Make Sure Your Business Model Includes Profit Up Front
Venture capitalists do not appreciate hearing about a business model that includes the words, "I'll make it on the back end." When working your business model and thinking about investors, make sure you can see profit right away.
This business plan calls for sacrificing today in the hopes of a better payday later. The loss leader concept utilizes this strategy. Get the customers in the store for cheap lettuce, and they’ll spend money on other, higher margin, items.
This profit model worked much better pre-Internet. Customers are much more informed today and know what items should cost. Luring them in with loss leaders in hopes of getting them to pay a premium for other items is getting tougher and tougher. Customers simply matriculate to another vendor offering your high margin items as a loss leader.
The Groupon phenomenon is a perfect example of this issue. Retailers deeply discount an item on Groupon in hopes of getting a new customer. The data say that a very small percentage of Groupon users become new customers, leaving the merchant selling items below cost. The hope of making it up on the back end with the business gained from a new customer has never materialized.
Some business models still use this concept effectively. McDonald’s, Wendy’s and Burger King have used $1 menus to drive traffic and upsell to more expensive meals and high-margin sodas. Gas stations make little or no money pumping gas but have outstanding margins in their convenience stores. Before you use this business model, test your assumption that you will make it up on the back end.