Here is an excerpt from an article written by Randal C. Picker for the Harvard Business Review blog. To read the complete article, check out other articles and resources, and/or sign up for a free subscription to Harvard Business Review’s Daily Alerts, please click here
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In 1904, King Gillette — who names their kid King? — received two patents on razors, blades, and the combination of the two. As the patents make clear, Gillette had a clear vision of the markets that he would create: “Hence,” stated the patent application, “I am able to produce and sell my blades so cheaply that the user may buy them in quantities and throw them away when dull without making the expense … as great as that of keeping the prior blades sharp.”
But Gillette did more than invent a new razor and a new blade. As Chris Anderson notes in his recent business bestseller, Free, Gillette invented an entire business strategy, one that’s still invoked in business schools and implemented today across many industries — from VCRs and DVD players to video game systems like the Xbox and now ebook readers. It’s pretty simple: invest in an installed base by selling a product at low prices or even giving them away, then sell a related product at high prices to recoup the prior investment. King Gillette launched us down this road.
Or did he? In a recent draft paper, I have looked at the early days of Gillette, and the actual facts from the dawn of the disposable razor blades market are quite confounding. Gillette’s 1904 patents gave it the power to block entry into the installed base of handles that it would create. While other firms could and did enter the replaceable-blade market with their own handles and blades, no one could produce Gillette-style handles or blades during the life of the patents.
From 1904 through 1921, Gillette could have played razors-and-blades — low-price or free handles and expensive blades — but didn’t. Instead, Gillette set a high price for its handle and fought to maintain those high prices during the life of the patents. The firm understood to have invented razors-and-blades as a business strategy did not play that strategy at the point that it was best situated to do so.
It was only in 1921, when the 1904 patents expired, that Gillette started to play something like razors-and-blades, though the actual facts are much more interesting. Before the expiration of the Gillette patents, the replaceable-blade market was segmented, with Gillette occupying the high end with razor sets listing at $5.00 and other brands such as Ever-Ready and Gem Junior occupying the low-end with sets listing at $1.00.
Given Gillette’s high prices for its handle, it had cause to fear duplicative entries into the handles market when its patents expired, but it had a solution: in 1921, it dropped its old handle prices to match those of its replaceable-blade competitors. And Gillette simultaneously introduced a new patented razor handle sold at its traditional high price point. Gillette was now selling a product line, with the old-style Gillette priced to compete at the low-end and the new Gillette occupying the high end. Gillette foreclosed low-end entry by doing it itself and also offered an upgrade path with the new handle.
Gillette’s pricing strategy for its replacement blades showed a remarkable stickiness. By 1909, the Gillette list price for a dozen blades was $1 and Gillette maintained that price until 1924, though there clearly was discounting off of list. In 1924, Gillette reduced the number of blades in a pack from 12 to 10 but maintained the $1.00 list price — a real price jump if not a nominal one.
If Gillette had finally understood razors-and-blades they might have coupled their new low-end razor with higher blade prices, and the two changes do roughly coincide. But the other event, of course, was the expiration of the 1904 blade patents and eventual entry of Gillette blade competitors. That should have pushed blade prices down and made it difficult for Gillette to play razors-and-blades.
With the expiration of the patents, Gillette no longer had a way to tie the blades to the handles and thus, at least on paper, seemed to have no good way to play razors-and-blades. With the expiration of the patents, other companies could now make cheaper blades for Gillette’s handles, undercutting Gillette’s prices and therefore the strategy. So how did Gillette remain profitable, given that it missed its apparent dominant strategy? With sale of razor sets to the U.S. government during World War I and the jump in handle sales with the introduction of the low-price old-style handle, Gillette’s installed based jumped rapidly and the profits followed.
So it was exactly at that point — when it seemed no longer possible — that Gillette played something like razors-and-blades. That was also, incongruously, when it made the most money. Razors-and-blades seems to have worked at the point where the theory suggests that it shouldn’t have.
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Randal C. Picker is the Paul H. and Theo Leffmann Professor of Commercial Law; Senior Fellow, the Computation Institute of the University of Chicago and Argonne National Laboratory. Picker’s primary areas of interest are the laws relating to intellectual property, competition policy and regulated industries, and applications of game theory and agent-based computer simulations to the law. He is the co-author of Game Theory and the Law.