A Bad Business Model Is Taking Over the World

Razor blades and iPhones are like addictive drugs. Here's why that's bad for your wallet and the economy.

Apple Starts iPhone 6 Sales In Germany
BERLIN, GERMANY - SEPTEMBER 19: Shoppers chat with a sales assitsant as a new Apple iPhone 6 Plus stands on display at the Apple Store on the first day of sales of the new phone in Germany on September 19, 2014 in Berlin, Germany. Hundreds of people had waited in a line that went around the block through the night in order to be among the first people to buy the new smartphone, which comes in two versions: the Apple iPhone 6 and the somewhat larger Apple iPhone 6 Plus. (Photo by Sean Gallup/Getty Images)

Imagine if you could only fill up your car with one brand of gasoline. Once you bought the car, you were trapped — try any other brand, and your car wouldn’t even start. It sounds crazy, but this same business model is proliferating across industries from coffee machines to cleaning brushes. Changes in the global economy are only helping it to spread, almost always to the detriment of consumers.

It’s often called the razor-and-blades business model, or freebie marketing. Give consumers a proprietary platform — or at least sell it to them cheaply — and then force them to buy replacement parts to make it work. You probably have several examples around the house: inkjet printers with costly ink refills, water pitchers with expensive filters, and, yes, supposedly high-tech razors with blades that can sell for as much as $5 each. You could even put e-book readers and smart phones, both often sold below cost to rope in consumers, in the same category, though their “refills” don’t create as much waste.

Not by coincidence, the razor-and-blades model has a lot in common with addiction. You get to try a product at price that’s often lower than the actual cost, and then you pay through the nose when you get hooked. This model isn’t based on the merit of the product; instead, it exploits several weaknesses in how consumers make decisions.

For example, consumers may not understand the long-term costs of the product when they first purchase it. If an inkjet printer with a built-in scanner, copier, and fax machine sells for $79, how much more will you pay to use it over, say, the next three years? To answer this question, you’d have to estimate how many pages you’ll print, how many pages — your kind of pages, not generic pages — can be printed with each ink refill, and the prices of the ink refills for the next three years. There’s very little transparency here; consumers are more likely just to go by the sticker price of the printer, which can be completely misleading.

Moreover, consumers typically underestimate their future consumption. Credit card companies take advantage of this weakness, too, by offering sweetheart deals with low interest rates up front; monthly payments can even turn big-ticket items into the equivalent of a razor and blades. To make matters worse, consumers tend to value money spent in the present disproportionately to money spent in the future, a tendency that makes their future selves relatively poorer. As a result, they’re more likely to buy a product with a low up-front price than one with a high up-front price but an actuarially lower cost over its useful life — consider auto leasing, for example.

The razor-and-blades model has costs for society, too. Instead of buying one razor that lasts for years, people discard countless blades with their plastic housing and rubber bumpers every week. Printer makers offer ink in tiny refills to ensure that consumers never face a high up-front cost, but they lose any economies of scale in the raw materials used to manufacture the containers. They pile up the waste just to keep consumers buying.

And in some industries, the razor-and-blades model may even replace public goods. Consider those home water filters. In the United States, their manufacturers rack up hundreds of millions of dollars in sales every year. Since laws require drinking water to be safe, these filters may be catering most to consumers’ tastes and peace of mind. But in other countries, where drinking water often isn’t safe, those pitchers and filters are a distributed solution to a problem that ought to be solved centrally. Instead of building the infrastructure to supply clean drinking water to millions of people, those who can afford them throw away millions of used plastic filters ever year.

Innovation may also be a victim of the razor-and-blades model. Companies that use the model have little incentive to make their products more efficient or durable, since waste is an explicit part of their strategy. Nor do they have much to gain from offering self-contained, more costly products that permanently fulfill consumers’ needs — a printer that never needs ink, a water purifier with no filters to replace, or a razor that stays sharp forever.

Only new entrants are likely to develop these kinds of products in an effort to unseat the incumbents. But even then, consumers may shrink from products with high up-front prices, even if they cost less in the long term. As a result, some companies — cheered on by opportunistic consulting firms — are offering disposable versions of the durable goods that ought to have destroyed the razor-and-blades model, like a throwaway digital camera.

Unfortunately, changes in the global economy are only making the razor-and-blades model more attractive. Lower oil prices will lead to cheaper plastics, giving companies a chance to drop prices or claim higher margins on disposable items. Tax cuts and austerity measures around the world will reduce funding for public goods. And as consumers’ attention spans shorten, their tendency to seek instant gratification from products will low up-front prices may increase.

So what will upset the razor-and-blades apple cart? Educating consumers might work, especially if they can find ways to make the business model work to their advantage. Long-term financing for long-lasting products might also help, as it already has for cars. But more likely, the model will stay profitable until resources are so scarce that consumers won’t want to throw anything away. Ironically, the razor-and-blades model is bringing that day ever closer.

Sean Gallup/Getty Images

Daniel Altman is the owner of North Yard Analytics LLC, a sports data consulting firm, and an adjunct associate professor of economics at New York University’s Stern School of Business. Twitter: @altmandaniel