Loss-leader pricing is an assertive pricing strategy marketers pursue to lure customers away from competitors into their own store. Once the customer steps in the store, the expectation is to negate the loss with the sale of profitable products.
Same as all pricing strategies, this one also has certain advantages and disadvantages. Moreover, it carries risks that you should be aware of. Luckily, in this post, we’ll cover everything you need to know about the loss-leader pricing strategy.
What is loss-leader pricing
Loss-leader pricing refers to the strategy in which one or more products are sold below cost to lure buyers into the store with the expectation that their additional purchases cover the loss.
The rationale behind this strategy is that once customers are enticed into the store, they will buy additional goods that are actually profitable.
In seasonal shopping events such as Black Friday and Cyber Monday, many retailers apply loss-leader pricing. On the other hand, some stores always loss-lead and profit from upsells, refills and accessories. For example, some stores sell printers for a loss but gain a higher amount of money from the ink and toner.
Online retail giants pursue this strategy, knowing that some shoppers will subconsciously assume that their store is ‘the cheapest destination to shop’ after seeing below-average prices.
However, that strategy won’t be working for some buyers.
Today’s shoppers are in general price-sensitive and tech-savvy. Their main criterion when making a purchase decision is price, and they know which technological tools to find the best price.
Comparison shopping engines like Google Shopping help them find the best deal in a few seconds. Therefore, this process became an essential part of the purchase journey for most online shoppers.
What does that mean for the firms that execute this strategy?
Beware of the bargain hunters
Bargain hunters are the shoppers that hunt the best prices, buy when they find one, and leave without purchasing anything else. Some shoppers even buy in lumps when they see a good deal. If most of the shoppers you’ve attracted are bargain hunters, it’s highly likely that you won’t be able to cover the loss.
But there are more serious consequences you must be aware of.
Be careful about the legal consequences
In some European countries and many U.S. states, loss-leading is partially banned, meaning, it’s banned for some products on the grounds that it restricts the competition.
For example, in 2015, the European Court of Justice has ruled that the Scottish Government’s minimum price for alcohol policy restricts the market.
The state of California bans loss-leader pricing of all retail products, whereas several states including the New York state has banned trade discounts of cigarette prices with the aim of reducing cigarette consumption. Wherever you operate your business, learn the laws that regulate the competitive environment.
Make sure to cover your costs
In most cases, retail giants leverage their purchase volume in their negotiations with the suppliers, and they often manage to get the cheapest offers. Since their costs are lower, their loss from loss-leading is smaller when compared to an SMB.
Furthermore, they can afford to take bigger losses for a longer period of time than SMBs.
SMBs run the risk of miscalculating their costs or overestimating the number of people they attract into their store. To minimize these risks, you need to estimate:
- The amount of loss you can risk
- The amount that customers will spend on the actually profitable products
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Don’t change shoppers’ perceptions for good
Shoppers can easily get used to the cheap price tags and expect to see below-average prices all the time. In those cases, when the firm raises prices to their normal level, it faces a backlash.
A safe way to implement discounts would be to limit the number of products you’re discounting to a small amount. Otherwise, your brand image may shift from a quality brand to a cheap brand.
Loss-leader is not race-to-the-bottom
It’s important to note that although the process of loss leader pricing involves setting prices that are at or below profit, it is not the same as a race-to-the-bottom approach (which we do not always recommend).
A race to the bottom approach is what happens when you lower your prices with no strategy in mind, other than to be lower than your competitors. What happens is you end up repricing your products so low that you barely make a profit on any of them.
An electric toothbrush is a great example of a loss-leader product. This electric toothbrush costs £99.
Although we do not know the manufacturing costs for these toothbrushes, we can assume they make most of their profits on the replaceable toothbrush heads.
When you think about an electric toothbrush, you realize that we don’t tend to buy them often. Also, brands can afford to sell them at a loss because they know they’ll easily recoup their lost profit costs form the toothbrush heads which need to be changed much more regularly for great oral hygiene.
So if you want to implement a loss leader strategy and are worried, consider whether you have any add-on products where people would need to come back to your store to make a further supplementary purchase.
Loss-leader pricing is a strategy marketers pursue to entice the highest amount of customers into the store with several below-cost prices, and aim to gain more from the profitable products. Although it might be profitable in some cases, there are risks that come with this strategy. Therefore, when you’re implementing this strategy, keep in mind that you must:
- Beware of the bargain hunters that won’t purchase additional products that you expect to profit from
- Be careful about the laws that regulate or even prohibit loss-leading in some countries
- Make sure to cover your costs with a risk assessment you’ll conduct prior to implementing this strategy
- Try not to be labeled as the destination of discounted shopping, unless you aim to