Have you shopped inside of a store and found a deal that’s too good to be true? The store associates tell you, “It’s such a good deal that we lose money on it!” That’s half the truth. This is Mike Bonadies with the Merchants of Business and I’m going to dive into the tactics that drive those “unbelievably low” promotions.
Promotions where the store “loses” money on the sale is generally referred to as a “loss leader”. The concept behind them is that the promotion is such a hot deal that it brings people into the store. They purchase the promotion in which the store loses money, but they also purchase other products while they are there. This ultimately helps the store recoup the profit they lost on the promotion and drive even more sales. In other words, a loss leader is a foot traffic generator.
Historically there was probably a point in which the stores actually lost money on these products, but that is rarely the case now. In fact, these promotions actually can generate a ton of profit for the store. How they do so is a bit unorthodox.
Rebate Loss Leaders
Oh, rebate programs. How I so dearly love you and your ability to leverage products in new ways. The number one way of promoting a loss leader, that actually drives profit, is through rebate programs. The concept is simple. The distributor sells the product at a loss, but the product is part of a fat rebate program that once accounted for, results in a profit.
Here’s an example. Let's say there is a new printer that is for sale for $99. The store’s cost is $105 but the printer is part of a rebate program that nets them 20% of invoice (trust me 20% isn’t unrealistic depending on the supplier size). When the promotional price, store cost, and rebate program are accounted for the store is actually making $15 in margin. It’s a loss in the system, and on the store level it is probably looked at it as a loss, but net-net the corporate entity is making some coin.
The catch? It’s a rebate program so the distributor only gets the check if they fulfill the terms of the agreement. If you banked on getting your rebate and Q4 falls apart making you a bit shy of your goal, then the promotion really will become a loss leader.
Freight-on-Board Loss Leaders
Freight-on-Board (FOB) Loss Leaders require a bit more financial logistics. They manipulate the P&L to show a loss but increase profitability on the store level. At its core FOB loss leaders initially are purchased at gain by the distributor but without shipping included. This typically involves some foreign made product that needs to be shipped to the region of sale. The shipping is expensive and the theory behind it is that distributors get better terms on shipments than suppliers since they ship more. The distributor absorbs the cost of shipping the product to their stores. By the time the product arrives there are a total of two additional costs realized by the distributor after purchase from the supplier. One is a real cost, the cost of shipping the product. The other is an intangible cost, which is store overhead. Usually the cost of shipping the product to store drives the promotion into the black (no profit or loss) and the overhead cost certainly drives them into the red (financial loss at sale). The key to financial gain is the overhead cost. I’m going to go a bit deep here, so bear with me.
The cost of shipping is real. That isn’t going away but the cost of overhead is a bit of a volume game. Store overhead is calculated a bunch of different ways but generally it’s a lump cost that is spread across all your sales from that particular store. Generally overhead is a fixed cost that doesn’t fluctuate radically. That said, store sales certainly do fluctuate. Since overhead is spread across total sales, the more sales a store generates the smaller the impact overhead has. Also, the opposite is true. The less sales generated, the higher the overhead hit to the store. FOB loss leaders jam empty calories into the store that dampen the impact of overhead. At the time of sale, the promotion may be upside down but its absorbing overhead which lessens overhead's financial impact across all items in the store. At the end of the day that is making the distributor's store more profitable.
The catch? Its straight P&L manipulation. A store couldn't survive on just jamming empty calories into their business. There must be some monetary nutrition behind it. Try living on a diet exclusively made out of celery. It won’t go so well.
In the end, loss leaders are more than just foot traffic generators. They have a financial place as well. If executed through a rebate they can be outright profitable, or if a FOB approach is taken then they can help reduce the impact of store overhead.
I hope you guys enjoyed learning about loss leaders. If you are interested in learning more about channel decisions or P&L ownership then follow me on Instagram @themerchantsofbusiness or follow my Podcast. Again, this is Mike Bonadies with The Merchants of Business and that’s Great P&L Management.