Under the Influence with Terry O'Reilly - S2E16 - Loss Leaders: How Companies Profit By Losing Money

Episode Date: April 20, 2013

This is the very interesting selling strategy where one product is given away for free, or at a high discount, in order to attract people to buy another more profitable product. We’ll track the earliest loss leaders of shaving blades and Jell-O recipes, all the way up to today’s printers, video games and even Kindles – all of which are loss leaders. You might be surprised to know how many loss leaders swirl all around you every day.Advertisers know what to give away in order to profit.  Hosted on Acast. See acast.com/privacy for more information.

Hi, it's Terry O'Reilly. As you may know, we've been producing a lot of bonus episodes while under the influences on hiatus. They're called the Beatleology Interviews, where I talk to people who knew the Beatles, work with them, love them, and the authors who write about them. Well, the Beatleology Interviews have become a hit, so we are spinning it out to be a standalone podcast series. You've already heard conversations with people like actors Mark Hamill, Malcolm McDowell, and Beatles confidant Astrid Kershaw. But coming up, I talk to May Pang, who dated John Lennon in the mid-70s. I talk to double fantasy guitarist Earl Slick, Apple Records creative director John Kosh. I'll be talking to Jan Hayworth,

who designed the Sgt. Pepper album cover. Very cool. And I'll talk to singer Dion, who is one of only five people still alive who were on the Sgt. Pepper cover. And two of those people were Beatles. The stories they tell are amazing. So thank you for making this series such a success. And please do me a favor, follow the Beatleology interviews on your podcast app. You don't even have to be a huge Beatles fan. You just have to love storytelling. Subscribe now and don't miss a single beat. In case nobody's told you, weight loss goes beyond the old just eat less and move more narrative. And that's where Felix comes in. Felix is redefining weight loss for Canadians with a smarter, more personalized approach to help you crush your health goals this year.

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this episode is from Season 2, 2013. You're soaking in it. You're loving it in style. Your teeth look whiter than noon, noon, noon. You're in good hands with us. You're under the influence with Terry O'Reilly. Back in 2007, Prince released his 32nd studio album. It debuted at number three on the U.S. Billboard chart. But when Prince released it in England, he chose to market it in an unusual way. He struck a deal with London's Daily Mail newspaper. A copy of his new CD was stuffed into 2.8 million issues of the paper's Sunday edition.

As Chris Anderson breaks it down in his superb book titled Free, Prince lost money on the deal, strictly speaking. He charged the Daily Mail 36 cents per CD as a licensing fee, instead of his customary $2. So, instead of making customary $2. So, instead of making $5.6 million, Prince incurred a loss of $4.6 million. But he had a plan. As a result of the excitement and publicity the free CD generated in the newspaper,

Prince sold out 21 shows in a row at London's O2 Arena. Let's do the math on that, shall we? Prince lost $4.6 million licensing his CD to the Daily Mail. The gross on his 21 sold-out shows was $23.4 million. Net revenue to His Purple Highness? $18.8 million. Not bad. The Daily Mail saw an upside, too.

Their circulation jumped up 20% that day. That brought in extra revenue. But even more important, the Daily Mail was seen as a forward-thinking and innovative brand in the staid world of newspapers. And, as a result, it attracted many new advertisers. It was a highly unusual way for a top recording artist to sell concert tickets, and many reported it as groundbreaking.

But, in reality, Prince was using one of the oldest marketing strategies in the book, namely, the concept of loss leaders. By definition, a loss leader is when one product is given away to create demand for another. It's one of the most powerful marketing tactics of all time because the psychology it employs is fascinating. And it has its roots in, of all things, whiskers and gelatin.

You're under the influence. Please, pardon me, can you call the dust gate, please? The concept of loss leaders, or the strategy of giving products away for free or near free, has been around a long time. The basic idea of a loss leader is to offer a product at a loss in order to lead people to purchase more profitable products, hence loss leaders. So, for example, around Thanksgiving, grocery stores will often offer turkeys at below their cost in order to attract people into the store,

knowing that the chances of shoppers buying other profitable items while there is extremely high. The loss leader turkey may even entice some people to that store that would normally have gone elsewhere to shop. So, it can be a double win in many cases, a new customer plus additional purchases. When Sir John Neville was the artistic director of the Neptune Theatre in Halifax, he used to give free tickets to taxi drivers and their families. It was a lost leader for the theatre, but a profitable one in the end.

Neville knew that taxi drivers would talk up the shows to passengers and tourists. Soon, the theater's deficit was gone and subscriptions doubled. Loss leaders is an interesting and profitable strategy with many iterations. And one of the first companies to pioneer Loss Leaders also pioneered a brand new category. When you wanted a shave back in 1900, you used a straight razor. That blade would often get dull, so you would have to strop it often. What is stropping? Well, recognize this sound? That is a blade being sharpened on a piece of leather, or stropped, in other words.

One day, a man named King Camp Gillette, there's a handle and a half, was working for the Crown Cork and Seal Company. One of the products his company made was a bottle cap with a cork seal. Gillette watched day after day as customers opened bottles, then proceeded to throw away the cap and the cork. Clearly, there was a hugely profitable business to be had in products that people used every day, but threw away. All he had to do was come up with a product

One day while he was shaving he noticed his blade needed sharpening again Then he had an idea What if you could invent a thin blade that men didn't have to strop and when it became dull they just threw it away so Gillette did just that he invented a thin sharp blade and moved the blade stability into the razor handle that way the blade could be easily removed and discarded but the razor remained it was a major breakthrough in his In his first year, in 1903, he sold 51 razors and 168 blades. Not exactly a runaway success. He charged $5 for his razor and blades, which was not inexpensive. As a matter of fact, $5 was roughly one-third of the average weekly wage at that time.

But the ease, the close shave, and the freedom from stropping eventually convinced many men to switch from straight blades. By the next year, he sold 90,000 razors and over 123,000 blades, and King Camp Gillette was on his way to becoming rich and famous. Now, there is an urban myth that has grown around Gillette, namely that he invented the first ever lost leader by giving away his razors for free and charging a hefty price for the disposable blades.

By most accounts, that wasn't true because Gillette had a patent on his invention for 17 years and didn't have to give away razors until that patent expired. But what Gillette did do was convince other companies to give his razors away for free. He would sell the razor handles at a very low price to other businesses, like banks,

who then gave them away free when customers opened up new accounts in shave and save promotions. Gillette sold his razors to food companies who gave them away free in everything from coffee and tea packages to bags of marshmallows. Gillette also sold millions of razors in bulk to the U.S. Army. So when soldiers went overseas to fight the war in Europe, they developed new shaving habits that he could leverage when they got back home. All those free razors helped Gillette drum up enormous interest for his new disposable blades.

When his patents finally expired in the early 1920s, Gillette, along with his new competitors, started giving away the razors to capitalize on the profitable blades. That is what has become known as the razors and blades strategy. The concept of giving one thing away to sell something else. Around that same time, another product was invented. It had the most unlikely recipe. It was made from a protein collected from collagen extracted from the boiled bones, connective tissues, and intestines of animals.

Sound yummy? You bet. The result of that concoction was called gelatin. But you know it best as jello. In the mid-1800s, an American industrialist named Peter Cooper obtained a patent for powdered gelatin. Cooper was an interesting man. He built the first American steam-powered locomotive, and at 85 years of age, was the oldest person ever put forward by any American political party to

run for president. He lost. But, Cooper did struggle to get the public interested in gelatin. Finally giving up, he sold the rights to a cough syrup manufacturer named Pearl B. Waite. Pearl, who was a man, and his wife May, decided to add strawberry raspberry orange and lemon flavor to the gelatin and may rename the product jello but they too had difficulty getting jello to gel with the american public so in 1899 they sold the product to their neighbor francis woodward for 450 dollars soon Francis Woodward, for $450. Soon, Woodward ran into the same wall trying to interest the public in a gelled dessert.

But in 1902, he had an idea. He spent $336 to take out a three-inch ad in Ladies Home Journal magazine and proclaim Jell-O to be, quote, America's most famous dessert. Next, he sent well-groomed salesmen out in beautiful horse-drawn wagons to small towns, church socials, and country gatherings. The salesmen were taught to sell the benefits of Jell-O,

but, more importantly, they gave away recipe books. Those free recipes changed everything. Suddenly, people understood how to use Jell-O, that there were hundreds of ways to serve Jell-O, and an entirely new dessert world was created. It was a very smart marketing strategy. As Anderson notes, salesmen were prohibited from selling door-to-door in those days

without a costly traveling salesman license. But because these recipe books were free, it wasn't technically selling. With that loophole, the salesman told local shops to get ready for a wave of shoppers looking for Jell-O, so better stock up.

In a single year, 15 million free recipe books were given out, and Jell-O hit a million dollars in sales by 1906. As radio became popular, Jell-O became the sponsor of the top-rated Jack Benny Show. J-E-L-L-O The Jell-O program, coming to you from the Grand Ballroom of the Hotel Pierre, starring Jack Benny with Mary Liz...

Those recipe books were, along with Razors, one of the earliest models of successful loss leaders. And that loss leader strategy propelled Jell-O to become an enduring brand to this day. Here's a commercial I want you to hear from the 1960s. It features the sitcom cast of Hogan's heroes selling Jell-O. The light dessert with fresh fruit taste. Would you care for a dish? Now, give me the little dream whip on top. Schultz, he was talking to me. Besides, he just had a big meal. There's always room for jello, sir.

With dream whip on top. It has more than just the flavor of whipped cream. The bar. Sergeant Schultz, eating with the prisoners is absolutely forbidden. Now, report to my office. Put more dream whip on it, will you? Sergeant Schultz, not a word about this to anybody. Nothing! Nothing!

It's hard to believe Nazis were used to sell anything, isn't it? The selling concept of lost leaders is fascinating to track through different industries and eras. In the 1880s, Thomas Edison offered lamps at a loss in order to stimulate sales of his incandescent light bulb. In the 1890s, Standard Oil gave away over 8 million kerosene lamps, at a loss, to the people of China. It was a strategy to convince them to switch from vegetable oil to kerosene. Soon, China became Standard Oil's biggest market in Asia. In 1925, RCA began broadcasting shows over the air for free

so people would buy their radios. In the mid-1950s, the Corvette was created to be a sort of loss leader strategy for Chevrolet. The car's distinctive look was created by famous auto designer Harley Earl in 1953. The Corvette was built, in part, to throw a

halo over the entire Chevrolet line. Its sexy contours and V8 power made Chevrolet seem hip and progressive, and it attracted attention to GM's full stable of brands. Chevrolet knew that very few men could afford a Corvette, and that a Corvette didn't exactly fit into most families' transportation needs.

But, Corvettes would attract men into Chevrolet dealerships. Last year, around 13,000 Corvettes were sold that's pocket change for GM who sold over 9 million cars globally but Corvettes are a loss leader with a purpose as writer Greg Easterbrook notes men would gaze at the Corvette in showrooms and dream of driving one with a glamorous woman in the passenger seat they would sigh wistfully and, if all worked as planned, they would buy an Impala. It's a strategy you'll hear echoed all the way back to this 1963 commercial that uses the Corvette to sell GM's full line of cars.

See if you don't think this is the most exciting car in America today. Know what makes this car so exciting besides its obvious style? It's the Corvette's not-so-obvious engineering. The things you feel but don't see. The things that led Car Life magazine to award Corvette its coveted Engineering Excellence Award. But this same spirit of engineering, this idea of special design for special needs, is true for all of Chevrolet's four entirely different kinds of cars, 463. The Chevy II, designed for people who want practical transportation in its most luxurious package.

The Chevy II. The Corvair, an exciting blend of family car and sport car a family sports car the most popular of all the 1963 Chevrolet Impala with the jet smooth look of luxury for entirely different kinds of cars but all with the spirit of the award-winning Corvette in our world, you are tempted and tantalized with lost leaders in almost every conceivable shopping category. And you may not even think of some of those offers as lost leaders, but they are. And we'll be right back. If you're enjoying this episode, why not dip into our archives,

available wherever you download your pods. Go to terryoreilly.ca for a master episode list. The printer in your home or office is often a loss leader, sold well below cost. The real profit is in ink and ink cartridges. An article in Wired Magazine reported that printer ink runs as high as $8,000 per gallon. And you thought gas was expensive. Many printers have a built-in microchip that hinders the use of third-party ink cartridges or refilled ones. Some companies build in expiration dates that report when a cartridge is empty or out of date, even when there is still ink in the cartridge, as a way of prompting you to buy more. The underlying marketing is clear. The profit is in the ink,

so companies need to keep you tethered to their brand in order to profit from you. Sometimes, printers are even sold for less than the cost of replacing the ink cartridge, which means, theoretically, it might even be cheaper to buy a whole new printer than it would be to replace the ink cartridge. The book industry is in a period of flux right now.

Hands up if you like to read books on a tablet. It's a big trend. Close to 120 million tablets were sold in 2012. The Amazon Kindle is a popular way to read, and it is a loss leader. Reports suggest it costs Amazon around $156 to manufacture a Kindle 3G, not including licensing technology and marketing costs. At this writing, the Kindle sells for $89, and the Kindle Paperwhite 3G sells for $199. So, it's clear Amazon is selling some Kindles at cost or below.

And while those Kindles are priced at about half of what the Apple iPad 2 sells for, Amazon isn't really trying to outsell iPads as much as it's trying to drive sales from its website. Smart Money reported that Kindle owners spent an average of $136 per month on Amazon. Compare that with non-Kindle owners who spent $86 per month. The more Kindles that are in circulation, the more music, movies, and e-books they will sell.

As Amazon CEO Jeff Bezos told the BBC recently, he wants to make money when people use their devices, not when people buy their devices. He must be serious about that. Amazon spent over $120 million advertising the Kindle last year. Amazon's free shipping offer is also a loss leader. If you buy more than $25 worth of goods, Amazon ships them to you for free.

There's interesting psychology at work here. A 2004 study showed that shipping and handling costs triggered a 52% abandonment of online shopping carts. Wharton marketing professor David Bell noticed that a free shipping offer that saves a customer six dollars and ninety nine cents was more appealing than a discount that cuts ten dollars off the purchase price that's how alluring free shipping costs are to most customers Amazon's $25 shipping minimum

is a carefully chosen amount to a large percentage of Amazon shoppers increase their purchases to qualify for the $25 free shipping threshold so say you've made a total purchase of $22 why not buy an $8 DVD to qualify for free shipping Amazon is the big winner in that equation That's why a full 60% of online merchants cite free shipping as their most potent marketing tool. Amazon's free shipping is a loss leader, but it leads to shopping carts that proceed directly to checkout.

Many cell phone carriers have offered free or near-free phones if you sign up for a three-year contract. The phones are the raisers, the monthly service fees the blades. If you ever received a free phone in return for signing a contract, you might have noticed that there was a hefty cancellation fee if you wanted out of the contract early. That, of course, is the cost of the foam. No longer free if you break the contract.

Even the movie business has its own form of loss leader. Popcorn sales subsidize the loss leader of movies for theater owners. And many argue that box office revenue is, in effect, a loss leader for studios. Blockbusters aside, the enormous cost of film production and marketing costs are barely recouped with ticket sales. The real money, for many years, was DVDs. But while one man's ceiling is another man's floor,

one company's profit source is another company's loss leader. As Hollywood was raking in the profits with DVDs, Walmart has long used DVDs as loss leaders. They feature below-cost DVDs to entice people into their stores, knowing they'll spend more in other aisles on their way out. The video game world is a powerful example of loss leaders the Xbox 360 and the ps3 game consoles are both sold at below cost but Microsoft

and Sony take that loss to make all their money on licensing fees and software sales the Wall Street Journal reported that Sony loses six cents for every dollar of PlayStation hardware sales. In other words, if Sony were to sell the consoles to retailers for $300, it would lose $18 per sale. Plus, analysts believe

it really costs Sony over $500 to make that console. But using consoles as loss leaders is a hugely profitable strategy for the industry, because video games have now eclipsed the movie industry. In 2011, the domestic box office take for movies was $9.42 billion. According to the NPD Research Group, the take for video games that same year was $17 billion. Newspapers are loss leaders. The price they sell for doesn't come close to paying for what it costs to create the content.

But then again, they're not selling papers to readers. They're selling readers to advertisers. It's a business model shared by another company that may be the greatest loss leader story of all. Google makes billions of dollars from advertising.

The way they do that is to offer over 100 products for free to attract users that advertisers covet. From Google Maps to Google Earth to Google over 100 products for free to attract users that advertisers covet from Google Maps to Google Earth to Google News to Gmail millions of people log on to enjoy these free services the only thing that limits Google's growth is the growth of the internet itself so all of Google's loss leader products are designed to do one thing, to help people grow the web. It is the ultimate razors and blades strategy of the 21st century.

When you sit down at a bar, one of the first things you're given is a free bowl of peanuts. It is one of the greatest yet least thought thought about, lost leaders in our world. Those salty little treats aren't just a nice gesture, they're there for a reason. They make you thirsty, and you buy more beer. That's what makes lost leaders so fascinating. It's all about psychology. You have to lose a fly to catch a trout.

So, cheap razors sell profitable blades. Free recipes persuaded women to embrace gelatin. And Corvettes pull men into showrooms. Google gives away free services to help people expand the Internet. Amazingly, a full 20% of the searches done on Google every day have never been searched before. Because, as the Internet grows, so grows Google's business. Chris Anderson says lost leaders create a feeling of moral debt that encourages you to buy the other item at full price.

Even to this day, Gillette sends out free razors to men on their 18th birthday. Lost leaders swirl around each one of us in every corner of our lives. Some subtle, some not so subtle. And it all comes down to one of the most fascinating aspects of marketing. Companies make enormous profits because they know exactly what to lose money on. When you're under the influence. I'm Terry O'Reilly. Hello, Terry. This is the car dealership calling.

It was nice to do business with you last Saturday. Those Corvettes are beautiful machines, aren't they? You're a lucky man. Your Chevy minivan is ready for pickup. Give me a call. Under the Influence was produced at Pirate Toronto. Sound engineer, Keith Oman. Theme music by Ari Posner and Ian Lefevre. Series coordinator, Debbie O'Reilly.

Research, Shea Cole. By the way, I know you've been dreaming of wearing an Under the Influence t-shirt. Or maybe I was dreaming that. But anyway, we have them for sale on our shop page. And if you listen to the show while sipping a tea or a coffee, have we got the mug for you. Go to terryoreilly.ca slash shop. See you next week. New year, new me. Season is here and honestly, we're already over it. See you next week. metabolism felix gets it they connect you with licensed health care practitioners online who'll

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