There's a management theory that says it doesn't matter if Safeway, Kroger (or any business) makes a profit on every tomato it sells, as long as the grocery chain makes an overall profit. This theory has been used for everything from filling airline seats or motel rooms at ridiculously cheap prices to creating 'loss-leaders' (items sold at prices below cost) at retail stores.
There are six problems with selling anything below cost:
1. You need very sophisticated tracking mechanisms to measure, restrict and control sales. If everyone only goes to Safeway to buy loss-leader tomatoes, Safeway will go bankrupt. Therefore, much time and energy must be expended to measure (and, ultimately, restrict) tomato sales. Most small businesses don't have the time or ability to track such information. Most large companies have the ability, but don't use it. Or don't know how to use it.
2. Any time you offer anything below cost, you attract the worst kind of customers - price shoppers. These folks have no loyalty and buy strictly on price. And, their very presence may drive your good customers away. When the airlines began filling their seats with super-discounted fares in the early 1990s, one flight attendant remarked, "We are now getting rude, smelly people who have no manners and used to ride Greyhound. Now they ride with us and are driving our (full fare-paying) business customers away."
3. Loss-leaders are often bigger loss leaders than companies may think. Buying tomatoes for 34¢ and selling them for 29¢ doesn't tell the whole story. By the time you add in the cost of delivery, unpacking, in-store placement, etc., that 34¢ tomato may end up costing 49¢. Suddenly, a small loss-leader becomes a bigger one.
4. Once you've started selling 29¢ tomatoes, you begin to give yourself a reputation. It will be very hard to convince your present customers to pay 49¢ for the same item. I am convinced that many of the problems at Nordstrom have been caused by the 'success' of Nordstrom Rack. Racks were started as a way to offload out-of-season and obsolete merchandise at hot, discount prices. Now, everybody that I know checks the Rack for 'deals' before they go to Nordstrom and pay full-tilt retail. When Midwest department store chain Dayton-Hudson decided to start a discount division (many years ago), they used a different name - Target. With good reason - they didn't want to cannibalize sales from their full-service stores.
5. There's a certain cynicism among buyers which is brought out every time they're exposed to a 'loss-leader'. They're sophisticated enough to know that, if you're taking a loss on one item, you're probably overcharging them elsewhere. Your firm is now perceived as less-than-honest to them.
6. It is well-known that the cost of 'investing for the future' (new machinery, expansion, new promotional materials, etc.) is ever-increasing. It's driven by competition - companies which are always making improvements. How can you invest in the future if you have a negative return on investment? You can't, yet that's exactly what unprofitable offerings provide.
In my manufacturing company, we only offered discontinued, hard-to-get-rid-of items at less-than-cost prices. Everything else was priced to make a profit; even though several of our competitors offered 'loss-leaders.' Many of our customers told us that they went to our competitors strictly to buy loss leaders, but bought everything else from us because we offered better service. We could afford to provide better service because we were making more profit than our competitors.
Make a profit on every product or service you offer. It's the key to long-term success in business.
