The Proper Use of Loss Leaders

Did you ever wonder how someone could sell something so cheaply? Did they consciously know what they were doing? Did they have to sell at a loss because perhaps they were liquidating a slow-moving, damaged or obsolete product, or were making room for a new product? Did they make a mistake in pricing? Did they somehow get their costs down so much that they could actually make profit at the price they were selling at? Or did they know exactly what they were doing by losing money to get customers in then door and then selling them more things at a higher price to make up for their initial losses?

Very often, the later situation is the rational for offering prices below cost — which is known as a loss leader. This is where initial losses are intended to be more then made up for with higher prices later on. Have you ever used this kind of marketing strategy? When it is properly used it can be very profitable.

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Perhaps the most famous example took place many years ago with razor blades. The leader in the industry was Gillette who famously sold their mechanical razor well below cost to get new customers. The blades did not last for many shaves and the reoccurring sales for replacements were very profitable year after year, netting Gillette a tidy profit.

There is one caveat, and that is something called “predatory pricing.” This is where very low price can be set with the intention to drive competitors out of the market and create a de facto monopoly. This is illegal, but usually rather difficult to prove.

The vast majority of companies can use a similar strategy themselves. The key is, will your customers come buy enough other things to make up for your loss leader?

Let’s provide an example. Your company is trying to break into a key client with a larger volume potential. You know you have a great product or service, but must get your foot in the door to demonstrate this. Your best option may be to use loss leader with a price your competitors can beat and tie this to a one-time offer so that your customer can’t ask another vendor to match it. This approach often works if you can make your customers first experience so good that when you present them with an ongoing price for repeat business at a higher price this will not be an issue if properly unveiled.

A similar approach is the Gillette example, whereby they are tied into your company as very satisfied, to switch out would be a major headache, and the new cost structure is not a problem.

In all situations, make sure to run the numbers to know how much incremental volume and what price you will need to overcome your loss leader deals. Whatever you do, don’t do business always as a loss leader. A loss leader may get you in the door, but you must generate profit business after that or walk away from that account.

MORE: Value-Added Services

Michael Neidle

Michael Neidle
Michael Neidle is president and CEO of Optimal Management, an advisor to staffing firm owners and managers.

Michael Neidle

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