Small Business Marketing
Loss Leader - Losing Money To Make Money
Written by James Garvin for Gaebler Ventures
Why do some firms deliberately lose money, in order to make money? A loss leader is bait and hook tactic used by several firms that looks to lure customers into their stores or in their platforms with the expectation that they will make a profit off of the customer on other products or over the long-run.
Loss leaders are a deliberate and often times effective means for new product launches to help gain an increase in market share.
Video game devices such as the PlayStation, Wii, and others often lose money on the game system itself, but make a long-run profit by selling the customer a certain number of games over their lifetime use of the gaming platform. The most popular loss leaders are the razor and razor blades and the printer and print cartridges who also benefit from a strong long-run profit from their customers.
The challenge with loss leaders for entrepreneurs is that it takes a lot of cash to run an effective loss-lead strategy. Wal-Mart recently announced huge price discounts on some newly released books creating a pricing war with Amazon and others. Wal-Mart's strategy was to lure customers into the store to buy the book, which they lose money on, but they expect the customer to buy other products while inside the store which allow Wal-Mart to make a slight profit with your store visit, if you buy enough other merchandise.
As an entrepreneur or small business owner, you may be able to use a loss-lead strategy to garner more market share from existing competitors, however choosing the wrong model can be costly.
Restaurants have for a long time offered coupons for huge discounts as a way to incentivize customers to try their restaurant. Websites such as Restaurant.com and Groupon.com offer in upwards of 50% off your dining bill when you purchase a coupon. The restaurant's hope is that that a certain percentage of customers who came to the restaurant using the highly discounted coupon will return to pay full price fare.
However, consumers who eat at a restaurant for 50% off are likely to be very price sensitive and almost never return to the same restaurant if they have to pay full fare. A restaurant has trained these customers that their value is only what they have paid, which is 50% off of what the restaurant usually charge in order to turn a profit.
Loss leading strategies work when you have a platform good that requires continued use of consumable products that only work on your platform or if you have other products that you know a customer will buy while they are buying the heavily discounted item. Items such as print cartridges, video games, and razor blades are all consumable components that only work on a specific system and require the customer to buy the branded components that work on the platform that they purchased.
In the case of a restaurant and comparable businesses and models, they're only hope is that the customer comes back again, but since they have no incentive or need to return, the loss leader often times turns out to be just a loss.
There is no doubt that effective pricing and promotion of your products and services is critical to your success, but before you heavily discount an item or service as a means to stimulate higher demand, ensure that you have the right business model to capture long-term profits if you are losing money on your promotional items or services.
James Garvin began his education studying biotechnology. In recent years he has turned his interest in technology to helping two internet startup companies. The first business was an online personal financial network and the second was an e-marketing platform created to help entrepreneurs demo their web sites. Currently a student at University of California Davis, James is spending his summer incubating two new online businesses and writing about his entrepreneur experiences.
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