Probably the most important fact when it comes to analyzing Unilever’s purchase of Dollar Shave Club is the $1 billion price: in the world of consumer packaged goods (CPG) it is shockingly low. After all, only eleven years ago Procter & Gamble (P&G) bought Gillette, the market leader in shaving, for a staggering $57 billion.

To be sure Gillette is still dominant — the brand controls 70 percent of the global blades and razors market — but there is little question that Dollar Shave Club is a much better deal, in every sense of the word. Understanding why Dollar Shave Club was cheap means understanding why its blades are cheap, and understanding that means understanding just how precarious the position of P&G specifically and incumbents generally are in the emerging Internet economy.

The P&G Formula

No great company — and P&G is one of the greatest of all time — is built on only one competitive advantage. Rather, the seemingly unassailable profits and ceaseless growth enjoyed by P&G throughout its history — amazingly, the company basically doubled its revenue every decade from 1950 to 2010 — was driven through multiple interlocking advantages that created a whole even greater than the sum of its impressive parts.

Research and Development: P&G has long lived by the maxim articulated by former CEO Bob McDonald: “Promotions may win quarters, innovation wins decades.” To that end P&G has always outspent the competition when it comes to R&D: $2 billion in 2014, double Unilever, their next closest competitor, and the company employs over 1,000 Ph.D.’s and a host of ethnographic researchers. This has allowed P&G to consistently come up with new products and brand extensions and charge a premium for them.

P&G has long lived by the maxim articulated by former CEO Bob McDonald: “Promotions may win quarters, innovation wins decades.” To that end P&G has always outspent the competition when it comes to R&D: $2 billion in 2014, double Unilever, their next closest competitor, and the company employs over 1,000 Ph.D.’s and a host of ethnographic researchers. This has allowed P&G to consistently come up with new products and brand extensions and charge a premium for them. Branding and Advertising: As inspiring as that McDonald quote may be, P&G also dominates advertising: in 2014 the company spent $10.1 billion in global advertising, 37% more than second-place Unilever. This is hardly a new trend: the company invented soap operas in 1933 to help hawk the cleaning products it was built on, and invented the idea of a brand manager who had a holistic view of products from research to creation to advertising to distribution.

As inspiring as that McDonald quote may be, P&G also dominates advertising: in 2014 the company spent $10.1 billion in global advertising, 37% more than second-place Unilever. This is hardly a new trend: the company invented soap operas in 1933 to help hawk the cleaning products it was built on, and invented the idea of a brand manager who had a holistic view of products from research to creation to advertising to distribution. Distribution and Retail: P&G’s huge collection of brands and products not only gave the company massive scale efficiencies in manufacturing, but more importantly led to a dominant position in retail. P&G built strong relationships with retailers that let them dominate finite shelf space, the scarcest resource for an industry producing relatively bulky inexpensive products.

P&G leveraged these resources in a simple formula that led to repeated success:

Spend significant resources on developing new products (more blades!) that can command a price premium

Spend even more resources on advertising the new product (mostly on TV) to create consumer awareness and demand

Spend yet more resources to ensure the new product is front-and-center in retail locations everywhere

In a world of scarcity this approach paid off time and again: P&G grew not only because its markets grew, but also because it continually justified price increases due to its innovations.

The Gillette Distillation

Small wonder the company was willing to pay a fortune for Gillette; “More blades for more money” was perhaps the purest distillation of P&G’s growth strategy, and Gillette opened the door to the men’s market that P&G had to that point largely ignored.

To be sure, that distillation was easy-to-mock; in 2004 The Onion famously wrote an article entitled Fuck Everything, We’re Doing Five Blades:

The market? Listen, we make the market. All we have to do is put her out there with a little jingle. It’s as easy as, “Hey, shaving with anything less than five blades is like scraping your beard off with a dull hatchet.” Or “You’ll be so smooth, I could snort lines off of your chin.” Try “Your neck is going to be so friggin’ soft, someone’s gonna walk up and tie a goddamn Cub Scout kerchief under it.” I know what you’re thinking now: What’ll people say? Mew mew mew. Oh, no, what will people say?! Grow the fuck up. When you’re on top, people talk. That’s the price you pay for being on top. Which Gillette is, always has been, and forever shall be, Amen, five blades, sweet Jesus in heaven.

That’s exactly what had happened with the Mach 3, Gillette’s previous top-of-the-line model: Gillette increased blade and razor revenue by nearly 50% with basically no change in underlying demand, easily making back the $750 million it cost to research and develop the razor, simply through its ability to charge a premium for new technology, create awareness and demand through advertising, and capture consumers through retail shelf dominance.

Surprisingly, though, when the Onion’s satire became reality — Gillette launched the five blade Fusion with a 40% price premium in 2006, after being acquired — sales were slower than expected: many customers decided that three blades were good enough. Still, things weren’t that bad for Gillette and P&G: customers just kept buying the Mach 3. No business model worth $57 billion falls apart just because one component hits a soft spot!

The Dollar Shave Club Disruption

There was another product launch in 2006 that I’m sure no one at P&G even noticed: Amazon Web Services. Even if they did notice, I doubt the executives focused on the Fusion launch appreciated that P&G’s seemingly unassailable advantages were on the verge of declining precipitously.

AWS made it easy and cheap to start an online company; YouTube, launched a year earlier, made it cheap and easy to share video; Facebook, launched in 2004, made it possible to spread said video to millions of people. All three came together with the 2011 founding of Dollar Shave Club and its 2012 launch with one of the best introductory videos of all time:

Do watch if you haven’t — it’s really that good — but also look carefully at exactly what founder Michael Dubin is saying:

I’m Mike, founder of DollarShaveClub.com. What is DollarShaveClub.com? Well, for a dollar a month we send high quality razors right to your door. Yeah! A dollar! Are the blades any good? No, our blades are fucking great.

Gillette’s model and P&G’s formula generally cost a lot of money: R&D cost money, TV advertising cost money, and wholesalers and retailers had to earn a margin as well, and that’s before P&G realized the return on their investment. The result was that cartridges that cost less than a quarter to manufacture and package were sold for $4 or more. That worked as long as P&G’s other advantages in technical superiority, advertising, and distribution held, but were they ever to falter, it was eminently viable to sell cartridges for less and still make a healthy margin.

Each razor has stainless steel blades and [an] aloe vera lubricating strip and a pivot head so gentle a toddler could use it. And do you like spending $20/month on brand name razors? $19 go to Roger Federer! I’m good at tennis. And do you think your razor needs a vibrating handle, a flashlight, a back-scratcher, and ten blades? Your handsome-ass grandfather had one blade AND polio. Looking good Pop-pop!

This is a direct attack on Gillette having over-served the shaving market: P&G’s first advantage, their willingness to spend money on research and development, was neutralized because razors were already good enough.

Stop paying for shave tech you don’t need. And stop forgetting to buy your blades every month. Alejandra and I are going to ship them right to you…

AWS and Amazon itself, having both normalized e-commerce amongst consumers and incentivized the creation of fulfillment networks, made the creation of standalone e-commerce companies more viable than ever before. This meant that Dollar Shave Club, hosted on AWS servers, could neutralize P&G’s distribution advantage: on the Internet, shelf space is unlimited. More than that, an e-commerce model meant that Dollar Shave Club could not only be cheaper but also better: having your blades shipped to you automatically was a big advantage over going to the store.

That left advertising, and this is why this video is so seminal: for basically no money Dollar Shave Club reached 20 million people. Some number of those people became customers, and through responsive customer service and an ongoing focus on social media marketing, Dollar Shave Club created an army of brand ambassadors who did for free what P&G had to pay billions for on TV: tell people that their razors were worth buying for a whole lot less money than Gillette was charging.

The net result is that thanks to the Internet every P&G advantage, save inertia, was neutralized, leading to Dollar Shave Club capturing 15% of U.S. cartridge share last year.

Value Destruction

Note that metric: cartridge share. According to the traditional way of measuring marketshare Dollar Shave Club only has 5% of the U.S.; the discrepancy is due to the massive price difference between Dollar Shave Club and Gillette. And yet, the price difference is the entire point: in a world with good enough products (Dollar Shave Club imports their blades from Korean manufacture Dorco) that can be bought on zero marginal cost websites and shipped to your home directly there is no reason to charge more.

The implications of this go far beyond P&G: fewer Gillette razors also mean less TV advertising and no margin to be made for retailers, who themselves are big advertisers; this is why I argued last month that the entire TV edifice is not only threatened by services like Netflix, but also the disruption of its advertisers, of which P&G is chief.

More broadly, while razors with their huge gross margins and high replacement rate were a particularly good match for the Dollar Shave Club subscription model, I suspect this sort of disruption will not be a one-off: the Internet (and e-commerce) has so profoundly changed the economics of business that it is only a matter of time before other product categories are impacted, with all the second order effects that entails.

Perhaps the biggest of these second order effects is on value, and that’s where I come back to this purchase price: the tech community is celebrating the massive return for Dollar Shave Club’s investors, but $1 billion for a 16% unit share of a market dominated by a brand that cost $57 billion is startlingly small. Indeed, that’s why buying Dollar Shave Club was never an option for P&G: even if their model is superior P&G’s shareholders would never permit the abandonment of what made the company so successful for so long; a company so intently focused on growing revenue is incapable of slicing one of their most profitable lines by half or more.

For their part, Unilever is fortunate they don’t have a shaving business to protect, because being an incumbent is going to increasingly be the worst place to be. Dollar Shave Club’s motto may be “Shave Money Shave Time,” but just how many shareholders and policy makers are prepared for the shaving of value that this acquisition suggests is coming sooner rather than later?

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