Forget about the price of gas. The most dramatic inflation news this summer involves razor blades. Gillette is charging $27.99 for eight of the high-tech cartridges that snap onto its much-hyped, battery-powered Fusion Power, the first razor with five blades (six, if you count the "precision trimmer" on the back). That works out to about $3.50 a cartridge, a level that would have seemed every bit as unimaginable a few years ago as $3-a-gallon unleaded gas.
Of course, getting men to spend more money than they ever dreamed possible on razor blades is a specialty at Gillette. Starting with the two-bladed Sensor in 1990, the company has devoted immense scientific and marketing resources to what was once one of the most humble products in the medicine cabinet. And it has raked in unprecedented profits with each increase in price and blade count. In fact, between 1997 (the year before it rolled out Mach3, the first triple-bladed razor) and 2004, Gillette's overall blade and razor sales soared nearly 50%, even though underlying demand barely budged, increasing in line with population. That's a big reason why Procter & Gamble paid a premium price of $57 billion last year to buy the company in the biggest consumer-products deal ever.
But now a fierce debate is raging about whether Gillette's venerable business model is finally hitting the wall. The critics, including a number of analysts and some retailers, say they are disappointed with sales of Fusion and argue that it is lagging behind the wildly successful launch of Mach3 eight years ago. They reason that Gillette has finally hit the ceiling on what it can charge for its top-of-the-line razors. "They have pushed the model to its limit," says Douglas Christopher, an analyst at Crowell, Weeden & Co.
The critics were waiting in the wings on Aug. 2, when P&G (PG) Chairman A.G. Lafley conducted a conference call to discuss the consumer giant's impressive results for its fiscal fourth quarter and year, ending June 30. Net income for the quarter soared 36%, to $1.9 billion, on a 25% increase in sales, to $17.8 billion. For the year, earnings rose 25%, to $8.7 billion, on a 20% increase in sales, to $68.2 billion. Both periods included Gillette's results and surpassed consensus estimates, sending P&G's shares up 4.2% to $59.29.
Even with those results, Lafley was repeatedly peppered with questions about Fusion. Lafley did yield some ground, conceding that "we're a little bit behind where we wanted to be on blade (sales)." Still, he insisted, "I'm feeling pretty good about Fusion." And in a later interview in his Boston office, Peter Hoffman, head of P&G's Global Grooming Division, dismissed the skeptics. He said that many of the same criticisms were leveled at Mach3 when it was first launched. Too expensive! Too many blades! But in the end, he noted, it went on to become the biggest brand in shaving history.
But just because a formula has worked in the past doesn't mean it will continue working. And if critics like Weeden's Christopher are right, that could ultimately be a big disappointment for P&G, which counts on blades and razors for 5% of total sales and an even greater percentage of profits. One unhappy customer is Shawn Phillips of Chicago. The 25-year-old is just the kind of early adopter Gillette likes to attract. He bought a Fusion starter kit for next to nothing soon after the launch in January. But the customer-service representative has already gone back to his three-bladed Gillette Mach3, largely because Mach3 cartridges cost 40% less. "The Mach3 works just as good as Fusion," he says. "It's not worth the price difference."
MARKET SHARE DISAPPOINTS.
Skeptics worry that kind of resistance is hurting sales. Indeed, P&G's fourth-quarter results didn't answer that question. Sales for the razor and blade division fell 5%, despite the Fusion launch and a big Father's Day push behind the brand. P&G attributes the decline to a big reduction in razor blade inventories, as it continues to integrate Gillette's distribution facilities with its own. That's because P&G has a policy of running leaner on inventories than Gillette had.
Gillette launched manual and power versions of Fusion in January. That followed the debut of Mach3 in 1998 and the 2004 introduction of M3Power, which added battery-powered vibration to the handle for a better shave along with a higher-priced blade than the original Mach3. Fusion blade prices—at about $3 a cartridge for the manual model—were more than 80% higher than what Gillette charged for the first Mach3 cartridges back in 1998. Similarly, Fusion Power cartridges were priced around $3.50 apiece, some 30% higher than those for M3Power. The launch was backed by Gillette's largest marketing and promotion spending ever, contributing to operating losses for the new brand in the first and second quarters of its introduction, according to Citigroup.
For all that, Citigroup analyst Wendy Nicholson figures that Fusion's market-share growth has been far weaker than what Gillette saw after the Mach3 and M3Power launches. Mach3's U.S. market share, excluding Wal-Mart and warehouse-club stores, rose from 6.6% in the launch quarter to 11.7% in the second full quarter, she figures. But Fusion's has hardly budged, from 10.6% in the launch quarter to 10.8% in the second, she adds. "Given that (the Fusion launch) included two Fusion products, we would have hoped that the initial shares would have been considerably higher," she writes in a recent report.
FIVE BLADES? "OVERKILL."
Similarly, James Ahneman, director of sales for American Safety Razor, the nation's largest marker of store-branded razors, says Fusion handle sales have fallen faster than expected after an initial surge, while the pickup in sales of replacement cartridges has been weaker than expected. And officials at two major U.S. retailers of razors say they are disappointed in the launch and thought cartridge sales would be far stronger by now. They declined to be named for fear of causing friction with P&G. But Ahneman says sales people at his company have told him drugstore chain Walgreen Co. (WAG) has been disappointed in the launch, while warehouse club BJ's Wholesale Club has told him that directly.
Adding to the chorus, Bear Stearns says that its price checks have picked up signs that some mass discounters are lowering prices on Fusion blades. "Is this a sign of desperation?" asks Bear Stearns analyst Justin Hott, who is generally bullish on the launch.
William Chappell, an analyst at SunTrust Robinson Humphrey, argues that all this suggests that men don't see the value in trading up to Fusion. Most of Gillette's innovation in recent years has come from increasing the number of blades on a cartridge. Mach3 added a third, one more than Sensor Excel's two. Meanwhile, Energizer Holdings' (ENR) launch of the four-bladed Schick Quattro in 2003 made Gillette's move to five even less groundbreaking, says American Safety's Ahneman. "Five went to overkill," he says. "It's to the point where it is a gimmick."
That is the way Kevin Kelm, shopping in the shaving aisle at a Wal-Mart in Madison, Wis., sees it. "I get the job done fine with Mach3," says the 30-year-old graphic designer. "Fusion is just extra bells and whistles."
Nor does the brand name Fusion do much to communicate the advantages of the razor, says Allen Adamson, managing director of Landor Associates, a New York brand consulting firm. The Mach3 name conveyed power and the benefit of three blades. Fusion "doesn't say what the benefits are," he says. "If the brand idea is not simple, it is extremely difficult and expensive to execute in the marketplace."
Back in his Boston office, blade veteran Hoffman isn't buying any of this. What the skeptics don't grasp, he says, is that the launch of a new blade system is like a marathon—one that will last for seven or eight years. "And if this is a marathon, we're only at the two-mile mark," he says. "What the (critics) are trying to (determine) is who will win the race and what the time will be." Hoffman argues it's way too early to reach any such judgments now.
Besides, he argues, the critics aren't even looking at the right yardstick. Because both disposable razors and women's razors have grabbed a much bigger share of the overall razor market in recent years, it doesn't make sense to compare Fusion's overall share gains today to those of Mach3 almost a decade ago. Instead, he says, the proper measure is to look at how Gillette is doing with males in the systems (or nondisposable) part of the market. Hoffman says that P&G's proprietary data show Fusion has gathered a strong 25% of the male systems market in the U.S. and Canada. Moreover, Fusion and the Mach3 together hold 75% of this market, seven percentage points more than Gillette held a year ago, before it introduced Fusion. That, he argues, is a clear success.
As for price cuts, Hoffman says that retailers, not P&G, make the decisions about how to price razors and blades. CVS (CVS), which claims to sell more blades and razors than anyone except Wal-Mart (WMT), has been especially aggressive in promoting Fusion. Around Father's Day, for instance, it offered customers buying a Fusion a $6 credit for any other purchase in its stores. Mike Bloom, senior vice-president of merchandising at CVS, says these promotions were part of their launch plan for Fusion all along. At this stage, "pushing handle sales is the key to success," he says. "This has been a very successful launch for us. We are getting way more than our fair share."
Nevertheless, Ahneman of American Safety Razor contends Gillette is likely to continue to face pricing resistance on Fusion, which could ultimately force it to reduce prices. He says his company's research shows that 64% of men look at the price of blades before buying the handle, which undercuts Gillette's strategy to offer handle discounts to eventually drive cartridge sales. "They are getting to the point where they are pricing themselves out of the market," he says.
The debate has been joined. Now it's up to the world's men. Is a fancy razor blade worth as much, or more, than a gallon of high-priced gasoline?