Loss Leader Pricing
Posted on 29 January 2020 Conjoint.ly
The loss leader pricing strategy requires extensive planning and research, or its execution will be a failure (and a costly one too). The logic behind this strategy is that selling a product at an extremely low price will draws large numbers of customers to a business, who will also purchase more expensive items in the process.
Essentially, loss leader pricing relies heavily upon the belief that the ‘loss’ incurred from selling a product at so cheaply will eventually ‘lead’ to higher sales volumes and profits in the long run. In this sense, loss leader pricing is not dissimilar to penetration pricing – a strategy wherein businesses introduce a new product to the market at an extremely low price to drive sales volumes, rather than revenue or profit goals.
Maximising sales with loss leader pricing is only achievable through an in-depth understanding of how this strategy works, when to use it, the risks involved, and an overall assessment of whether or not this is the right strategy for your product. This article further explores these elements to help you gain a further understanding of loss leader pricing practices.
How it works
There are many ways in which a business can implement loss leader pricing, with all having a general rule in common; selling at a loss will lead to more sales. Another shared trait among loss leaders is that they tend to thrive on necessity, i.e. the loss leader cannot fully function without the purchase of another, more expensive product. Here are some common examples of loss leaders:
- Razor + Razor blades: Razors are usually priced quite low to entice customers to make a quick purchase. However, customers must replace disposable blades after only a few uses and these cost a proportionately higher rate than the razors themselves. The idea is that the razors are a one-off loss to the business and the profit made from the razor blades will recoup costs.
- Printer + Ink cartridges: Printers are a well-known loss leader – businesses know that they can quite easily capture an initial sale with their relatively low price, before continuing to generate large profits from the sale of the pricier ink cartridges, toner, etc.
Loss leader pricing can also work more indirectly – by drawing customers in with the offer of low-priced goods and then subtly encouraging them to make additional purchases in the process. For example:
- Milk: Milk is a relatively low-priced grocery and a staple in most households; many people make trips to the supermarket just for milk. As such, retailers often place milk at the back of the store, forcing customers to walk past a vast array of other products in the process. In most cases, they will end up making additional purchases as a result of this exposure.
- Free samples/trials: Supermarkets often have free samples of new food products on display with hopes that the taste will tempt customers to purchase the full product. Industries with membership/subscription models commonly offer trials for their services with the same expectation that their offerings will lead customers to purchase a membership/subscribe to the service.
When to use it
Loss leader pricing works best for businesses looking to increase sales volumes and/or grow market share. With a well-considered strategy in place, loss leaders can bring many advantages to a business, including:
- Clear old stock: Slow-moving products can be sold at heavily reduced prices to clear out inventory and make room for newer products. The clearance sale attracts crowds of customers, who will potentially feel the urge to purchase other items as well. If the reduced items sell out, a business can then offer its customers an alternative, higher-priced product as a customer is more likely to buy something once they’re already in-store.
- Drive loyalty: Once a low-cost product draws in customers, it’s expected this will result in continued sales as the customer becomes loyal to the brand. As loss leaders typically attract large sales volumes, there is opportunity to expand brand awareness and diversify into new markets
- Remain competitive: As loss leader pricing is an ideal strategy for growing market share, it works well to help acquire business from competitors. Attracting customers with low-priced items can encourage them to see value in the product and opt for the same brand for future purchases.
Like any pricing strategy, a business should only implement loss leader pricing once it’s fully aware of the risks involved, and after it’s conducted thorough research. Even the most extensive planning initiatives cannot guarantee the success of loss leader pricing, however, being aware of which factors can hinder its performance can help plan more effectively.
Some risks to be mindful of:
- Cherry pickers: When working effectively, loss leader pricing leads customers to also purchase higher-value products, recouping the loss of the cheaper product. However, not all customers are partial to this process and instead “cherry pick” low-priced products from business to business without buying additional items. This is harmful as it lessens a business’ ability to regain profits/revenue and can lower profit margins in the long run. It’s important to track the revenue of sales leaders vs. profitable items to ensure the loss leader is steadily contributing to their profits and, if not, re-align the pricing strategy accordingly.
- Brand perception: While being the lowest price provider for a product will attract many customers to buy a product, this is not necessarily the most sustainable model in the long-term. Studies have shown that a growing number of consumers directly associate price with quality, meaning loss leaders could be damaging to a brand’s image if a business puts in insufficient effort to marketing the product’s worth. Businesses should thoroughly research which/how many products they position as loss leaders to ensure products that are popular among price-sensitive markets are the ones being targeted.
- Under-pricing: Despite loss leader pricing dictating that certain products are sold at a loss to lead further sales, it is still important that loss leaders are sold at an optimised price, otherwise, it will be almost impossible to recoup the loss no matter how profitable other products are. A business should test willingness to pay, observe their competitors’ prices, and assess the cost of goods (COGS) before deciding on loss leader pricing to ensure it will not irrecoverably affect revenue and profit.
- Loss leader pricing works by putting products on sales at low prices to attract customers and, in turn, generate more sales for higher-value products as well.
- It can work by encouraging one-off purchases which then require relatively costlier add-on buys and through strategic positioning to entice additional purchases.
- It works best for growing market share and increasing sales volumes.
- You should conduct extensive market research before implementing loss leader pricing to mitigate its risks.
- This strategy works best when you choose the right products as loss leaders.