Episode #0031 - What is a loss leader?

In this episode of Pricing College we discuss the concept of a loss leader. You may be aware of supermarkets and similar businesses selling very common or staple items at very low - or even loss making prices. We discuss the rationale or this and what they may be hoping to achieve. We also ask whether it is something that non retail businesses can use.   So today we're gonna talk about a concept that everybody knows and it's called a loss leader. So we're going to be talking about, What it is, Why do companies do it? Is it useful in terms of attracting more customers?  So what is a loss leader? I think any human being who's ever been to a supermarket is probably aware that some shops and some chains will do very low pricing on staples and obviously in different countries, that staple may be different. It could be milk, it could be bread, it could be a can of beans or a can of peas, and whatever it is. It's the staple that a very large number of the population buy on a very regular basis, and it's a price that they're commonly aware of. I even remember back in Britain years ago, when they wanted to prove how out of touch politicians were, they would ask them how much is the price of milk? or a pint of milk? And very often, they wouldn't know. Often these loss leader products, if you're thinking in terms of supermarkets, can be that sort of private label product in terms of milk,  margarine, butter, obviously growing in popularity in supermarkets. So, we're going to just look at, why that is? One reason would be the assumption that people buy on price and low price brings and attracts people to the store. Yes, to a certain extent there are some people who will be attracted to a supermarket or buying these sorts of goods because of price.  Certainly, they will be a shop around and when we say a loss leader, we don't know what the shop is making a loss on every can of beans or every bottle of milk, but what they're doing is they're cutting the price below what they would like to sell that. If they were only selling that bottle of milk and didn't think they'd sell anything else they wouldn't do it, but what they're doing is they're selling one item at a loss, hoping and being quite confident that they will make up that profit on the other items that customer buys. The big question is for a successful loss leader program, once you get them in the store, you need them to buy other items also. And often these loss leaders are designed and produced based on things that people want to buy, and there will be a competitive product at a slightly higher price which this loss leader is competing with and that's putting in the mind of the consumer a question, which one should I buy? Should I buy on price? or the assumption is, should I buy on quality? Now, of course, many of these loss leaders aren't necessarily cheaper or worse than the competitive product. So you asked the question, are loss leaders loss-making? Well, initially, perhaps but they've recouped their money by optimising price across the customer and product lifecycle. I don't know the answer to this but I'm pretty confident that supermarkets in most countries nowadays they're getting bigger and bigger. Certainly the out of town store, so once you make the effort to go, there's a time and effort invested. It's almost like a queueing system and the old Soviet block.  So you've driven to the car park, you walk into the store, you avail yourself of the advertised loss leading bottle of milk for $1 or whatever it is, and that would have had $4 elsewhere and then when you're there, you think I might as well get the rest of my groceries or the rest of my items. You're focusing on that loss leader and there's a psychological aspect to it. But you're buying those other items, maybe a packet of lollies, a newspaper, whatever it is that you probably still come out of. It may be a little bit ahead of what you would have done at your local corner store but the supermarket certainly is on average making profits. A loss leader is very similar to the Startup Platform freemium model, it's like give it a go try it. It's not gonna hurt you, it's low cost, and it's not going to take a big hit on the bank account. And as you do, you try something and you go back if you like it, then you might buy an extra two things and put that in your basket because you bought a particular product. So here they're thinking not just about one product, they're thinking about frequency coming back to the store but they're also thinking about what other things you would buy if you bought that loss leader product. One thing I think we can all learn from this, we obviously don't run supermarkets but sometimes in the pricing community, it's hard to get it across to management why potentially you should make or should consider making a loss on one item or one SKU if you stock thousands of SKU's. This concept of bundling, or baskets or the common shopper and what they will generally buy, that's a message that I think we can all take away from it. The supermarket analogy is a clear and easily understandable example that nearly everybody will get.  I think another key takeaway from this is if you're going to do it, you must make sure you monitor your customers' response to the loss leader. There's no point introducing loss leaders if you're not going to track. What are your customers' responses to the price? Are they going to come back? Are they going to put other stuff in their basket? I mean then that would be unprofitable, so it's understanding your product portfolio and understanding your customers' response to the product and the price.  One thing which we'll cover in future episodes is obviously in supermarkets, they're very keen and they'll probably be some of the earliest adopters of loyalty cards, you scan them and collect certain points etc. So generally, they know exactly what you're buying, exactly what you're bundling, and what you're buying instead of something else. If you're buying a bottle of milk, you're not buying soy milk or almond milk. So there's still some of that big data that they have also available and that really can help them track, monitor and have a good estimate of the profitability of these projects and promotions. Not every business can do that but we can all move to some extent in that direction.