I’ve had a few conversations with eCommerce merchants recently on this topic, so I thought it was worth a blog post. In both cases, they were thinking about discontinuing a product and pulling it from their online store because they were making terrible margins on it even though the volume was relatively high.
Don’t get me wrong … sometimes you HAVE to do things like that. We deeply and intuitively understand that a business cannot afford to lose money.
You know that a “but” is coming ….
When Is It OK to Lose Money? When It’s Strategic Marketing.
Sometimes selling products at very low margins – or occasionally at a loss – is a part of your strategic marketing plan. In fact, it can be one of the most effective marketing tools of the modern age. And to be clear, I am not talking about “loss leaders.”
With a “loss leader,” retailers will sell an item at an intentional loss to gain traffic and additional sales during the window of a promotion. Perhaps the most famous example is selling inexpensive turkeys before Thanksgiving Day in the US. We went into “loss leaders” and other types of promotions in our blog post last month that you can read by clicking here.
We’re talking about something completely different here. We’re talking about using the simple, almost mundane sales of low-margin items to manage customer behavior. It’s super-important for consumer items – especially things like health and beauty products, nutrition items, consumables, services, and subscription goods. Really anything that thrives on semi-regular repeat business. And the failure to recognize the power of these things has severely damaged and even bankrupted entire industries – both online and in the physical realm.
Let’s start with a broad, industry-wide example when not recognizing this strategic advantage nearly killed a business ... and that industry is still suffering the consequences decades later.
Nobody Wants to Do Oil Changes
Back when I was a kid, the dealerships hated doing things like tire rotations and oil changes. The market for those services left skinny margins and it took up a lot of time that their mechanics could better spend doing more profitable, big repairs. And the oil change cars took up valuable real estate in their service bays. Seriously ... they would actively over-charge in order to drive those services away.
So, Jiffy Lube came along and systemized the process to do oil changes fast and efficiently. They were completely comfortable making a dollar or two per customer. At the time, that was pretty much all they ever did. Then firms like Discount Tire came along and gave away FREE tire rotation, safety checks, and inflation to everyone. Even if you didn't buy your tires from them. So, you’d think that everyone would now be happy, right?
A Marketing Mistake That Almost Killed the Dealership Model
The dealerships made a HUGE error (among many at the time). By driving away the smaller, less profitable tasks, they lost control of the customer. The customer no longer thought of them as THE point of service. Now, the dealerships were just one of many possible service choices in the customers' mind. So, they lost the simple, low-margin business AND their existing premium services became less profitable because now they had to advertise and compete for the business since customers did not automatically come to them first.
Then, Things Got Even Worse
The Jiffy Lube shops added mufflers and brakes, and the Discount Tire shops added alignments. This bit horribly into the kind of work the dealerships WANTED to do and things got really bad because the low-end players had control over the customers' most common service needs.
Then the dealers tried to cheat.
They lobbied the car manufacturers to make it that if you got a car serviced anywhere except at an "authorized dealer-servicer" it would void your car's warranty. Well, that just everyone mad, so all the small service shops got together and filed a class-action anti-trust lawsuit and things got messy. The dealers had to relent AND pay penalties and fees. Now, the dealers send you ads for tire rotations and oil changes to try to get customers back in the door. But their previous cherry-picking behavior shot them in the foot.
Who Knows About This? Amazon and the Shopify Ecosystem Do
Amazon.com is the eCommerce giant everyone uses as an example. This is with good reason. They have magically transformed a relatively small online bookstore into an eCommerce and technology behemoth that poses an existential threat to some major businesses.
It will surprise no one that Amazon makes a TON of money. But what many folks have forgotten is that for years, the business made no profit whatsoever. Seriously. Each quarter they would report hundreds of millions of dollars in sales tied to tens and hundreds of millions of dollars in losses. It drove stock analysts crazy. The old-school financial and marketing plans were being stood on their heads.
The vision of Amazon was to establish customer habit. They offered the lowest prices they could with the cheapest – hassle free – and eventually free delivery. They lost more than a billion dollars over the years … right up until they became insanely profitable last year (2017).
The app developers in the Shopify ecosystem rely on the same principle. All of the successful app developers have a similar model. They offer free trials and inexpensive entry-level versions. It’s called the “Freemium Model.”
The low-price stuff makes little or no money and requires a lot of support and documentation. The big stores pay heavy fees and service contracts for support. All of them want to have the thousand-dollar contracts with the big Shopify Plus stores selling millions per year. But they know that you cannot get the big sales unless you have the small shops too. Sure, the free trials and low fee versions take away perceived risk. But small stores grow into larger stores – that’s what EVERY store is trying to do. App developers know that if the smaller stores establish the habit of using their apps, they will continue to use those apps as they grow.
In marketing terms, it’s called being “sticky.”
The Moral of This eCommerce Story
No, you can’t afford to lose money as a business. Not at all. But believe me when I tell you that you can’t afford to have your customers relying on your competitors for their day-to-day needs because you can’t be bothered with low-margin sales. If you expect them to come back to you for the big stuff or just for your exclusive products, you are betting against human nature. You are betting against the power of habit.
Just keep that in mind. A business cannot afford to lose money overall. But it can be good marketing and economics to break-even on a part of the business and even to lose a little money on an individual sale so long as the operation is profitable overall.
If your brand becomes the only thing a customer thinks about when they need something, it might be worth it – and ultimately more profitable.
Thanks for reading!
eCommerce Links and Resources
Our recent blog post, “Four Holiday Promos for Shopify that Sell and Won’t Damage Your Brand:”
Financial Performance Charts Courtesy Ychaarts.com