Loss Leaders

Many HME companies that have applied activity costs at the product level have been surprised to learn that some products are real losers. In other cases, the products were believed to be losers, but the amount of the loss had never been quantified.

Regardless of the amount of the loss, there seem to be three thoughts after the realization that a loss is created with each delivery of a product: (1) Let’s think about this; (2) We can’t drop the product from our offering; and (3) The product is a loss leader.

A “loss leader” is an item that is priced below cost to attract customers who will then presumably purchase other profitable products. There can be good reason to use loss-leader pricing strategies. Selling 10 items with a net loss of $50 each ($500 total) in order to sell two items with a net profit of $1,000 each ($2,000 total) is 50 percent better than selling no items at a loss while selling one item with a $1,000 net profit.

With HME’s declining reimbursement rates, it is just as important for providers to manage loss leaders as it is for Wal-Mart to manage them. This can be done without the powerful computing technology that large companies use, but it cannot be done without mining the data in the billing system. Here is a way.

Consider first that your company is reasonably profitable and that net profit is not declining at an alarming rate. List the products you consider loss leaders and those that are most desirable and profitable, your “target products.”

With this list, query the billing system to get a list of referrals for the last six to 12 months. The data should be sorted first by product and then by referral source. The result should resemble the following:

Next, count all of the referrals for loss leaders and all of the referrals for the profitable products, and express them as a ratio, i.e. 1.5, meaning that there are 1.5 (6 divided by 4) loss leader transactions for each target product transaction. This ratio becomes the benchmark for the company, and managers should keep it from growing.

One way to manage the ratio is to manage the referral sources. In the example shown, the ratios for the referral sources are:

Clearly, referral sources “A” and “C” require some management decisions. “A” is above the benchmark for the company but is referring the target product, and “C” is above the benchmark and not referring the target product.

Prudent sales management dictates that a remediation plan should be designed for “A” and “C.” The plan could be as subtle as changing the sales message or as drastic as not accepting referrals from the source. Referral source “B” is carrying the day for the other referral sources. This value should be recognized and protected.

If your company’s profitability is lower than your want or is falling, the management of loss leaders requires the same data and analysis. There are two big differences. First, the ratio of loss leaders to target products must decline from whatever the benchmark is. The decline in the ratio will improve profitability so long as all other factors remain constant.

The second big difference is that loss leader management alone may not be sufficient to correct the profitability of the company. In these cases, there may be additional work needed for sales growth, business process reengineering and target marketing.

In all cases, however, reducing the mix of unprofitable products will increase profits.

Wallace Weeks is founder and president of Weeks Group Inc., a Melbourne, Fla.-based strategy consulting firm. He can be reached at 321/752-4514 or by e-mail at [email protected].