Retail Strategy Secret #18: Loss Leaders

LossLeader

Welcome to the eighteenth post in our series of “Retail Strategy Secrets”!  Here you will learn the angles, approaches, and tactics retailers are using every day to try and separate you from your hard-earned cash.  Understanding these unlocks the door to spotting great deals, and you never want to pass up a Dealicacy…

Loss Leaders

On occasion retailers may select a specific item (or items) to sell at a loss. Then in what seems a move contrary to the very nature of running a business – making a profit – they then proceed to promote the heck out of the negative margin item.  This approach is referred to as using a “loss leader” strategy.  Contrary to how it sounds, it can pay off handily for the retailer when well executed.

The term’s origin can be explained by looking at each word individually…  “Loss” doesn’t necessarily imply that the product or service is sold below cost (although it can be).  Rather, the price range of a loss leader is quite broad, starting from free and including any price point below the normally acceptable level profitability for the retailer (negative margin).  This small nuance is important, as it allows us to better identify the strategy “in the wild” and how the retailer is ultimately trying to profit from it.

Similarly, the latter half of the phrase is broader in meaning than it first seems.  Instead of simply describing the product or price, it refers to the desired outcome: attracting lots of attention.  A former co-worker of mine would always “jokingly” respond to distributors trying to gain more business by saying, “what will get my attention is if you drop the price and tape a dollar to every box.” His sentiment pretty well sums up the essence the “Leader” portion of this strategy.

So why would a retailer voluntarily offer a product that so obviously ends up in the red?  To drive interest, foot traffic, and create brand awareness.  Once they have grabbed your attention, it is no longer as difficult (or expensive) to retain it.  Plus, when properly executed, the payoff can come immediately – regardless of whether the business is new or established within its market.

Let’s look at a couple of examples. The first is the well-known (more or less) “Gillete Razor” business originating in the late 1800s / early 1900s.  The handles were practically given away, with the disposable razor blade inserts – the “accessory” – being sold for a handsome sum.  “Free” typically gets lots of attention, and in this case profitability is instant since you have to buy razors to get the thing to work.

Many modern day electronics use the same approach.  Ever wonder why inkjet printers are featured as doorbusters every holiday season?  The profitability of the ink required to make the printers work is practically through the roof – especially for manufacturers such as Lexmark.  By the way, the starter cartridges in many printers are hobbled (e.g. half the standard capacity) to speed up the payoff.

Going off on a tangent here: if you think gas prices are expensive these days, you may (or may not be) encouraged to know that it is still gallon-for-gallon cheaper than printer ink.  By some counts, *thousands of dollars* per gallon cheaper! Don’t believe me? Just google “printer ink vs oil”.  Now, don’t get caught printing coupons on the printer at work to save on ink at home… 🙂

Some more examples that perhaps aren’t as obvious:

  • XBOX360s. Despite their entry-level price of around $200, they are literally sold at about a $100 loss to the cost of production. Profitability comes from licensing everything from video games and t-shirts (the “accessories”)
  • Sam’s club handing out free bite-sized samples of their rib-eye steaks. The “accessory” being the ready-to-grill, non-bulk packages of the meat (which also includes the markup on the labor to cut them – learn more about this in our newsletter).
  • Your local grocery store’s Labor Day sale on hamburger.  99 cents a pound sells lots of buns and ketchup!

Deal hunting seems pretty simple here. It is more or less human nature to gravitate toward things that offer some amount of benefit for little to no effort or less than usual cost.  Duh, nothing fancy required to notice eggs are 79 cents a dozen this week – especially when it takes up half of the weekly ad’s front page!

However, human nature doesn’t stop there and tends to overly complicate things – risking whatever savings were to be had.  Here are some things to think about to avoid ruining your Dealicacy:

  • Frequently, loss leaders are placed in “inconvenient” areas of the store. Don’t reverse your fortunes along the way to the dairy section by allowing your kids (or yourself) to grab high-margin items like chips and candy bars.  It’s ok to get to the checkout lane with only a cart full of eggs and milk and a hand full of coupons!
  • Similarly, don’t “reward yourself” for snagging a great deal by using your “savings” as an excuse to buy an overpriced accessory or complementary item.
  • Don’t be too brand loyal or nostalgic. The “enemy you know” often prevents you from venturing out into / considering the unfamiliar. Just because you got a great deal on the entry-level model doesn’t mean you need to continue to accept annoying quirks by upgrading within the brand.
  • When the deal you are after is no longer available (i.e. limited quantities), insist on a raincheck.  You may even have a better selection the week after the sale when the shelves are restocked. I love this approach, especially when my favorite wine brand is on promo.

By the way, if no raincheck forms are allowed and the store did not publish a minimum quantity number per store, you may have just stumbled upon a “bait and switch” ploy.  This is a very unfair (and highly illegal) business practice that should be pointed out to the Better Business Bureau.  However, that’s a topic for another time.

Next up is a form of pricing strategy that can capitalize on Loss Leaders: Basket Pricing.

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One Response to “Retail Strategy Secret #18: Loss Leaders”

  1. Ahmad says:

    Awesome article, will be recommending this to family and friends!