LOSS LEADER

In marketing, a 'loss leader' (also called a 'key value item' in the United Kingdom) is a type of pricing strategy where an item is sold below cost in an effort to stimulate other, profitable sales. It is a kind of sales promotion.

Contents

Sales of other items in the same visit

Characteristics of loss leaders

Sales of related items over time

Low margin products

References

Sales of other items in the same visit

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. Marketing academics have shown that retailers should take both the direct and indirect effect of substantial price promotions into account when evaluating their impact on profitability.^[1] To make a very precise analysis one should also include effects over time since deep price promotions may induce stockpiling, which may invalidate the effect of such product associations, typically discovered by association rule analysis.^[2]
An example would be a supermarket selling sugar or milk at less than cost to draw customers to that particular supermarket chain.
When automobile dealerships use this practice, they usually 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 has no choice but to try to sell another vehicle at regular price. If you are not the first person at the dealership when there is a "1 only at this price" vehicle for sale, do not expect that vehicle to be there if you show up at the end of the day. Loss leader vehicles are typically new vehicles and they are almost always base models that do not bring much profit to the dealership anyway. However, at the end of the month, provided sales have been good, the manufacturer will give the dealership bonus money. If the dealership is a certified dealership, e.g., Ford "Blue Oval Certified," part of their advertising funding will come directly from Ford. This bonus/ad money will often be used to pay for the loss of profits with the loss leader. Loss leaders help generate lots of foot traffic at vehicle dealerships.

Characteristics of loss leaders

★ A loss leader may be placed at the back of a store, so that purchasers must walk past racks of other displayed goods which have higher profit margins.

★ A loss leader item is usually a product that customers purchase frequently—thus they are aware of the usual price and that the offered price is a bargain.

★ Items offered as loss leaders are often very limited in number, which discourages stockpiling by customers. A retailer must subscribe to this method of selling on a regular basis in order to compel customers to make repeat visits.

Sales of related items over time

This is also known as the razor and blades business model, referring to the most famous example. Razor handles are sold at a loss, but sales of disposable razor blades are very profitable. American businessman King Gillette famously invented this business model, in which safety razors were sold or even given away as loss leaders so that his company could profit by selling disposable razor blades.
This practice is commonly used with video game console makers that sell their console units at very low margins, or even at a loss, to achieve a higher market share. They rely on profits from software sales where the markups are considerably higher. They also receive profits from third party software companies for licensing fees. Microsoft has used this technique with the Xbox and Xbox 360. Sony has done the same with the PlayStation 3 (PS3) and, to a lesser extent, with the PlayStation 2 and PSP. This also translates to higher prices that are charged for the games and for original console accessories such as game controllers. Furthermore, the price of a game developed for multiple platforms (for example, Xbox 360, PS3, and PC) is typically the same across all of those platforms, even if one or more of the platforms is not actually a loss leader (in this example, the PC; however, Nintendo's Wii is also sold at profit, unlike its console brethren^[3]).
Inkjet printers are also often sold to retail customers below their true value and could also be viewed as loss leaders. Some of the printers, especially the entry-level models, are sold at a loss-leading price which seems apparently affordable to most consumers, but they pay the regular price for ink cartridges and specialty papers supplied by the manufacturer.
Dealers who normally use "fruitshop" style trading methods--stocking small quantities of a variety of products, cannot compete with loss leaders by negotiating to buy larger quantities of consumables at a lower price because they would still have to sell at a loss to be competitive.
Loss leaders can be an important part of companies' marketing and sales strategies.

Low margin products

Some products are sold at very low profit margins, generating only minimal profit for the company. The reasoning is the same as the reasoning behind loss leaders. Technically, these products are not loss leaders because they do not generate a loss. Examples of these include:

★ Several fast food chains have a "value menu" of low-priced items to draw customers to the restaurant, where they may buy higher-priced items (or soft drinks, whose true cost to the restaurant is minimal). This trend started with Wendy's but soon spread to most other chains.

★ Convenience stores that sell gasoline often do so at very low margins, relying for profits on increased sales of snacks and coffee to stopping motorists. Competition for gasoline prices, especially in urban areas, is intense (especially since the prices are often readily visible to passing motorists) and as such it is hard to make a significant profit on selling gasoline, if any profit is made at all.

★ Retail music sales has always generally been viewed as being a low margin category, with this becoming even more evident with the advent of digital file-sharing. As a result, some Internet-based music stores, most notably Apple's iTunes Store, also operate at low margins, with the possible intent of increasing sales of electronic devices such as the iPod.

★ Movie theaters often make almost no money on tickets—ticket sales are largely passed on to the distributor. Theaters generate most of their revenue by selling concessions.

References

1. 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.
2. 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.
3. http://www.gamasutra.com/php-bin/news_index.php?story=11103