Definitive Guide to Loss Leader Pricing
Imagine that you are a retailer who sells a variety of goods to consumers. Of course, you must first purchase your merchandise from the suppliers and manufacturers who sell the goods in the first place. Now according to normal business sense, you would say that it makes complete logical sense to sell it at a higher price than the purchasing price. That is how businesses make a profit. That is how they maintain a profit margin.
This seems understandable and something we can all agree upon. Now what if we told you that some retailers actually decide to sell their products at a lower price, thereby incurring a loss instead of a profit on the goods sold. You might find that hard to believe. “Why would any retailer sell at a loss?” This is actually a common practice employed in the retail business and you have most likely bought goods in this manner.
Loss leader pricing is the act of selling goods at a lower price than their purchasing cost, thereby effectively selling them without earning a direct profit. It might be puzzling as to how this business strategy makes sense. Luckily, this guide on loss leader pricing will solve that puzzle for you and clarify any questions you have on the subject matter.
We will explain the reasons for retailers implementing this sales and marketing strategy as well as the manner in which it is employed. We will also give examples of loss leader pricing to give you a better idea of this particular sales promotion strategy.
WHAT IS LOSS LEADER PRICING?
Before we describe the reasons and benefits of implementing loss leader pricing, we will formally define the term to make it clear for this entire report.
“An aggressive cost setting strategy where retailers set the price of goods below the market cost to attract customers.” – Business Dictionary
In addition to this definition, it is worthy to note that the product or service being sold below the market cost is called a loss leader. For instance, grocery stores and department stores use loss leader pricing to promote their goods, such as some fruits and vegetables, to get more customers to buy their other products on the shelves.
It gets customers to come through the door and see you vast selection of merchandise that you are offering that could intrigue customers. This is actually the ulterior motive for businesses to use loss leader pricing and enhance their profits on the other goods. While customers are at the store, they will see other profitable goods and be enticed into buying them.
STRATEGY AND BENEFIT OF LOSS LEADER PRICING
Loss leader pricing is a very effective sales promotion technique to get more people to enter your store to buy more goods. When these customers purchase loss leaders, they are inherently saving money on buying goods. As they believe they are saving money, they can used this “saved money” to buy other things from your store that are priced much higher to make a profit.
This works in your favor as a retailer because you get to sell your loss leaders and the products that are set at a higher price. Ultimately, you make a profit by selling the goods.
These products are actually called loss leaders because they “lead” customers into buying other products from your store that are priced higher. Loss leaders play an integral role in a company’s sales and marketing strategies. We have summarized some key advantages of the loss leader pricing method.
Advantages of Loss Leader Pricing
- Increasing Sales – By offering selected products at a much lower price, you as the retailer can make profits on the goods that your buyers will purchase with their savings. You directly increase exposure on the loss leaders and you indirectly boost exposure on the leads. This will actually increase your sales.
- Exposure to New Stores – A very good method to get customers into going to one of your new outlets is to offer goods at a very low price. The enticing prices you set will get more people to go there and your new outlet will flourish just as well as any of the other existing ones.
- Clearing Inventory –When your outlet is about to receive a new stock of goods but you are still holding on to older goods on your shelves, you need to find a way to get rid of them. Loss leader pricing is a good way of quickly eliminating merchandise to make room for your new stock.
- Marketing – Loss leader pricing is a great sales promotion strategy to quickly promote some new products by selling them temporarily at a very low price. This draws in more customers and helps spread the word about your retail store.
HOW TO EFFECTIVELY IMPLEMENT LOSS LEADER PRICING
Although it is an amazing marketing strategy, loss leader pricing needs to be applied correctly in order to reap the benefits. Otherwise, you will only experience losses. Years and years of research have shown that product placement plays a key role in driving more sales.
Additionally, the type of products you set as loss leaders will determine how much money you actually earn as profits. Some products simply sell better than others do. That is where conducting market research on your consumer base is very important to realize exactly which products should be discounted and which ones should be sold at a higher price.
This is where the loss leaders need to be clearly defined in your store. They should be placed at the end of an aisle or at the back of the store, far away from the entrance. This forces customers to walk all the way to the end to actually get it. While you want to make the customer experience as easy as possible, you also want to expose them to other interesting products along the way. This is your opportunity to strategically place your leads in locations and arrange them in such a manner that attracts customers into buying them, too.
Make sure you assign the right product the title of loss leader. When an obscure, unpopular product has its priced drastically slashed, it may not catch everybody’s attention. The product is not well known by everyone. However, if your loss lead is a common product that everyone buys regularly, you have a higher chance of people purchasing it. They are aware of the normal price and will instantly realize the sweet bargain they are getting with the price slashes you set on them. Therefore, loss leader pricing is usually a successful technique when it is performed on the right products.
There are certain times of the year, like in winter and in summer, where loss leader pricing is very effective and can drastically boost your sales. During Christmas, retailers generally provide sales on all goods but some are more discounted than others. When you badly need to clear some merchandise during the holiday season, make those goods your loss leaders. Everything else can be your leads.
As a result, you clear your inventory and sell more of your leads. The same can be applied in mid-summer sales to get rid of some goods that you do not want on the shelves in the upcoming colder seasons.
Disadvantages of Loss Leader Pricing
We do not want to paint this marketing strategy as a perfect method that has not drawbacks. Every marketing technique has some drawbacks that definitely need to be considered. Failure to consider the downsides of misusing or mishandling loss leader pricing can result in major losses with no returning profits whatsoever.
We have listed some of these problems below. We also gave you some details on the measures you can take to avert them to get the best out of this tactic.
- Risk of Loss – Some companies have some loss leaders and some leads in their stores but they never analyze the sales of the products and pairings. This could lead to significant losses, as having products drastically discounted does not guarantee a boost in sales and an increase in profits. Always monitor and evaluate your sales on these goods and determine if you are satisfied with the results. If they are less than anticipated, then it is best to change things up and determine new loss leaders and leads for your retail store.
- Cherry Pickers – One major problem that is closely associated with loss leader pricing is the presence of “cherry pickers”, buyers who only buy the goods that are discounted but they never consider buying the other products that are you leads. Some buyers cherry pick the best deals when they go shopping. Hence, they are termed cherry pickers. This poses a serious problem to retailers because the regular priced items, your leads, are never being sold. In order to curtail this issue, restrictions are placed on the number of loss leads you can purchase at any given time.
- Stockpiling – Another frequent problem of this marketing strategy is when customers purchase in bulk because they are getting a bargain for now. They want to cash in on the situation and they think that they do not have to buy it again in the near future. Just as with the problem with cherry pickers, retailers can curtail the quantity of goods bought by any given customer.
- Possibility of Deception – If the goods are being sold at a discounted price for too long, then customers will start to think that the discounted price is the regular price. When you decide to discontinue the loss leader pricing scheme, then customers will instantly notice it and studies show that retailers experience a drop in sale. In order to prevent this issue, clearly state that the discount is limited time offer with a definite end date. As a result, your unit sales will not drop after you stop giving discounts.
EXAMPLES OF LOSS LEADER PRICING
You have a good idea of the basic concepts of loss leader pricing as a marketing strategy and how it can be used effectively to benefit retailers. Additionally, we would like to present some cases where loss leader pricing are used to generate more sales and increase customer base. This will help you see how beneficial it can be and perhaps you can implement it in your retail business in some manner.
Example 1 – Perishable Groceries
Fruits and vegetables do not last forever. You refrigerator helps to extend their lifetime, but that is only by a few more days at best. In grocery stores, these goods are not even contained in a cold environment but they are stored in baskets and crates usually at room temperature. Eventually, fruits and vegetables will rot and because many people buy these goods based on their appearance, it becomes very difficult to sell them. This poses a major problem to grocery stores, as they need to get rid of their inventory to replace it with a new batch of perishable goods.
A typical technique that stores like Kroger, Costco, and Walmart use is to sell these products at a ridiculously low price, so low that is below the market cost. It may seem as if they are selling at a loss but in fact, they are actually making a sizeable profit on other goods. These supermarkets will strategically place these perishable groceries at the back of the store so that consumers walk through the entire store to get there, looking at other things along the way.
Supermarkets use this opportunity to promote other products (leads) that are similar to the goods being discounted (loss leaders) that may encourage a purchase in shoppers. As a result, the supermarket gets rid of their older goods and buyers will spend more money because they have saved money on some groceries and can use their savings on other things.
Did you ever notice why some goods, particularly milk, are always at the very end of a supermarket? It is a highly consumed product and several studies show that many people go into a grocery store just to buy a carton of milk. Many people open their fridge and realize they have some things but they are running out of milk.
Grocery stores successfully take advantage of this situation and slash the price of milk on several occasions while promoting other goods, too. Markets sell more milk (which quickly rot) and they sell other goods where they make their real profit. A win-win situation.
Example 2 – Free Samples
Loss leader pricing is commonly implemented in supermarkets and grocery stores. The example above clearly demonstrated that. Another instance of these stores using this marketing strategy is when they offer free samples of food to customers. We are sure that you have seen this before.
You are walking down the aisle at your local supermarket, looking for something to buy, and you see a salesperson standing by a stall offering shoppers free samples of some food. This is a good way to introduce customers to a new product during a soft launch. Besides receiving free samples, customers sometimes receive coupons that they can redeem on their subsequent purchase.
The reason why this method is effective is due to psychology. When you receive a free sample of a new product and are sweet-talked by the salesperson, you feel compelled to buy the product. While there will be some who just eat the free sample and walk away, they are heavily outnumbered by the number of people who taste a sample and then feel compelled to buy the actual product. Psychology plays a key role in selling goods and loss leader pricing plays with the buyers’ psychology. They subconsciously feel obliged to buy the item after sampling it.
You give out a tiny amount of your product to customers for free but you can quickly move large amounts of it out of the store with this method. It effectively nets you more customers that you did not have before. This is a secondary effect of loss leader pricing by giving away samples – acquiring new consumers and keeping them.
Here is q quick introduction to the psychology of pricing.
Example 3 – Black Friday and Cyber Monday
If there is one time of the year, where shoppers look for the best deals on the marketplace, it is definitely the Friday after Thanksgiving. It is called Black Friday, the biggest and wildest shopping experience that originated in the US but has now spread throughout the world. Retail stores slash the prices on several of their products that customers are very familiar with.
Retailers, such as Walmart, K-mart, Toys R Us, and Best Buy, just to name a few, give promotional offers on selected things like toys, apparel, and electronics. There are instances where buyers can grab something at 50% off the usual price! That is a steal in everybody’s eyes and they instantly run to the stores on Black Friday to buy something at their heart’s content.
By saving so much money on selected goods, they feel like they can use their savings and spend it on something else in the store. This is where retailers make their money. You might think that stores incur a significant loss by selling all of these heavily discounted goods at a low price but to the contrary, they benefit greatly from this. Retail stores can clear inventory quickly during Black Friday and quickly sell new inventory with these massive reductions in price.
Likewise, another holiday takes place a couple of days after Black Friday that has the same intentions, only that it is conducted online. This event is called Cyber Monday and on this day, online retailers such as Amazon and EBay offer massive sales on several products. Many people are too busy enjoying Thanksgiving on Thursday and enjoy it until the weekend.
The only time they have to buy something is on the Monday after Thanksgiving. Hence, Cyber Monday began and online retailers took advantage of this. These retailers receive the same benefits as other ones do on Black Friday. Loss leader pricing works wonders when giving massive sales.
Example 4 – E-commerce
We primarily talked about brick and mortar stores until now, although in the previous example we briefly mentioned online stores. We would like to dive deeper with online retailers and the manner in which they implement loss leader pricing into their marketing strategy. E-commerce is a great place to employ loss leader pricing to attract customers to your website and generate traffic.
Amazon and EBay started the online business trend by offering users special discounts on selected goods. If you ever go to their sites, you will see landing pages or banners of promotional offers on some products. When you click on them and view the actual product, you will notice something else that entices many online customers. There is a section called “People also viewed” to attract customers to view other products that may not even be discounted.
Let us analyze this a little bit. The goods being promoted are the loss leaders because the online retailer wants to attract viewers into going through their website and see the goods. In doing so, the viewers will be exposed to other products, or leads, that are at a higher price but just as appealing. Typically, the leads are related to the loss leaders to get more people into viewing them and even buying them. This is a very good way of increasing sales.
Following the success of these tactics by Amazon and EBay, many brick and mortar stores decided to follow suit and create their own e-commerce solutions for buyers. Now major retailers like IKEA, H&M, and Best Buy have online stores using loss leader pricing as an effective strategy to entice more customers into buying goods online and increasing traffic to the site.
Example 5 – New Outlet and New Competitor
A very good example where loss leader pricing is very effective is when a retail chain opens a new outlet. Shoppers are used to frequenting a particular outlet of a brand because it is convenient for them. When a company decides to create a new outlet to reach new customers in different locations, it still wants to drive customers into coming from other locations to boost sales even higher.
For instance, consider Lidl, one of Germany’s largest retail chain stores. They have plenty of outlets everywhere but they still plan to expand to other locations to acquire even more customers. In doing so, they are entering areas where their competitors exist. They have stiff competition because the consumers in that area are accustomed to the competitors, not to this new retailer.
This is where loss leader pricing comes into play. Lidl will offer crazy offers on selected goods, selling them at a much lower price than any of the competitors are currently doing on the market. In addition, Lidl will tell customers of their other nearby outlets that there are amazing deals available at the new outlet.
While it may be an inconvenience to drive all the way to a faraway outlet, people ultimately want to save as much money as they can. Retailers know this and capitalize on it. Next time you go to a new outlet of any store, take notice of the amount of special deals they give only at the new outlet. This is all done to drive more customers into their doors and get them to buy the loss leaders but more importantly, the leads.
A similar situation arises when a brand new company bursts onto the scene. In order to stand a chance against existing, well-established competitors, they need to shake things up and offer amazing deals on their products. A very good example of this was when OnePlus, a Chinese smartphone manufacturer, launched their flagship high-end phone, OnePlusOne, in 2014.
In that year, Apple and Samsung were the definitive market leaders with very large consumer bases. OnePlus made the decision to retail it at a staggering low price of $399, much lower than many of the other high-end models on the market that retailed for around $599. That is $200 dollars cheaper!
In doing so, OnePlus had a loss leader on their hands that attracted many customers who wanted to use a high-end flagship model but at the price of a mid-range model. They had that in the OnePlusOne. After the successful launch of this smartphone, OnePlus grew their customer base was able to generate more sales on their subsequent model, OnePlus 2, which was retailed at a higher price. They successfully created trust in their customers and generated sales to conduct more research on their future smartphones. This shows how loss leader pricing can be very effective for new companies, too.
Example 6 – Summer and Winter Sale Clearance
We have all seen this before; it is nothing really new. Clothing retail stores give massive sales during the middle of the summer and in the holiday season to get more customers to buy their products, thereby raising sales. The other reason for giving these massive sales is to clear inventory. When the summer starts, stores stock up on summer clothes, like bikinis, shorts, and t-shirts, because it is the perfect season to wear them. By the middle of summer, retailers want to get rid of all of their merchandise to make way for the next batch of goods, i.e. winter clothing. Hence, stores like H&M and Zara slash the prices on their summer apparel to quickly sell them and clear space on the shelves.
Likewise, clothing retail stores stock up on winter clothes, such as coats, jackets, and scarves, to get more people into their store and buy them. When Christmas fast approaches, retailers give mega sales on many of their winter apparel because they want to boost their sales. Besides, winter will eventually end and retailers need to clear their stock of goods quickly before the impending summer season arrives. As a result, some stores even give more winter sale clearances well after Christmas.
Holding on to inventory is a major loss for clothing stores. For example, having leftover summer clothes in the winter season serves no purpose and simply wastes space in your warehouse. When that happens, you are unable to sell them because no one will buy them in the wrong season. By the time the next summer rolls in, you older clothes are out of season and the trends have changed.
Therefore, clothing retail stores do everything they can to sell their merchandise before the next season arrives. Even if they sell it at an extremely low price, it ultimately helps them by being able to sell the new merchandise at a regular price. This is how loss leader pricing is implemented in apparel stores.
We went through the key concepts of loss leader pricing, the manner in which it should be implemented to reap the biggest benefits, and the measures you should take to prevent any losses from this marketing strategy. If you are a retailer, you should definitely consider this strategy to clear your inventory of older merchandise and quickly boost your sales by using loss leaders to sell more leads.
We also presented some examples to help you visualize how loss leader pricing is implemented in various situations. We are sure that you have experienced some of them firsthand and are now aware of the entire process. As a retailer, you can now implement them in your own retail business to boost your sales. It is all about merchandising, particularly visual merchandising.
For someone with very little to no background in accounting or financial matters, making business …