Risking Fearlessly

Unfamiliar with lossless systems?

This article references lossless systems multiple times, if you want to know more about them check out our blog on Lossless Systems.

Most businesses know the saying: “you have to spend money to make money.” But spending recklessly can dig your company into an early grave.

Lossless systems stop accidental losses, but how do you take intentional risks without opening the door to disaster?

Running a sale

Let’s say that we’re a 2-way marketplace selling retail goods. Sellers list products on our site, then we sell them with a markup to consumers. In order to keep things simple we’ll say that we add a 30% markup to every item.

Here is a small sample of what we sell and what our margins look like:

#	Item	Customer Pays	Seller Gets	We Get
1	Custom King Size Comforter	$356	$249.20	$106.80
2	Humorous Coffee Mug	$17	$11.90	$5.10
3	Lizard Pencil	$3.99	$2.80	$1.20

It’s our slow season and the marketing team wants to run a $5 off sale to help drive traffic. We apply it to the catalog to get an updated breakdown:

#	Item	Customer Pays	Seller Gets	We Get
1	Custom King Size Comforter	$351	$249.20	$101.80
2	Humorous Coffee Mug	$12	$11.90	$0.10
3	Lizard Pencil	$0	$2.80	-$2.80?

Ok, now with this sale applied we are still way in the black for item 1, and we’re breaking even on item 2. However, item 3 is now actively losing us $2.80 (the amount we owe to the seller) on every sale.

It might seem obvious that we’d want to exclude item 3 from the sale, but we’ve got a super large catalog and it isn’t viable to review every product for every sale.

We make the decision that we’ll just keep the sale going for all items, and if we lose a bit of money we’ll write it off as a marketing expense.

A ticking time bomb

The sale goes well — at first. It’s driving a lot of traffic, and although we haven’t seen the bills yet, we don’t think it’s costing us too much money. Our best data analysts are seeing signs that the volume from the discount is offsetting the reduced profits.

Unfortunately for us, there is a sub-culture of deal hunters on the internet who love free stuff. Worse yet, they figured out that if you buy two items the remaining $2.20 off the lizard pencil discount will apply to other items in the cart even if they are also using the deal. This effectively loses us $5 on every pencil sale instead of the $2.80 we were expecting.

Then they post it on Reddit.

Now in a matter of hours we have millions of pencil orders - more than half of which contain at least one other item that was inappropriately discounted. We’re now staring at millions of dollars in potential loss, and hundreds of hours of ops work and customer outreach if we want to try to roll back all these orders.

At a minimum we’re looking at serious brand damage and support costs. At worst we’re legally required to honor the deal for every item.

It might sound far-fetched for a simple sale to explode like this, but it happens all the time. The wall of fine print around promotions was born, at least partly, out of stories like this.

This is where lossless systems come in: not to entirely prevent all loss but to contain it.

Reining in loss

So how can lossless systems help with a mess like this?

Like the name suggests, lossless systems are designed to prevent actual loss from happening, but they are ok allowing reduced profits. As long as the net total is above zero there is no problem. So customers buying item 1 or item 2 won’t have any issues.

Item 3 is problematic though. Since the system doesn’t allow loss, it will actively block the purchase.

In a lossless system money always has to come from somewhere and right now there is nothing providing the $2.80 for the seller portion of the pencil. In order to allow the sale to apply to item 3 we need to create a pool of money that can contribute to the purchase. We’ll call this a loss budget.

For this example we’ll set a loss budget of $200,000 for this specific sale.

Now, when someone goes to buy a lizard pencil with the discount, we’ll use money from the loss budget to cover the unpaid customer cost.

Protection by default

Now that we have a budget, and we’re counting it down for each discount that would lose us money, the system will automatically start blocking lossy sales once we’ve hit the maximum.

This means that even if the pencil sale goes viral, and even if our discounts end up working in a way we don’t expect that the system will automatically shut down purchases that would exceed the amount of money we decided on in advance.

In the meantime, however, purchases that don’t cause loss will continue to work as expected.

This is the great synergy between lossless systems and intentional risk. It forces you to make a business decision to accept loss, and then budget for it. The second that we go over budget the system immediately takes action to shut it down. If the sale is actually just going great, and you are seeing the results you want you can just add more to the budget and it’ll go right back to working.

Requiring budgets that are strictly enforced transforms a risky promotion into a controlled experiment. You can set your limits, measure results, and expand only if it’s working.

Broader budgeting

What if you don’t want to budget just for actual loss, but also for the reductions in profit due to the discount?

Not a problem. All you need to do is consider the profit margin as an expense for the purchase. Now when we draw from the budget we’ll always pull the full amount due to the seller as well as our normal profit margin.

Now our budget will enforce the effective total cost of the discount, including the lost profits. This means that you aren’t just protected from catastrophic losses but also in full control of profitability.

Is this a big deal?

You might think a flat 30% margin makes promotions simple. But in the real world, pricing isn’t that tidy. You’ll probably face complications like:

• Varying markup rates from vendor to vendor
• Some sales might be partially funded by the sellers (you split the discount 50/50 instead of eating it all)
• Things like shipping that complicate the purchase math (even more so if you also mark up shipping)
• The customer might be using multiple discounts together
• Exchange rates might make the cutoffs difficult to broadly state
• A whole host of other things that you’ll run into as you grow your business

Together, these concerns mean you’ll need a team of analysts to try to figure out how to run a promotion that won’t lose you too much money, but even with their hard work it’s just not possible to do by hand. Worse yet, if they are wrong you won’t even know that you’ve lost more than you wanted until months later when you’ve settled up with all your sellers and closed your books.

The beauty of lossless systems is that all of this is enforced for you programmatically. You’ll still need to make some tricky decisions about how much to risk on your promotions, but you will never lose a single dime more than you want to.

• It doesn’t matter how complicated your pricing is.
• It doesn’t matter how complicated the incentive is.
• It doesn’t matter how crafty your customers are at finding loopholes.

You are always in full control of everything.

Ready to grow faster without gambling your future?

Let us show you how lossless systems let you risk with confidence, not fear.

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