Loss or Top Leader??

In order for companies to become listed they have to go through rigorous checks, have a substantial mount of capital and maintain and endure demanding rules at the time of flotation and in subsequent years. However once listed the options and networks available for companies become endless. The London Stock Exchange for example in 2010 had around 3,000 companies from over 70 countries, with £20.8 billion being raised and traded on their market (London Stock Exchange, 2012). Whilst the decision to ‘go public’ should not be taken lightly the reasons for a company becoming listed are clear.

The hard work however doesn’t end there; many companies are then faced with issues of ‘How are we going to finance our operations’?

A primary source is through external sources: Equity finance, issue of new ordinary shares and Debt finance, variety of loans and debt securities. Both of these sources are risky, debt finance is much cheaper but can become a burden whereas in financial difficulties companies are under no obligation to pay dividends but equity finance means a dilution of company control.

In order to entice investment, companies need to offer returns to shareholders; equivalent to the risk they are undertaking. Therefore many companies have adopted a mix of both equity and debt to finance their activities, this is known as the ‘Weighted average cost of capital’ (WACC).

This begs the question ‘why do companies sometimes have projects, offers, products or services which are referred to as ‘loss leader’, with a return below that of the WACC’??

For example the Bugatti Veyron is one of the world’s most rare, expensive and fastest cars.  With a two-year waiting list and a UK price of £850,000 it is Volkswagen pivotal product. However incredibly, development of the supercar is rumored to be in excess of £2million per car and sold at a loss.

I ask myself why make it then, especially when I wouldn’t otherwise associate Volkswagen as a premium brand?

However Volkswagen argues that thanks to the supremeness and status of the Veyron, it has helped raise the group’s profile. Whilst this may seem like a drastic and expensive corporate strategy, if it is positively impacting and stimulating profitable sales in the Volkswagen group then it is an effective and seemingly feasible strategy.

Therefore I believe that sometimes companies need to adopt the strategy of ‘loss leaders’ in order to raise their profile and increase their external finance options.