Lose Money On Line

By Jason Compton

This just in: companies are selling products and services on line at a loss. Sure, an awful lot of companies just closed their doors because they pursued Internet business through a loss-leader strategy. They ran online operations that sold goods and services below overall cost and never converted bargain-hunting customers into long-term profits.

The corpse-strewn landscape is one of the major reasons you won’t hear many independent advisors advocating the loss leader strategy. ‘I don’t think loss leaders are tolerated that much anymore,’ says AMR Research senior analyst Louis Columbus. ‘The concept of making it up in volume’ is pretty well gone.’ But that doesn’t mean that businesses aren’t still trying to make it work.

Low, Low Prices
The concept of the loss leader is considerably older than the Web browser, and the recent venture capital-fueled foolishness has not made it a completely unworkable strategy. Live advice marketplace Keen of San Francisco, Calif., which links subject authorities on matters ranging from health care to astrology with knowledge seekers, continues to take aggressive measures to lure new customers. All new users are given a free three-minute call with the expert of their choice, and recurring promotions offer such bonuses as doubling the number of minutes $10 buys.

Although Keen was reluctant to share the precise bottom-line implications of its discount offers, the company passes along 70% of caller revenues to the expert speaker, and COO and VP of marketing Bill Bettencourt said the company typically underwrites at least the majority of promotional expenses.

‘We never actually looked at it as a loss leader, and we wouldn’t be doing it if it wasn’t profitable,’ he says. ‘We know that once a customer gets into a call that our service is pretty compelling, so if we give them $10 [credit], they wind up spending $50.’

Nevertheless, some people can and do simply exploit the system for three free minutes of talk time, never to be heard from again. Venture backing or no, that is not a promising result. When new users register for the trial, they are asked to opt-in for promotional notifications, which Keen later uses to try to lure them into the black ink fold. ‘We have the blessing of having a very addictive service: We give them a taste and people come back for more,’ Bettencourt says.When is a loss leader not a loss?

‘We broke into the auction industry basically to get rid of things we couldn’t move through our regular channels, and it grew very rapidly.’ says George Crist Jr., president of Harrisburg, Pa.-based computer components dealer PC Parts Inc. ‘Our eBay department right now is twelve people. Now, we actually seek out products [for online auction], and it’s going pretty well.’ The company runs hundreds of eBay auctions in a week, which Crist says contributes between $200-$250,000 in monthly revenue.

Although many auctions are listed at a loss-making price (bids start as low as $1), Crist says the market has protected him every time. ‘Assuming the lister didn’t make a mistake [listing the wrong item for $1 or listing too many of one item], we have not lost money on a single item.’

Crist insists there’s no magic, just sound business strategy: In a commodity business that demands selling low, one must learn to buy even lower. ‘It’s all in the purchasing,’ he says. ‘You have to have a purchasing edge that allows you to sell for what it’s going to get on eBay and make money,’ he says. At the same time, the ability to lure eBay bidders time and time again with too-good-to-be-true pricing enables him to make bolder acquisitions. ‘At least we know we can liquidate it on eBay at some point if it doesn’t go through our normal channels,’ he says.

Plotting a Course
Internet promotions can be changed and rearranged at a moment’s notice, which is both a blessing and a curse. While it gives businesses the agility to revamp ineffective campaigns with greater speed and reach than conventional print or telemarketing efforts ever could, there is a danger as well. Once you start a loss-leader promotion, it may be tempting to slash the price ‘just a little bit more’ if the uptake isn’t immediately as great as was hoped, or to pull the plug prematurely because of mounting interest and, by extension, mounting short-term losses.

Like any well-crafted marketing strategy, loss leaders need to be driven by a clearly articulated plan. Lake Forest, Calif.-based Game-Xpert Inc., an online computer game retailer, uses the occasional undercut to ensure a steady stream of new customers, but the window of opportunity is regulated and narrow. Game-Xpert’s ’48 Hour Madness’ sales are just that – two days long, usually offering a few titles for 50% or more off the retail or even the company’s own standard discount price. The special deals are publicized through the company’s customer mailing list as well as by a network of affiliated gaming sites.

Not all Game-Xpert’s sales bleed red: The company prides itself on taking advantage of pricing opportunities in its distribution chain to offer cut-rate deals. Still, ‘sometimes we lose,’ concedes company rep Matt Aziz. Since computer games are not a passing fad, however, the company is confident many of those lured in by the sale will be back. ‘Now you know about the Web site, and it draws you [back] to it,’ says Aziz. Furthermore, the Web site will not honor the price unless the customer subscribes to the company’s e-mail list, which keeps reminding customers of new sales and promotions every two days. And to entice a buyer to put a cash cow in his shopping basket alongside the loss leader, the firm adds just $1 to ship an additional title.

Dangerous Dance
Clearly, some companies are able to flirt with losses and come out stronger for doing so. ‘We’re doing it, we’re actually making money, and we’re not venture capital based,’ Crist boasts. Still, the experts say that if you ponder delving into red ink promotions, consider yourself fully warned of the potential consequences. Most small businesses simply don’t have the capital to make the strategy work. ‘[They] are typically operating on low margins and need to sell products at a profit to maintain cash flow and profitability,’ says Christine Goodno, VP of corporate relations for business consulting nonprofit Service Corps of Retired Executives (SCORE). ‘It’s better if a small business can sell a product or service based on value and sell at a fair value to the purchaser. It’s frequently less expensive and much more profitable for the business to meet its public with a standard pricing strategy.’

‘It comes down to trading margin for mindshare, but the mindshare you’re getting is the fact that you’re the cheapest one on the block,’ says AMR’s Columbus. ‘It would be better to ask how we wrap more value outside the box.’ He suggests footing the cost of an extended warranty and being more responsive to both customer and vendors – but not cutting into the core prices. ‘Compensate for that margin, but do not apologize for it.’

If you’re looking to attract customers with loss leaders on your Web site, many e-commerce services and applications feature marketing and reporting tools to make sure you stay in the black.

Zoovy Inc.
Zoovy Merchant provides Web store services.
$20 to $80 per month

Bigstep offers Web site hosting and e-commerce services.
$25 to $35 per month

Bizfinity features a suite of Web-hosted e-commerce applications.
$15 to $300 per month

Jason Compton covered online financial planning solutions in the September issue.

Small Business Computing Staff
Small Business Computing Staff
Small Business Computing addresses the technology needs of small businesses, which are defined as businesses with fewer than 500 employees and/or less than $7 million in annual sales.
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