game-theory
, competition
, loss-leader
The specific example I am thinking of is SCUBA tank fills, but the problem is generally applicable to many markets. In the SCUBA market, local dive shops (whose start-up costs are at least $300k and are more typically $1m) have traditionally sold tank fills at or below cost, to ensure that customers stop in regularly and buy (high-margin) gear. Now that internet sales are driving LDS’s out of business, in some regions (the Mid-West in particular), fills are reportedly quite hard to come by, with some individuals driving a few hours round trip.
In response, individuals are building their own compressor setups (to get a sense of the efficiency loss here, a basic set-up costs $4-5k, and a fill costs $6-8).
Has the “loss-leader” aspect of tank fills kept a market for fill-only shops from developing? Is there a theoretical model what would give better insight into this phenomenon, and if so what interesting conclusions result? Any empirical evidence from other markets?
Trade dumping (or predatory pricing, depending on your level of malevalence):
occurs when manufacturers export a product to another country at a price either below the price charged in its home market, or in quantities that cannot be explained through normal market competition.
When it happens within the borders of a country it is called loss leading (unless you're Chris Anderson at Wired and think you've invented something new, when you call it Free! Why $0.00 Is the Future of Business) and is a viable and effective business strategy.
Companies are unable to sustain a loss-leader (or a "dumped" trade) for very long as it destroys their capital. The only reason to do so is if it creates an advantage in selling other products. As you identify, dive shops offer low-cost tank fills in order to drive sales of high-priced equipment much as did King Gillette did with his razer handles in order to sell blades. That works as long as no-one offers blades as a loss-leader, or massively cuts margins on high-priced dive equipment and ruins the pricing strategy.
To rephrase your question for the general case, what happens when one company's critical profit-driving products are selected as another company's loss-leaders (or, more reasonably, their optimised main products)? For instance:
There are strategies which companies can adopt to counter the undermining of their primary income source:
In a slow-moving market companies will adopt different pricing strategies in order to adapt to changes in competitor practice. However, where change happens rapidly then it leads to disruptive innovation which may happen too quickly for adaption, or from an unseen market area. HP, for instance, may have waited too long to adapt their strategy to changing market conditions.
I would imagine, however, that some of your SCUBA shops will experiment with alternative models and the winners will then move into the spots vacated by their less adaptable counterparts.
This seems like you are blaming the horse because the wagon lost a wheel. The business is losing sales to internet companies selling at a lower margin. While selling the tank fills below cost is not helping the bottom line, it is not the cause of the failure of the dive shop to sell profitable equipment. The failure is the business not adapting to the changing market to remain competitive. There are lots of marketing models that can leverage the commodity purchase like a tank of air, to increase sales of profitable items and services.
The problem with Air becoming a profitable commodity on its own is that it is a relatively low volume product. Soda is regularly used as a loss leader at supermarkets. But that does not prevent the sale of individual bottles for huge profit. But this is a high volume market. I suspect that if bottled air were higher volume of sales then you would be able to compete though service, or quality. But it is low enough volume that there is no driver to reduce quality standards to achieve efficient distribution. Also because it is a niche industry already service standards are already high.
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