So, say you're watching television and on comes a commercial
for a local supermarket
chain. Wonderful deals on soda
, $2.99 for 2 24-can cases! Well my, that's quite a deal, just over 6 cents a can - cheaper than the local convenience store
, cheaper even than rival chains, and more than 90% off the vending machine
price. Wonderful, but hey, that's the magic of economies of scale
, right? Well, yes and no.
While the supermarkets certainly get their products cheap, the truth is, they don't get them that cheap, and they are in fact losing money on the cans. So why are they doing this? Hopefully, the low prices on these "loss leaders" will draw consumers to the store, where they are likely to purchase other products, as well. The losses incurred in the employment of this tactic may cut into profitability, but from a supermarket's perspective, a $10 profit on a $120 sale at their store is infinitely preferable to $15 profit on a $125 sale at their competitor's store. What matters is that they are getting the money. If you come back every week, that's a $500 gain yearly. If low prices on a few key items draw just 300 shoppers to give their store a try, and even if only a third of them make the switch permanently, that's more than $50,000 a year added to the store's bottom line.
Products used as loss leaders are usually "staple" items, those which are in high demand (you were going to buy it anyway, might as well get it cheap), and those for which customers are easily able to conceptualize savings. Stores often place loss leaders in highly visible locations, near entrances and high-traffic areas (and also near more profitable items which the retailer wishes to draw attention to). Obviously, loss leaders tend to be lower-priced items, the loss on which should not be too serious a drain on the retailer.
The ability to absorb losses (or tolerate fewer profits) and the ability to entice customers drawn in this manner to purchase more profitable items means that this tactic often operates to the benefit of large, powerful companies. Wal-Mart, for example, is able to use its comprehensive product line to leverage loss leaders to significant advantage - come for cheap potato chips and CDs, leave with patio chairs, shoes, and a new microwave oven - and this is one of the reasons why it has been able to dominate the retail environment in many areas.
Of course, this behavior is not exclusively confined to the retail, or even the tangible-product industry - airlines, for example, may offer (relatively) cheap overseas coach fares, betting that familiarity and their exclusive frequent flier program will bring you back for domestic vacation or business flights. Of course, in industries like this it gets more complicated, as regulation may prohibit this behavior or create perverse incentives, and executives may fear starting a costly and mutually disadvantageous price war.