money matters: Using loss leaders – can it work?

By Peter Cox December 11, 2015 Industry news

Loss leaders fall into the category of stock that I call “cash cow” products – products with low Gross Profit Margin but with a high stock turn, sales rate.

This category of stock could possibly generate 80% of sales and cover the overheads of the store and possibly even produce some residual profit.

Loss leaders are named exactly for what they are out to achieve – a product that is extremely heavily discounted and advertised.

Why do hardware and trade outlets lose profit on this product and sell generally below cost? Firstly, if only the loss leader product is sold, that is precisely what it will achieve, a loss…

 

WHAT “LOSS LEADER” MEANS

For the purpose of this article I will use a recent sale advertised in newspapers, radio, catalogues, television and multimedia.

The product was very well-known brand of household paint – call it Brand X.

The advertised price was $10 for a 4 litre tin (and 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: expenses in running the business like wages, rent, interest etc. In our case study store they run at 25% of sales.)

So, selling one tin of paint has generated a loss of $7.50 – no wonder they are called loss leaders!

In fact, the cost would be even greater if the full cost of the advertising campaign was included with the share of general overheads.

 

DON’T LOSE, LEAD!

The purpose of Loss LEADERS is to LEAD the customer to come into the store, buy the $10 tin of paint and then LEAD THEM TO BUY OTHER PRODUCTS!

The first priority is to sell add-on products to 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 them? By merchandising. The add-on lines are grouped around the display of the loss leading product in prominent high traffic areas within the store.

If some accessory lines are sold with our 4 litre tin of Brand X paint, 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 (25%)

–$2.50

$3.75

$5.00

$11.25

Net Profit

–$7.50

$3.25

$5.00        

$0.75

 

By the way this example does not take into account other purchases made in the store that have no association with our loss leader tin of paint.

 

ABOUT MARGIN MANAGEMENT

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, the heavily advertised car. The profit, 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” on accessories and associated lines to cover the loss and hopefully generate a profit from the combined sale.

Of course, you would also try and sell other non-associated, high margin lines.

Remember, in hardware retailing it is not immoral to make a profit. How much profit is of course determined by how well you do it!           


Peter Cox is a senior consultant for Macquarie Advisory Partnership based in Sydney. He has over a decade of experience training and consulting in the retail hardware industry. He conducts key-note addresses, and management and sales workshops, which are aimed at improving profitability and liquidity in one of Australasia’s most competitive retail environments. Phone 0061 438 712 200 or visit www.petermcox.com.au

You can find all of Peter Cox's regular columns here.

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