Many of us know of the term ‘loss leader’, especially in regard to supermarket products. Can the practice of selling items at a loss work for pest control companies too? Peter Cox offers his take on the subject.
Loss leaders fall into the category of stock which I call ‘cash cow’ products. These are products with a low gross profit margin but a high stock turn or sales rate. This category of stock could possibly generate 80% of sales and cover the overheads of the store and even produce some residual profit.
Loss leaders are named exactly for what they are out to achieve. They are products that are extremely heavily discounted and advertised. Why would you sell these products below cost and lose profit on them?
Firstly, if only the loss leader product is sold, that is what it will achieve – a loss.
For the purpose of this article I will use a recent sale advertised in newspapers, radio, catalogues, television and multimedia. The product was a very well known brand of household paint. The advertised price for the sale was $10 for a four litre tin!
The cost alone for a full page advertisement for this tin of paint in a major city newspaper was $45,000.
| Sale Price | $10.00 |
| Cost Price | $15.00 |
| Gross Profit | -$5.00 |
| Overheads* | -$2.50 |
| NET PROFIT | -$7.50 |
*Overheads are expenses in running the business such as wages, rent, interest, etc. In this case study the store runs at 25% of sales.
So selling one tin of paint in this case study has generated a loss of $7.50. No wonder they are called loss leaders! The loss is even greater if the full cost of the advertising campaign is included with the share of general overheads.
The purpose of loss leaders is to lead. Lead the customer to come into the store, lead them to the $10 tin of paint and then lead them to buy other products.
The first priority is to sell the add-on products along with the cash cow loss leader $10 tin of paint. These add-on products, the accessory lines that go with the $10 tin of paint, fall into the category of stock lines called stars.
How to sell the star line
In our case study we sell the star products by smart merchandising. The add-on lines are grouped around the display of the loss leading product and prominent high traffic areas within the store If some accessory lines are sold the result could be as follows:
|
Loss leader |
Add-on 1 |
Add-on 2 |
Total |
|
|
Sale Price |
$10.00 |
$15.00 |
$20.00 |
$45.00 |
|
Cost Price |
$15.00 |
$8.00 |
$10.00 |
$33.00 |
|
Gross Profit |
–$5.00 |
$7.00 |
$10.00 |
$12.00 |
|
Overheads |
–$2.50 |
$3.75 |
$5.00 |
$11.25 |
|
Net Profit |
–$7.50 |
$3.25 |
$5.00 |
$0.75 |
This example does not take into account other purchases made in the store that have no association with the loss leader tin of paint.
Your mailbox is stuffed each week with catalogues full of loss leaders. Loss leaders are one of the major forms of advertising for supermarkets, for example.
The car industry is another classic example of using a loss leader to generate profit on the showroom floor. The loss leader is the heavily advertised car. The profit comes from the car accessories.
Of course the final step in using loss leaders is to ‘margin manage’ the loss leader. What does this mean?
Whilst cutting the price of a product to create a loss leader, prices are tweaked up on the associated and accessory lines to cover the loss. Hopefully this will generate a profit from the combined sale and you will also sell other non-associated high margin lines.
Remember, it is not immoral to make a profit. The amount of profit is determined by how you do it!
Peter Cox, Director, Peter M Cox & Associates
