The Wall Street Journal recently reported that Costco has not raised the price of its $1.50 hot dog special since 1985 and has no plans to even in today’s inflation.
Costco’s hot dogs are a loss leader – something sold at a loss to attract customers who are subsequently cross-sold and upsold.
Why does Costco’s hot dog work? How do they prevent customer abuse? Would your business profit from a loss leader?
The 5 qualities that make a loss leader successful are:
- They create cravings.
- They facilitate cross-selling.
- They have a low cost-to-basket ratio.
- They cannot be abused.
- They are scarce or evergreen but never in-between.
Loss leaders must be craved.
To attract customers, a loss leader must be delicious, refreshing, fun, or sexy. That’s why Costco uses a hot dog and soda (delicious!) as their loss leader instead of a 24-pack of paper towels (boring.) Southwest Airlines outsold their competition in 1973 by offering a free fifth of whiskey (delicious) rather than a cheaper ticket (boring.)
Loss leaders facilitate cross-selling.
Turkeys are an excellent loss leader during Thanksgiving since the grocery store will cross-sell you other goods for holiday dinner. Flowers are a terrible loss leader on Mother’s Day because most people never buy more than one gift for this holiday. Make sure you can cross-sell your customers once they come in for the loss leader; otherwise, you are wasting time and money.
Loss leaders have a low cost-to-basket ratio.
Costco members know you rarely escape that store with less than $200 in your basket. That makes a $1 or $2 loss on a hot dog minuscule and easily overcome. When choosing a loss leader for your store, make sure you have at least a 100x ratio of loss to average basket size.
Loss leaders cannot be abused.
Choose items with shelf life or limited storability to avoid consumer abuse. I can only eat so many hot dogs in one sitting. Avocadoes spoil and are unreasonable to stockpile, making them excellent loss-leaders during The Superbowl. On the other hand, cigarettes and liquor are easy to stockpile, so you will rarely see them as loss leaders.
Loss leaders are scarce or evergreen but never in-between.
Evergreen loss leaders create habits. “My boyfriend and I love going to Costco for the hot dog special,” my colleague Lauren told me today, “It’s our favorite date.” Two-buck Chuck, the bargain wine sold by Trader Joe’s, is another evergreen loss leader that functioned as their leading marketing strategy for decades.
Other loss leaders use scarcity or a limited time offer to create a sensation. That’s how Black Friday door-busters work.
Whether you choose a scarcity or evergreen strategy, be consistent. Customer whiplash will damage your reputation.
Forecast your loss leader strategy.
Before you take the chance and commit to a loss leader, take time to update your strategic business forecast and see the impact on your financials. Calculate a break-even on cross-selling and take-rate. Most importantly, measure actual results against the budget to evaluate performance.