When Losing Money Makes You Money
McDonald’s (The corporation, not the workers) isn’t a big fan of orders that ONLY include sandwiches.
The profit margin on these sandwiches are incredibly low compared to other items like soda or fries.
If you ordered $15 worth of Big Macs, McDonald’s makes less money than if you were to order a Big Mac meal that costs $15.
Related to this is the idea of a “loss leader”. Sometimes companies sell a product at a loss, only to make that back elsewhere. For example, video game consoles are usually loss leaders, especially towards the launch of a console. Sony sells each PlayStation at a loss, but makes their money back when customers pay for online multiplayer access or when they buy PlayStation Games.
I think the idea behind the “loss leader” is a simple one, but it is an example to show that real world business decision making doesn’t always have to be restricted behind the ideas of surface level accounting ratios.
I was once working on menu pricing with a client, and it was our goal to price items so the COGS would be around 30% of the item’s price. We worked through the menu, and made small adjustments here and there until we got to one specific milkshake. We did the math and realized that if we were to price this drink so the same 30% ratio was maintained, the drink would be a ridiculous price (something around $25). I asked if he could change the drink, or make it smaller to lower this cost, but in response they explained the concept of loss leading without even realizing.
He said, “I understand that this product doesn’t hit our goal, but I don’t think it would be a good idea to increase or change the price because
1) They are iconic to our brand, and
2) Whenever someone buys this milkshake, they usually buy a ton of other things. It brings customers in who spend a ton of money on other things as well.”
Since we established that the milkshake was a item that enticed people to buy other more profitable items, we decided that the milkshake being a little bit less profitable was well worth it.
Long Story Short, when going through processes like menu pricing, it is important to think about your margins, but you should be thinking a couple of layers deep. Not every single item needs to have a 30% COGS ratio for your COGS to actually be 30%. It is easy to look at an accounting ratio and try to change everything to try to achieve that ratio, but you have to think about the actual business reality behind each decision made, not just the numbers.
The business reality affects the numbers more than the numbers affect the business reality.
