Tuesday, April 12, 2011
Strategic Planning Analogy #387: Loss-Leader Customers
The movie “The Lincoln Lawyer” is about a lawyer who defends mostly criminals and low-life people from the bad side of town. One of the groups he frequently defends is a rough motorcycle gang. Everyone knows this motorcycle gang is involved in illegal activities, but the Lincoln Lawyer, named Mick Haller, keeps enough distance so that he doesn’t know what that activity is.
At one point in the movie, Mick needs some help, so he asks the motorcycle gang to beat up somebody who was threatening him. Later, when the gang needs Mick’s legal help again, they ask for a discount on the legal fees in return for beating up that person. Mick goes further and says he will take the case for free.
Earl, Mick’s driver, is surprised that Mick is willing to take the case for free. After all, Mick’s reputation is to do whatever it takes to make as much money off a deal as possible. Mick’s response, “Repeat customer, Earl; we will stick it to them the next time.”
It seems that everyone knows about the principles of loss-leader pricing. The idea is that you price certain items at a loss, because you know that the customers lured by that loss will eventually spend enough to more than compensate for that loss. For example, if a supermarket sells milk at a loss, it will get more customers in the door to buy a basketful of profitable groceries. Having spent a few decades in retail, I’ve seen the effectiveness of loss-leader pricing.
Even the Lincoln Lawyer knew how to use loss leader pricing on a tough motorcycle gang. By giving the gang one deal for free, he knew that:
1) The gang would be a more loyal customer in the future (ensuring Mick more business);
2) The gang would be less likely to haggle over future fees, since they had gotten such a good deal on the free one (so Mick can charge more in the future—enough to more than recoup his expenses on the free deal);
3) The gang will be more willing to do more favors for Mick (for free) in the future;
4) The gang will recommend him to others (creating even more customers).
If you can use loss leader pricing on legal fees to tough motorcycle gangs, then you can use it on just about anything.
But here is the twist. Although it is common to think of products and services as loss leaders, we do not often think of having customers as loss leaders. As we will see in this blog, having loss leader customers can be just as viable a strategy as having loss leader products and services.
The principle here is that you can develop a strategy where some of your “best” customers can be customers with whom you never make a profit. The reason is because these “best customers” are used strategically as “loss leader customers.”
Just as a supermarket can decide to never make a profit on milk because it helps them make greater profits on other items it sells, you can decide to never make a profit on certain customers because it will help you make greater profits on other customers. We will look at four strategies for loss-leader customers.
1. Gaining Credibility
In the fashion business, credibility and image mean everything. If your fashion product is not seen as the hot /“in”/gotta-have-it product, then it will fail. One way to get credibility as being a desirable fashion is to associate your product with the hot tastemakers. If you can get the hottest movie stars and athletes to wear or use your product, then the desirability of that customer will transfer to your product.
That is why people in the fashion business spend a lot of time and effort to get the hottest people to use their product. They know that they may never make a profit off of these customers (since they give these celebrities the product for free or even pay them to use it). However, these loss-leader customers make the fashion item more desirable to other customers. The celebrities give the product fashion credibility, creating a larger group of profitable customers who want the item.
But it doesn’t just have to be fashion items. I know of a cell phone service provider who was targeting the teen market. They gave away the service for free to the cool kids in school, such as cheerleaders. These were the loss-leader customers. When other teens saw that the cool kids were using this service, then they wanted to use it, too. Hence, the company got a larger pool of profitable customers, because they first invested in loss-leader customers.
I worked with a furniture retailer who did everything possible to please the members of the local garden club. The garden club had a reputation for having members with the highest of taste in home decor. By associating his furniture store with the garden club, he was gaining credibility as having a store with high-taste furniture. This meant that others who wanted a tasteful house would buy their furniture from this retailer, because the loss-leader garden club members were associated with this retailer.
This also works for industrial business products. There may be a business customer who has a reputation for being a very astute buyer of equipment. You may want to sell to them at a loss, because that will make other potential customers will see your product more favorably. Since that loss-leader company is perceived as always making a good buy, by selling to them you gain credibility as being a good buy to others.
2. Gaining Exposure
In a crowded marketplace, it is often difficult to make your product stand out and get noticed. One way to do this is by using loss-leader customers. For example, one can give away free samples of a product to influential bloggers. If these bloggers then say favorable things about your product or service in their blog, you gain invaluable exposure in the marketplace. You won’t make any money off the blogger (loss leader customer), but you may make a ton of money off the people who read the blog (profitable customers).
Anyone who has lots of access and exposure to the public can become a great loss leader customer. If you can get them to talk well about you, then you may gain a large mass of profitable customers from the people who see or hear them.
There is a big movement now to find out who the most influential Tweeters, You Tube users, and other Social Media users are. If you can influence these influencers, then you gain great exposure.
Even paid endorsements, such as getting your logo on the shirt of a famous golfer work. People see the logo on TV in a non-threatening way and it gets planted in their mind. There is a reason why you see so many product logos on race cars. It works.
3. Setting Standards
Often times, a product needs a critical mass of customers in order to be profitable. The idea is that people want to use the product which is the industry standard. The winner of the battle for the industry standard gets virtually all the business, while the loser gets almost nothing.
Think of the old battle for the standard on video tape. VHS won the battle and Beta lost. Or, with DVDs, Blue Ray won the battle and HD-DVD lost. The winners got all the business, the losers disappeared.
With so much at stake, it can very much be worthwhile to gather a large number of loss-leader customers in order to tilt the battle in your favor. The quicker you can tilt preference in your direction, the sooner you can be perceived as the de facto standard.
Remember, the best product does not always become the standard. There were many who thought that Beta and HD-DVD were superior products. Yet they lost the battle because they did not get enough early usage. By investing heavily in loss leader customers, you can get the momentum in your favor perhaps more effectively than investing in product superiority.
This applies to more than just high tech. Back when the Discover credit card was being introduced, it faced a difficult path. Visa and MasterCard were already the standard. Retailers did not want to offer use of the card because nobody had the card. Shoppers did not want to have the card because no retailer was using it. The product almost did not get off the ground.
Eventually Discover convinced the Dayton Hudson company to accept the credit card. They owned the Target store chain and many influential department store groups. That was enough of a start to get people to want the card and other retailers to then accept the card. I am sure that Dayton Hudson got a preferential deal to help make Discover another standard. And it was worth it for both Dayton Hudson and Discover.
4. Reaching Friends
When I was in high school there was a club which sold records by mail. They had a deal where every time you got one of your friends to join the club, you got free records. Well, a friend of mine and I worked hard to get as many people at our high school to join the club as we could. We got a ton of free records and the company got a ton of new members.
My friend and I were loss leader customers for the record club because we got our records for free. But it was worth it to them, because we exposed them to all of our friends (profitable customers). Hence, some customers are valuable to you, even if you lose money on them, if they can give you access to their friends.
Today, companies like Groupon work under a similar principle. They provide incentives to use social media to gather up your friends and expose them to a particular company. At home merchandise parties also work under this principle. They get you to invite your friends to a party which happens to include a sales pitch.
So What are the Strategic Implications
There are two main strategic implications from this principle. First, consider strategies which use loss-leader customers in order to reach a greater pool of profitable customers. Remember, just as you don’t have to make money off every product to be a success, you don’t have to make money off every customer to be a success.
Second consider strategies which make you desirable as a loss leader customer. In other words, make a profit off of the companies catering to you at a loss. Many sports and entertainment figures make more money off of endorsements than they do off their core activity. They are exploiting their loss-leader status. You may be able to do this as well. Convince vendors to give you an outstanding deal because of your loss leader status.
Just as products can be loss-leaders, so can customers. Consider strategies where you can either create loss-leader customers, or become a loss leader customer for someone else.
If the Lincoln Lawyer can use a loss leader principle on a rough motorcycle gang, then what’s stopping you from finding a way to apply loss-leader customer ideas in your business?