The Loss Leader Explained
What is a loss leader and how does it help sales?
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.
Let's look at 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? Well, 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 goes for the oil change. Common sense dictates that the garage is losing money. A filter and 4 quarts of synthetic blend oil are around $25. But 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...they'll always find a problem, even when there isn't one.
In the UK, supermarkets will discount tins of baked beans to a ridiculous price as a way to bring customers into the store.
Baked beans are a staple of the British diet, and many stores will offer them at prices nearing 5-6 cents per tin. The hope is that people will come for the beans, do the rest of their shopping in that same store, and the supermarket will more than make up for the loss of profit on the
beans with the other products sold.
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. 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 only have a very limited supply (maybe 2 or 3) of these, and know they lose money on them. But, once people are in the store, they shop. The 99% of customers who don't grab the doorbuster will still go shopping, and they will more than 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 1-2 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. A case of "I've started so I'll finish." 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 they're almost giving them away. In fact, they are in some cases. 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. Well, you usually get "starter 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. Now that's a loss leader that's gone too far, and it's environmentally dangerous.
The supermarkets love to cook up free samples of food and dish them out to shoppers who are walking the aisles. They will often hand and coupons, too, and have products at the stall that you can take away with you. The philosophy behind this is one of "tit for tat." 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 press, to say that you are cutting costs in a difficult economy, thus helping people out.
The 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. When KFC ran a coupon promotion and ran out of chicken there were people ready to start riots. So, stock up.
Also, 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, and that's bad for business.
Finally, the widespread network of deal hunters that have appeared via the Internet means people are targeting loss leaders with no intention of buying anything else in the store. You may find that your loss leaders don't lead to big sales due to this network, and you've basically just given away your product for almost nothing.