast will be buying cereal often. That 40% savings will go a long way of you look at the yearly savings and beyond. Let’s look at how this affects us in other areas in our life.

Another example is the cost of a car. Most people consider the listing price of the car to be the most important cost because it’s what you pay up-front. They use the sticker price when considering the affordability, but the list price does not take into account the lifetime cost.

Car B may cost $3,000 more up front, but Car B is more reliable, has cheaper repairs, better gas mileage, and holds its value phenomenally. Instinctively, people infer that car A is more affordable because it is cheaper to purchase.

It is a skill to automatically discern the lifetime cost for a product and consider additional costs in addition to the purchase price. In the example above, Car B is a lot cheaper to drive in the long run, making it the more affordable car after a few years.

The study above done by Loup Funds in 2019 that a Tesla Model 3 was cheaper to own than a Toyota Camry LE despite the Tesla being the undisputed superior luxury vehicle. Although the Camry is $14,300 cheaper to purchase, the insurance, fuel, and maintenance are all cheaper for the Tesla, but the deal-breaker comes from the cars resale value which brings Tesla’s cost per mile down to $0.41 in 2019, compared to $0.49 for the Camry.

Price is the amount of money you pay to a company for a product or service. Total cost assesses expenses that a price-only focus ignores; this includes all expenses associated with the acquisition, storage, use, maintenance, and disposal of purchased products and services. Lastly, value is the benefit that a customer gets by using a product.

The razor blade business model (also known as the ‘bait and hook’) is a strategy where an item is sold at a low price or given for free in order to increase sales of a complementary good. Common examples are printers which require ink cartridges, and game consoles which require accessories and games.

This model relies on selling what is perceived as the primary product at a very attractive price. Meanwhile, complementary goods get sold at high margins—similar to upselling. As mentioned earlier, it all comes down to the skill or just the effort of identifying lifetime costs.

Some common products that operate with this strategy are:

  • Sony’s Playstaytion who sells their hardware at a loss and profits from digital game downloads, add-on content, premium subscription services, and other digital add-ons.
  • Any airline offers additional features such as upgraded baggage limits, seats with more legroom, hotel rooms, lounges, and a lot more. They made a reported $28 billion in ‘ancillary’ revenue (revenue from anything other than tickets) in 2016 alone.
  • Movie theaters are a prime example. In 2018, 62% of AMC’s total revenue came from admissions, 31% percent was concessions. However, AMC kept 84% of concession revenue as profit, compared to less than 50% of admissions.
  • All small packaged items. As mentioned in the Costco example above, buying things in small packaging may be more convenient or seem cheaper. But the reality is, the larger the quantity you buy at once the cheaper you are paying per unit. This applies to any category, from food to electronics to clothing. Don’t overpay for something just because the price-tag is smaller!