Beyond the loss-leader strategy

Today, 23% more shoppers visit multiple stores and websites to find the best prices for their groceries than did in 2010.

George Faigen, Partner and co-author

Business models based on cross-subsidizing no longer work

Whether you’re selling diapers, home insurance, or internet access, within your portfolio certain categories and products will have higher profit margins than others. Some may not even be profitable at all, and are in the mix in order to draw in customer volume on other products and services.

But in the digital age, such a business model is at risk. Competitors – often newer, online competitors - are able to cherry pick the most profitable products and customers, leaving you in an accelerating downward spiral of falling earnings.

In this article, we explain how to identify where the risks to your business lie, and what tactics can be employed to help fend off these threats.

1Why do business models based on loss-leaders no longer work?

The model has weakened as consumers split their purchases across multiple suppliers as they shop for better deals. Loss-leader retailers rely on capturing a basket of purchases whose overall margin is attractive. As consumers split their purchases looking for great deals, loss-leaders are left with baskets with lower margins. Our measurements show basket-splitting increasing, enabled by the web and mobile apps, which provide consumers easy access to compare and purchase products.
2How can business tell if their most profitable purchases, services, or customers are being cherry-picked?

Most companies’ top-level numbers do not provide the granularity needed. In retail, we encourage our clients to pair together SKUs to distinguish cherry-picking from market trends. For example, declining toothbrush sales can be linked to toothpaste sales to tell if consumers are buying their brushes elsewhere versus a trend of declining sales in the category.
3How should businesses react?

Thematically, the play is to strengthen your defenses on highly profitable products and customers while cutting the resources devoted to less profitable product segments. Putting customers at the center of everything you do will help retailers frame the actions they should take. It will be helpful to identify what your best customers value in addition to low prices – for example personalized customer services, helpful apps, no-quibble guarantees – and provide it in new and innovative ways your competitors can’t. Finding ways to dis-incentivize your unprofitable customers can also help improve overall profitability and use of resources.