Loss leader

A loss leader (also leader)[1] is a pricing strategy where a product is sold at a price below its market cost[2] to stimulate other sales of more profitable goods or services. With this sales promotion/marketing strategy, a "leader" is any popular article, i.e., sold at a normal price.[3]

One use of a loss leader is to draw customers into a store where they are likely to buy other goods. The vendor expects that the typical customer will purchase other items at the same time as the loss leader and that the profit made on these items will be such that an overall profit is generated for the vendor.

"Loss lead" is an item offered for sale at a reduced price that is intended to "lead" to the subsequent sale of other services or items. The loss leader is offered at a price below its minimum profit margin—not necessarily below cost. The firm tries to maintain a current analysis of its accounts for both the loss lead and the associated items, so it can monitor how well the scheme is doing to avoid an overall net loss.

Strategy

Marketing academics have shown that retailers should think of both the direct and indirect effect of substantial price promotions when evaluating their impact on profit.[4] To make a very precise analysis one should also include effects over time. Deep price promotions may cause people to bulk-buy (stockpile), which may invalidate the long-term effect of the strategy. This is the association rule analysis.[5]

When automobile dealerships use this practice, they offer at least one vehicle below cost and must disclose all of the features of the vehicle (including the VIN). If the loss-leader vehicle has been sold, the salesperson tries to sell a more upscale trim of that vehicle at a slightly discounted price, as a customer who has missed the loss-leading vehicle is unlikely to find a better deal elsewhere.

Loss leaders can be an important part of companies' marketing and sales strategies, especially during "dumping" campaigns.

Characteristics

• A loss leader may be placed in an inconvenient part of the store, such as at the rear of the store, so that purchasers must walk past other goods that have higher profit margins.
• A loss leader is usually a product that customers purchase frequently—thus they are aware that its unusually low price is a bargain.
• Loss leaders are often scarce or provided with limits (e.g., maximum 10 bottles) to discourage stockpiling and to limit purchases by small businesses. The seller must use loss leaders regularly if they expect their customers to come back.
• Some loss leader items, such as fruits, vegetables and pastries, are perishable and cannot be easily stockpiled by customers.
• Some loss leaders, rather than being advertised as bargains, are high-end, costly products offered below profit margin to enhance the company's prestige and/or to attract "lookers" or "window shoppers" who may buy other less expensive but more profitable merchandise. For example, if a pawnshop offers a Harley-Davidson motorcycle in its display window at below the normal profit-making cost, this motorcycle will generate a lot of walk-in traffic during the period before it is sold. These shoppers may end up using the store's other services or making other purchases.

Some examples of typical loss leaders include milk, eggs, rice, and other inexpensive items that grocers would not want to sell without the customer making other purchases. While some customers may have the discipline to only buy the loss leaders, the loss leader strategy works because a customer who goes into a grocery store to buy an inexpensive bread or milk item may decide to buy other grocery items.

Examples

Record albums

The Warner/Reprise Loss Leaders were a series of promotional sampler compilation albums released by Warner Bros. Records throughout the 1970s. Each album (usually a 2-record set) contained a wide variety of tracks by artists under contract to Warner Bros. and its subsidiary labels (primarily Reprise Records); often these were singles, B-sides, non-hit album tracks, or otherwise obscure material, all designed to arouse interest in the artists' regular albums. Warner advertised the Loss Leaders albums by inserting special illustrated inner sleeves in all of its regular album releases, listing all of the currently available Loss Leaders and including an order form. Each loss leader double album was priced at US$2, significantly less than a comparable regular-release double album of the time.

The first Loss Leaders compilation was The 1969 Warner/Reprise Songbook, featuring a wide range of artists from Miriam Makeba to The Mothers of Invention; the last of the original series was the punk and new wave-themed Troublemakers in 1980.[6][7]

Video cassettes

In 1979, American businessman Earl Muntz decided to sell blank tapes and VCRs as loss leaders to attract customers to his showroom, where he would then try to sell them highly profitable widescreen projection TV systems of his own design. His success continued through the early 1980s.[8]

Automobiles

Chevrolet's Corvette was originally intended in the 1950s to be an "image builder" and loss leader for General Motors, the idea being that men would go to showrooms to look at this "automotive Playboy Bunny"—which they knew they could not afford—and end up purchasing a lower-cost model. However, it enjoyed significant sales successes in the 1960s and produced a substantial annual profit.[9][10]

On its launch in 1959 the British Motor Corporation's Mini car was sold at a starting price (including taxes) of £496 for its most basic model, and it was estimated that BMC lost £30 per car sold at this price. However, the headline-grabbing price was significantly lower than that of the car's contemporary rival, the Ford Anglia—indeed the only cheaper four-wheeled, four-seater car on the British car market at the time was very basic and old-fashioned Ford Popular, which sold for only £2 less than the basic Mini. While BMC lost money on every basic Mini sold, such cars were unattractive to many buyers since they lacked features such as heaters, floor carpets and opening rear windows and BMC priced the better-equipped models (which cost from £537) to make a small profit, using the basic car as a loss-leader to allow the promotion of a starting price below the significant £500 mark and to make the Mini at least appear to undercut its main rival on price. The ploy did not work entirely as BMC intended—even in its most basic form, the Mini was far superior in many areas to its rivals while also being lower in price. BMC sold far more basic Minis than it had anticipated, meaning that it sold many Minis at a significant loss. Despite the car being a bestseller in Britain (and several other markets) it made little to no profit for many years.

Perishable food

Supermarkets sell food staples such as bananas or milk at less than the cost at which they were purchased in order to draw customers to their business. These items are typically strategically placed far from the entrances of the store to enhance this effect. In the case of milk, supermarket chains often refuse to pay market rates to avoid making a loss.

Diapers/nappies

Many toy store chains and online retailers sell diapers or nappies as a loss leader in order to entice parents into the store in the hopes that the children will spot toys, bottles or other items that the family "needs".[11]

Hardware/tool stores

Large hardware stores such as Home Depot often sell larger tools, such as drills or electric saws, for cost or below. They do this expecting customers to buy accessories such as blades, drill bits, stands, or cases, along with the new tool. These items tend to have a much higher profit margin, and are often impulse buys.

Smartphones and mobile electronics

Some consumer electronics stores use smartphones and other mobile electronics as loss leaders. The company makes less profit on the smartphone or mobile device, but they make up for this by the sales of higher-profit accessories such as cases, headphones and power adapters.

See also

• Bait-and-switch
• Competition law
• Dumping (pricing policy)
• Freebie marketing
• Parallel importing
• Predatory pricing
• Pricing strategies
• Product bundling
• Razor and blades model
• Suicide bidding
• Tying (commerce)

References

1. Leader Archived 2009-01-25 at the Wayback Machine, The American Heritage Dictionary of the English Language: Fourth Edition, Houghton Mifflin Company, 2000.
2. Loss Leader Archived 2008-07-26 at the Wayback Machine, The American Heritage Dictionary of the English Language: Fourth Edition, Houghton Mifflin Company, 2000.
3. Leader, Random House Unabridged Dictionary, Random House, Inc., 1997.
4. Van den Poel Dirk, Jan De Schamphelaere, Geert Wets (2004), "Direct and Indirect Effects of Retail Promotions," Expert Systems with Applications, 27 (1): 53–62.
5. Vindevogel B., Dirk Van den Poel, and Geert Wets (2005), "Why promotion strategies based on market basket analysis do not work?". Expert Systems with Applications, 28 (3): 583–590.
6. Waldbillig, Larry (29 August 2012). "History's Dumpster: The Warner/Reprise Loss Leaders". historysdumpster.blogspot.com. Retrieved 28 April 2015.
7. Hill, Charles G. (11 March 2012). "Warner/Reprise Loss Leaders". Dustbury.com. Retrieved 28 April 2015.
8. Robert C. Post (October 2005). "Henry Kaiser, Troy Ruttman, and Madman Muntz: three originals". Technology and Culture. Johns Hopkins University Press. 46 (4). ISSN 0040-165X.
9. Easterbrook, Gregg (12 January 2011). "Cars on the Catwalk". Reuters Blogs. Archived from the original on 21 October 2012. Retrieved 8 August 2012.
10. "1970 Chevrolet Corvette Coupe". Car and Driver. September 1969. Retrieved 8 August 2012.
11. "Online retailer sells diapers as a loss-leader". Forbes.com. 4 August 2010.