Industrial Sector Says Goodbye to the Razor Blade Model
“Give ‘em the razor; sell ‘em the blades.” This was the guiding force behind the Gillette razor blade business model, in which Gillette sold their shaving tools at a low margin, then charged more for the razor cartridges customers would eventually need. This business model is standard in various industries and a staple in the industrial sector today. Manufacturers sell a piece of equipment, and then they drive purchases of complementary, aftermarket services at higher margins. The majority of original equipment manufacturers, or OEMs, consider their products just a foundation for their services revenue.
This business model is on its way out the door. Subscription-based models —common in the software industry— are currently being introduced in the heavy equipment industry. Industry leaders used to operating under the razor blade model now have an opportunity to transform their operations. Tulio Scacciati, an expert in the Catalant network, has worked in the industrial sector for years developing growth strategies and consulting. He recently created a whitepaper with Catalant Technologies to further explore and explain best practices on adapting to this model in the industrial sector specifically. “The New Competitive Advantage: Industrial Subscription-Based Models” explores the shift from the familiar product-focused model to an outcome-focused model.
Until recently, a heavy machinery manufacturer might sell a product at a low margin or even at a loss. Higher profit margins of 50 to 70 percent would be collected from the subsequent sales of spare parts, upgrades of the installed base and repairs. Historically, the basis for competition for OEMs was to increase the volume of their installed base sales. This grew the market for higher margin service sales. With the new subscription-based model, consumers have an “all-inclusive” sale of a product instead of a base-level product. The business model shifts from operating on high capital expenditures (CAPEX) to multi-year contractual agreements that the company manages as operating expenses (OPEX).
This subscription sale or contractual agreement offers stability and predictability to the consumer’s cash flow, as the contracts can be negotiated and managed through yearly budget checks. This can potentially eliminate the consumer’s need for a lower product cost. The move from CAPEX to OPEX drives new forms of purchasing and engagement, as consumers can eliminate business risk, improve their cash flow and increase their productivity.
Companies within the industrial sector have already seen the advantages of a subscription-based business model. Zipcar, a car-sharing company, is one of these companies. Zipcar’s current model allows drivers to pay for a car as needed instead of owning or leasing a vehicle. This eliminates the need and costs of maintenance, repairs and inconvenience. This growing market is enticing to auto industry leaders looking to sell product at a higher margin without selling the base product at a lower cost or loss initially.
Additionally, Noble Iron, a company that rents and sells heavy equipment to construction companies, based its original business model on subscriptions. The founder of Noble Iron stated that with this business model and the use of new technology, his company “can also track and analyze our customers’ activities. This allows us to continuously improve the Noble Iron experience.” Breaking from the mold of most capital-intensive industry leaders, Noble Iron rents equipment on a weekly, monthly or yearly basis. Noble Iron is ahead of the curve by conducting their business online. As more companies embrace the subscription model, they’ll also find it’s imperative to utilize new technology and cloud software to oversee, track and analyze their subscription businesses in ways they weren’t able to before.
Like Zipcar and Noble Iron, other enterprises adapting to the subscription model will see opportunity to include performance-based contracts in some cases. This gives them the benefit of being paid for the efficiency of their product, as some chemical industry companies are currently doing. This shift to a subscription gives customers the benefit of spreading out expenses over time. In this case, the manufacturer holds the equipment on its balance sheet and amortizes it over the life of the contract, bringing about predictability and steady cash flow. Gross margins in the rental model are typically higher — on average, 70 percent higher — than in traditional product sale models. The predictability, control over operating expenses and higher profit margins are all large benefits for enterprises willing to adapt to the subscription model.
This shift is large and not done overnight; it requires changes in operations, service offerings, pricing, liability, sales teams and overall financial structure. But the shift to subscription models is underway in innovative companies throughout various industries. This gives the industrial sector a chance to learn from early adopters. As more companies use this business model, the focus on creating an outcome-based economy will become clearer. When manufacturers pivot from selling products to selling measurable outcomes, industry competition will be transformed, and thus, companies will have to forge new ecosystem partnerships based on customer needs instead of individual products or services. Rigid companies that are hesitant to make these partnerships and changes will find themselves at a disadvantage sooner than later. Industry leaders will want to be on the good side of this change to ensure the livelihood of their businesses as the outcome economy becomes the norm.