A loss leader is a product that you sell that either breaks even or loses a small amount of money.
So why would you do such a thing?
There are many advantages to loss leaders. For new sites they can be very effective.
A loss leader is a product that is designed to create some action. If your site is new, then getting some traffic and some word of mouth is vital. When you create the loss leader you do it with the hope of the repeat customer. Customers that feel like they got a great deal are more prone to come back and buy from you again. They are happy, and happy customers buy more product. Customers that feel like they got a good deal also are prone to buy other products that you offer on your site.
We will look at the blue widget example and show you how this can help you.
Blue widget purchase price is $25
Blue widget selling price is $25
Cost to promote the blue widget campaign is $100 per month
Essentially you take a 100 loss every month promoting and selling the blue widget. The real value is when that customer tells their friends about the blue widget and when they themselves come back to buy from you again. Marketing losses are taken every day in business; it’s a part of life. Any good bookkeeper will tell you that these losses in moderation do not raise any red flags with the IRS. Think of it as a 100% deduction to offset your sales revenue each month.
Added Value
The up side is that you spent $100 to get more traffic to your site and attract buyers that are specifically looking for your type of product. This is only a good thing.
So how does a losing product give you value that you can take to the bank if it loses money? Great question. When you build a business you should always build your businesses with an exit strategy. Getting attached to a business, especially online, is not the best idea. For one reason the more you are in business, the more business opportunities will come your way. You should always build the business with a strategy to get out. When you have this in mind, a sale is a sale is a sale.
Increased sales add to a bigger number at the sale date. You can show that you can expect a certain amount of revenue. A new owner may think they can figure out how to improve the profit margin themselves. Everyone runs business differently thus changing profit margin ratios. While this won’t make a huge impact on your bottom line, it certainly will not hurt you which are the common thinking about selling a profit losing product.
Other examples
The other benefit of a loss leader is the sale of a related item. Many shopping carts allow you to cross sell similar products. This can be a great way to use your loss leader and generate a sale of a product that has a higher profit margin. Cross selling similar items can for some sites generate 40% more business. You need to make sure that you have the ability to cross sell. One of the best examples of a loss leader is in the shaver industry. Many times you will see the major manufacturers come out with new razors that promise the smoothest shave you have ever had. The real draw is not in selling a lot of razors but in selling the blades over time. You cannot use the razor without the blades and the blades only stay sharp for so long. This is a great way for the manufacturer to sell more blades over time if the customer feels like they got a great deal on the shaver itself.
Video game manufacturers sell their consoles at a discount with the idea that you are going to buy the latest and greatest full price games. The games stay at full price while they are hot and then very slowly go down in price. In this way they can gain the maximum revenue from a game as it comes out and stays over time. This in turn lowers the loss leader margin and helps the company sell more products.
Strategy
If you have already set up your store, think through the product line and look for something that you can offer as a loss leader. It may not be something like the video game example, but it may be something that can get your customers to come to your site. If you have done your homework and made it a little bit better than your competitors, you will gain some conversion. Be careful not to do this too early in your business model so that it does not cause a hardship. You must be able to sacrifice some product in order to increase your conversion. If you are riding on the edge of your business plan, switch to another tactic and come back to the loss leader strategy later.
Another good article on Startup Online business
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