What Is a Loss Leader and How Does It Work?
A loss leader is a common strategy used in many aspects of marketing and advertising. In very basic terms, loss leaders are products or services that are sold at, or often below, the wholesale cost to the business or supplier. But it is a gamble used to encourage further sales.
There are many different kinds of loss leaders, depending on the item, its use, location, and a variety of other factors. Some are related to a very specific product and purpose, others are more general as a way to stimulate store sales. Here are some classic examples:
Brake Checks and Oil Changes
You see the signs as you pass by garages and automotive stores, free brake check, or $18 oil change. The first may seem reasonable—after all, how long does it take to do a quick check of the brake pads? Actually, it takes enough time that it should cost at least $20, but the service is offered at a loss to the garage because most of the time, they'll find an issue that needs to be repaired.
The same holds true for the oil change. Common sense dictates that the garage is losing money. A filter and 4 quarts of synthetic blend oil cost about 25. Once again, the loss is taken so that the mechanics get a chance to put your car on the lift, check it out, and offer repairs. Reputable shops will only suggest repairs that are actually needed. Others will always find a problem, even when there isn't one.
Black Friday Doorbusters
When Black Friday rolls around, you will see a tremendous number of "doorbuster deals" that seem like they're going to put the stores out of business. These might include 60-inch 4K TV sets for $400, or 17-inch touchscreen laptops for $200. How can they do this and make a profit? The answer is, they can't. But, they have a very limited supply (perhaps two or three) and know they know they will lose money on them. But, once people are in the store, they tend to shop. The few customers who don't grab the doorbuster will still go shopping, and they will more than likely make up for the few thousand dollars the stores lose on the heavily discounted limited stock items.
CDs, DVDs, and Blu-Rays
A very popular model in its day, the Columbia House mail-order business gave away DVDs and CDs for pennies, but the customer had to sign up for a long-term agreement, usually one to two years. Once signed up, the customer is paying way over market prices for the products, and must buy at least one DVD or CD per month.
People often wonder how Gillette or Schick can sell a whole razor complete with cartridges for $8, but when it comes time to get refills, the prices have skyrocketed. This is a prime example of the loss leader. You are sold a complete razor with extra blades as a way to hook you into being loyal to that brand. Incidentally, this is not unlike the model that drug dealers use to hook people on cocaine or heroin. Get them hooked, then raise the price.
Ink Jet Printers
This is perhaps the best-known of the loss leaders. Ink-jet printers have become so cheap that outfits are almost giving them away. In fact, in some cases, they are. When you buy a complete printer with two ink cartridges for the price of one ink cartridge, you know something is not quite adding up. You usually get starter ink (which is actually a nominal amount of ink) in these packs, so you don't exactly get a lot of bang for your buck. But you do get the printer for almost nothing. The hope is that you come back for the ridiculously overpriced ink cartridges. People often throw away good printers and replace them because it was cheaper than buying ink.
The supermarkets love to cook up free samples of food and dish them out to shoppers. They will often hand out coupons as well, and have products at the stall that you can take away with you. The philosophy behind this is that if you get a free sample, you subconsciously feel obliged to buy the product in return. By giving out a tiny percentage of the stock for free, supermarkets can move huge quantities of one product in a short period of time.
Advantages of Loss Leaders
When done correctly, loss leaders not only bring in new customers but also bring back former customers. These carrots are often impossible to resist, even for people who have sworn brand loyalty to another store. And, if the math is correct, a small loss initially can lead to a big profit on the back end. It's also good for the public image to say that you are cutting costs in a difficult economy.
Disadvantages of Loss Leaders
There's a big downside to loss leaders, and it's all due to lack of preparation. First, you need to ensure that there is enough of the product in stock to keep people happy.
Also, you have to do the math. If you mark the item too low, you may never recoup the money you've lost on the loss leader. Remember, the word leader is important—you want the sale to lead to bigger sales. If not, you've just made a loss.