A loss leader is a pricing strategy where a product is sold at a price below its market cost in order to stimulate other sales of more profitable goods or services. Specifically, in retail businesses such as grocery stores the price of a loss leader is lower than the actual cost the retailer paid for the item.
Loss Leader Pricing
Toilet paper, milk and eggs are typical examples of loss leaders in supermarkets. They are sold at discounted prices so as to draw customers to the store, where they will also buy plenty of regular priced items. That is why you will notice milk and eggs are at the very back corner of the stores. This is because customers looking to buy these items will have to browse through other items and possibly purchase items where the store would make a greater profit.
Loss leader examples could range from essential items such as groceries to tools to electronics. Grocery stores employ loss leader pricing the most where they routinely advertise low prices on selected items. Other industries also use this strategy to introduce a brand, bring in new customers and liquidate old inventory.
Often businesses price a few items so low there is no profit margin. The goal is for shoppers to continue buying other products and become loyal customers after they buy the item with a low price.
Loss leader strategy works on the premise a small loss initially can lead to profits in the end.
Besides, these discounts could be put on highly needed essential items to make them your loss leaders. However, for a loss-leader strategy to really work, you should markup profits from other goods to cover the losses from the discounted item. A small loss, from the businesses’ point of view, is often required in order to make larger profits.
The key, however, is to generate higher customer traffic and volume purchasing.
When to Use Loss Leaders?
In addition, drawing customers to your store loss leaders have other advantages as well. By simply giving consumers good deals you can bring in added revenue to your business. Black Friday deals as well as holidays discounts employ loss leader pricing.
Loss leaders are also used in e-commerce. The cheaper the products are displayed on the landing pages the more chances customers will purchase other complimentary items. It is all about merchandising, particularly visual merchandising. You will need to have customers know there is a special incentive/offering for them to act on it.
Doing Away with Excess Inventory
This pricing strategy can be implemented during a change in season. For example, retailers can advertise discounts on summer clothes or barbecue grills to make way for fall and winter holiday merchandise. The attractive deals entice customers to help reduce your stock of items that are on their way to being out of season. Similarly, if there is a new model of a cellphone coming into the market you can make discounts on the older versions to make room for the new model.
Retailers can clear inventories quickly during special days/events and quickly sell new inventory with reductions in price.
Selling off Perishable Items
Perishable items such as food and drinks can be put down as loss leaders before going bad to mitigate losses. Very often these loss leaders are put on sale for a short period of time to generate a sense of urgency among customers.
For Opening New Stores
This pricing strategy can be an excellent way to attract shoppers to a new location. Customers who might not enter your store might want to take advantage of a particular pricing deal. This will help you build a customer base in the early stages of your store.
This is why loss leader pricing is also referred to as penetrating pricing. Some retailers even offer free gifts to the first hundred customers in line to drive up demand and push more people into their stores.
Loss leader pricing can be an alternative form of marketing. Here the seller is basically paying customers in the amount of any losses sustained to enter the company store. It could be introductory pricing.
For example, a service provider like a telecom company can offer a low introductory rate to entice clients to use its services. Then, after gaining the customer base, the company then raises its rates. The rates could be very low sometimes at a loss for the initial period. This will attract new customers or lure customers away from the competition.
Another instance includes when stores offer free samples of food to customers.
When customers buy other items in addition to the loss leader, you make a larger profit based on the volume of purchases from customers. By choosing your loss leaders and complementary products, you can actually use loss leaders to encourage purchases of other items in your store.
A discount on ties or scarves can help entice customers to purchase a shirt. Another example of a loss leader is the case of free copies magazines give with the subscription purchase.
Challenges of Loss leaders
As much as this pricing strategy is able to help boost sales, it also comes with risks you should be aware of. Here are some of the possible risks to keep an eye on.
Risk of loss
Businesses may incur a substantial loss from this strategy if they do not monitor closely sales of other items positioned alongside the loss leader. The risk is customers may buy only the loss leader also known as cherry-picking. In addition, if you have a high frequency of discounts you might inadvertently be encouraging your customers to hold off purchasing until you announce the next discount.
Running out of Stock
Once you decide to turn a product into a loss leader you will need enough of it to continue to make sales. You cannot afford to have a product you are leveraging to draw in customers to run out.
If the loss-leader price is too good to ignore, customers might buy it in bulk and then stockpile it for later use. You can avoid this issue by limiting purchase quantities or only offering products with a limited shelf life thus preventing stockpiling.
If you continue with the high discount you risk giving the impression the product should have a lower price at all times. Impacting sales of the item when it returns to its normal price.
Furthermore, those who purchase only loss leaders will often believe other items in the store are marked up ridiculously high.
Impact on small businesses
Large corporations with their deep pockets benefit the most from loss leaders. They can also leverage their purchase volume in their negotiations with the suppliers and can get the cheapest offers. Since their costs are lower, their loss from loss-leading pricing is smaller when you compare it to small businesses. They can afford to take a hit on some products to enjoy gains on other items. Small businesses can’t afford to cut prices so steeply as such and loose out.
Loss Leader Strategy
The loss leader strategy may seem simple but is tricky. There are no guarantees a business will make more money by losing money on certain items.
To mitigate this, you might want to put in place a rewards program. By encouraging frequent customers to earn discounts the product behind the discount will retain its value. This brings in the impression the low price is a special offer they have earned themselves. Airlines use frequent flier rewards to encourage loyalty. In the same token credit card companies provide perks for using their cards while purchasing.
Make sure you assign the right product to the title of a loss leader. When an obscure, unpopular product has its price drastically cut, it may not catch anyone’s attention. If your loss lead is a common product customers buy regularly, you have a higher chance of them purchasing it.
Pricing is important for the success of Loss Leader. The price can’t be so low your business is not able to recover the losses. So you make sure to decide on the price carefully; in such a way the loss has to lead to buying more products. It is important you make up for your loss on other sales
Though loss leader pricing is a good strategy towards building traffic to a store you would need to ensure you are actually generating an incremental profit, rather than a substantial loss. The careful combination of discounts and reward systems will help mitigate negative perceptions of your products by customers.