Loss Leaders That Can Lead to Profits

Joel Anderson |

AAPL, AMZN, ATT, CAJ, MSFT, PG, SNE, VZ, XRX, loss leader, Gillette, razors, kindle, kindle fire, playstation 3, XBox 360, Verizon, Apple, Amazon, Cannon, Printers, Printer ink, Microsoft, Proctor & Gamble, Sony, Xerox"There's no such thing as a free lunch." This popular old adage has long been passed around to explain how you can't really get something for nothing and was even the title Milton Friedman used for a book of essays released in 1975. Turn-of-the-century (not this one, the other one) saloons offered a free spread for any customer who bought a beer. However, the food was very salty and the price of beer was higher to make up for the cost of the free food.

This is also a perfect example of the classic marketing technique of the "loss leader." By selling some items at cost or at a loss, businesses can then use the discounted goods they're selling en masse (i.e. the sardines and crackers) to leverage a greater market share and sell companion products at a greater profit (i.e. the beer). There are several notable examples of loss leaders in the current marketplace, and each represents a calculated gamble by the company offering them that taking a loss on a popular product will pan out in the long run.



Profit Margins for Razors are Actually Quite Thick

One of the more well-known examples of a loss leader comes from Gillette, a brand now owned by Proctor & Gamble (PG). In the early years of the 20th Century, possibly while enjoying a free lunch at a local saloon, razor blade maker King Gillette came up with the idea of offering free handles while charging a premium for the disposable blades the handles used. While Gillette wasn't the first person to come up with the strategy (Thomas Edison offered lamps at a loss in the 1880s shorty after inventing the light bulb), it was a massive success and has become a staple of the razor industry for almost 100 years. Even now, Gillette mails free razors to young men on their 18th birthday in order to set for future profits and hopefully create brand loyalty.

Kindling the Fire of Future Sales

A more recent example of a loss leader comes in the form of the new Kindle Fire from Amazon (AMZN). Amazon is reportedly selling the new tablet at a fairly significant loss. However, by doing so, Amazon is able to price the Kindle Fire at only $200, allowing it to undercut Apple's iPad 2 by over $300. Amazon isn't just trying to beat the iPad, though. Its business model is based on putting the Kindle Fire in the hands of consumers at a higher rate to drive sales of goods from its website. By getting more Kindle Fires into circulation, Amazon expects movies, music, and e-books will be purchased from its website at a higher rate.

Tech Companies not Lost with Strategy

Technology has proven fertile ground for the loss leader category in general, though, as a number of different forms of products have used the method. Cell phones are a prime example (or rather they were until Apple (AAPL) decided to start charging $200 a pop). Companies like Verizon (VZ) or AT&T (ATT) are more than willing to give away phones for free provided that customers are willing to sign a two-year contract with them to provide telephone service. Video game makers also sell their platforms as loss leaders. Companies like Microsoft (MSFT) and Sony (SNE) sell the XBox 360 and Playstation 3 at losses in order to make more money on games and accessories. Finally, inkjet printers from companies like those from Xerox (XRX) or Cannon (CAJ) come cheap, but the ink cartridges will cost you. Printer ink can cost as much as $8,000 a gallon.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Companies

Symbol Name Price Change % Volume
PG Procter & Gamble Company (The) 90.88 1.03 1.15 7,140,732 Trade
HY Hyster-Yale Materials Handling Inc. Class A 83.78 0.29 0.35 59,239 Trade
AAPL Apple Inc. 172.27 0.57 0.33 23,808,487 Trade
AMZN Amazon.com Inc. 1,164.13 -0.95 -0.08 2,613,096 Trade
VZ Verizon Communications Inc. 52.89 -0.30 -0.56 17,704,769 Trade
XRX Xerox Corporation 29.42 -0.32 -1.08 4,010,613 Trade
CAJ Canon Inc. American Depositary Shares 38.67 0.02 0.05 55,646 Trade
SNE Sony Corporation 44.65 0.02 0.04 734,293 Trade
MSFT Microsoft Corporation 85.35 -0.23 -0.27 22,061,136 Trade

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