Definition of a Loss Leader and How It Works
In the business world, a loss leader is a product or service that is sold at either cost or below the wholesale value to a customer or supplier. Retailers often employ this common marketing strategy to drum up additional 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 below.
Free Brake Checks and Cheap Oil Changes
You see the signs as you pass by garages and automotive stores, free brake check or a low-cost oil change. These services are offered at a loss to the garage because most of the time, they'll find an issue that needs to be repaired. This gives the mechanics a chance to put your car on the lift and check for other repair opportunities. Reputable shops will only suggest repairs that are actually needed, while some 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, whether it’s a 60-inch 4K TV set for $400 or a 17-inch touchscreen laptop for $200. You might wonder how they can do this and make a profit. Spoiler alert: They don’t make money on these items.
How it works is they have a very limited supply and know they know they will lose money on these items. The point is to get people in the store, where chances are good that they’ll end up purchasing other items. The few customers who don't grab the doorbuster 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. In exchange for a customer signing up for a long-term agreement, usually one to two years, they received low-priced introductory items. Once signed up, however, customers ended up paying way over market prices for the products, and they had to buy at least one DVD or CD per month.
Have you’ve ever noticed that companies like Gillette or Schick sell razor packages complete with cartridges for around $8. The razor comes with extra blades as a way to lure customers into being loyal to their brand, and when it comes time for refills, the price increases substantially. This is a prime example of the loss leader.
Ink Jet Printers
This is perhaps the best-known of the loss leaders. Ink-jet printers have become so cheap that outfits are practically giving them away. You usually get starter cartridges in these packs, which include a nominal amount of ink. By picking up the printer for almost nothing, the goal is to get you to come back to buy the ridiculously overpriced replacement cartridges. This often leads people to throw away good printers and replace them because it was cheaper than buying ink.
Grocery Stores Giving Away Free Samples
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 on hand that you can take away with you. The thought 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.
The 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.
The Disadvantages of Loss Leaders
There's can be downsides to loss leaders, and it involves a 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 here—you want the sale to lead to bigger sales. If not, you've just made a loss.