Loss leader
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In marketing, a loss leader is an item that is sold below cost in an effort to stimulate other profitable sales. There are several varieties of these profitable sales.
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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.
An example would be a supermarket selling sugar or milk at less than cost to draw customers to that particular supermarket chain. Wal-Mart uses some toys as a loss leader, leading to the potential demise of toy-only competitors like Toys 'R' Us and FAO Schwarz.
A loss leader is typically 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 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 bulky or perishable, making it difficult for the customer to buy in bulk and thus avoid repeat visits to the shop.
Under some jurisdictions, this is considered dumping and is illegal.
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 the razor and blades 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 consoles. Here, the console is sold as a loss leader but the console developer makes a profit on licensing fees charged to game developers who wish to develop games for the console. This also translates to higher prices that are charged for the games and for original console accessories such as game controllers.
It also is used with the way inkjet printers are sold to residential users. Again, the printers, especially the entry-level models, are sold at a loss-leading price which seems apparently affordable to most consumers, but they pay dearly for ink cartridges and specialty papers supplied by the manufacturer. This is augmented by clauses in the printer's warranty that use of cartridges not supplied by the manufacturer will void that warranty. Some manufacturers even use technological limitations so that the printer doesn't work if it is used with aftermarket cartridges.
Similarily, some concession stands will offer free or inexpensive popcorn, then sell sodas at high prices to customers made thirsty by the popcorn.
In these situations, it can be harder for dealers who use "fruitshop"-style trading methods of purchasing to negotiate buying larger quantities of consumables at cheaper cost price in order to sell them off cheaper.
Temporary promotions
Loss leaders can also be attempts to build a customer relationship. For example, a grand opening sale at a new store might lose money in hopes of creating customer interest and building customer loyalty. A new restaurant may serve larger or higher quality meals during their first couple of weeks than they plan on doing in the future. The high value meals act as loss leaders, creating a marketing buzz.
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:
- The Wendy's fast-food chain has a "value menu" of low-priced items to draw customers to the restaurant, where they may decide instead to buy higher-priced sandwiches.
- Movie theatres often use the movies themselves in this way, making up the revenue on high-priced snack concessions.
- 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.
- Commercial vendors often release freeware as a loss leader to attract customers to other services or products available for a fee.
- Some Internet-based music stores, most notably Apple's iTunes Music Store, also operate at low margins, with the intent of increasing sales of electronic devices such as the iPod.