In very basic terms, a loss leader is a product or service that is sold at, or even below, its cost price as a way to create further sales.
Examples of loss leaders.
There are many different kinds of loss leaders, depending on the item, its use, location and a variety of other factors. Some are related to a very specific product and purpose, others are more general as a way to stimulate store sales.
In the UK, supermarkets will discount tins of baked beans to a ridiculous price as a way to bring customers into the store. Baked beans are a staple of the British diet, and many stores will offer them at prices nearing 5-6 cents per tin. The hope is that people will come for the beans, do the rest of their shopping in that same store, and the supermarket will more than make up for the loss of profit on the beans with the other products sold.
- CDs and DVDs
A very popular model in its day, the Columbia House mail-order business gave away DVDs and CDs for pennies, but the customer had to sign up for a long term agreement, usually 1-2 years. Once signed up, the customer is paying way over market prices for the products, and must buy at least one DVD or CD per month.
- Razor Blades
People often wonder how Gillette or Schick can sell a whole razor complete with cartridges for $8, but when it comes time to get refills, the prices have skyrocketed. This is a prime example of the loss leader. You are sold a complete razor with extra blades as a way to hook you into being loyal to that brand. A case of "I've started so I'll finish." Incidentally, this is not unlike the model that drug dealers use to hook people on cocaine or heroine. Get them hooked, then raise the price.
- Printer Ink
This is perhaps the best-known of the loss leaders. Ink-jet printers have become so cheap that they're almost giving them away. In fact, they are in some cases. When you buy a complete printer with two ink cartridges for the price of one ink cartridge, you know something is not quite adding up. Well, you usually get "starter ink" in these packs, so you don't exactly get a lot of bang for your buck. But you do get the printer for almost nothing. The hope is that you come back for the ridiculously overpriced ink cartridges. I've seen people throw away good printers and replace them because it was cheaper than buying ink. Now that's a loss leader that's gone too far.
- Free samples
The supermarkets love to cook up free samples of food and dish them out to shoppers who are walking the aisles. They will often hand and coupons, too, and have products at the stall that you can take away with you. The philosophy behind this is one of "tit for tat." You get a free sample, you subconsciously feel obliged to buy the product in return. By giving out a tiny percentage of the stock for free, supermarkets can move huge quantities of one product in a short period of time.
Advantages of Loss Leaders
When done correctly, loss leaders not only bring in new customers, but also bring back former customers. These carrots are often impossible to resist, even for people who have sworn brand loyalty to another store. And if the math is correct, a small loss initially can lead to a big profit on the back end. It's also good press, to say that you are cutting costs in a difficult economy, thus helping people out.
Disadvantages of Loss Leaders
There's a big downside to loss leaders, and it's all due to lack of preparation. First, you need to ensure that there is enough of the product in stock to keep people happy. When KFC recently ran a coupon promotion and ran out of chicken there were people ready to start riots. So, stock up.
Also, do the math. If you mark the item too low, you may never recoup the money you've lost on the loss leader. Remember, the word leader is important here, you want the sale to lead to bigger sales. If not, you've just made a loss, and that's bad for business.
Finally, the widespread network of deal hunters that has appeared via the Internet means people are targeting loss leaders with no intention of buying anything else in the store. You may find that your loss leaders don't lead to big sales due to this network, and you've basically just given away your product for almost nothing.