Loss leader – What is it and how does it work?

A loss leader is basically a pricing strategy, which in simple terms is when a product is priced below its market price.

 This technique is thought to incur losses, but in actuality, this strategy is employed in order to boost sales.

The idea behind this strategy is that once people enter stores in order to buy some marked down product, they will inevitably be interested in some other product that is not marked down, resulting in an overall sales bump in the store.

An introduction to the Loss leader strategy:

While it may be a little befuddling as to how these brands expect to make a profit when they are using this strategy, the truth is, they’re not.

Rather, it is the expectation that people will be spending money on other products in the store that will actually result in an overall profit.

One of the main contenders in loss leader pricing is Gillette, a regular user of this fairly ingenious pricing strategy.

Gillette offers razor packages coupled with extra cartridges for the minimal price of around $8.

By pricing their razers at such low market value, they build a loyal consumer base, and once it’s established, the cost for refills is sufficiently jacked up, resulting in an overall profit for the company.

The name “loss lead” is quite derivative, as it was formulated from the fact that the initial item was designed to incur a loss, while at the same time “leading” to an overall profit.

An important note to remember is that companies aren’t necessarily selling their goods below their cost, but instead, the products are being sold below the minimum profit margin.

For companies who are choosing to employ this strategy, it is vital that they maintain a record of current account analysis for both the product that is the loss lead, as well as the associated items that are being sold as a result of the loss lead.

By maintaining such records, a company can gauge whether this strategy is panning out for them, and if results aren’t very positive then this strategy may not be for you.

When should you use the Loss Leader strategy?

While the concept of this strategy has been explained at length, there still remains some confusion about whether it is advisable for your brand to use.

Loss leaders are designed to bring in more foot traffic to stores and result in linked advantages, but e-commerce ventures have also been known to utilize this strategy.

The basic idea is that cheaper items are placed on the landing pages, enticing consumers to buy cheaper goods and hopefully discover relevant items that are not marked down.

This is an excellent marketing strategy and has continued to draw results, which is why more and more businesses are attempting to use it.

The question remains, however, when should you use this strategy?

#1. Getting rid of excess inventory:

One of the main reasons for using this strategy is when the season is changing and there is still inventory left of merchandise like clothing items.

Seasonal items such as these need to be pushed out by shops so that the inventory does not remain when the next year’s new fashion trends make the old stock obsolete.

This strategy also applies when newer models of technology are being released. For instance, car dealerships will reduce the price of the old G-Wagon once the newer version of the G-Wagon is released. The same goes for the I-Phone:

By using special events or sales that drastically reduces the price of remaining stock, inventory can get finished at a quicker pace.

#2. Selling perishable goods:

Perishable items like food and drinks are usually marked down before they go bad, in order to make up for any losses that they may incur in the future.

Usually, perishable goods are put on sale for short periods of time to instill a sense of urgency in consumers.

#3. Promoting new store openings:

This pricing strategy is also a good option for when you’re planning a store launch.

Discounted items will work as a good promotional tactic, and can encourage more people to visit your store.

Tactics such as these can help you build upon a lacking customer base, as a large number of people will wish to take advantage of the affordable deals.

At times, this sort of strategic pricing is termed as penetrating pricing, as it can penetrate its way through a larger consumer base.

Another way that new stores try to promote their opening is by offering the first 100 people entry into a lucky draw to win exclusive prizes.

Marketing of this nature can be incredibly effective in creating awareness about your store.

#4. Marketing your Brand:

This pricing strategy can also act as a means of marketing your goods and creating a loyal consumer base.

Much like Gillette, telecommunication companies tend to offer packages that, at times, are making them operate at a loss.

Once the client has picked that telecom company as their permanent data provider, the company can then increase the prices until they are ultimately more profitable than before.

Such a pricing strategy can entice consumers away from the competition, and make them use your brand more regularly.

A simpler example of this strategy is when stores offer free food samples to customers.

#5. Increasing Sales:

If this strategy is used cleverly, it will have an item that is marked down but will also have other complimentary items that are regularly priced.

This way, the overall volume of goods bought will be greater than if both items had regular pricing.

For instance, for certain magazine subscriptions, the initial subscription comes with several free magazine issues, while the rest of the magazines are priced the same.

By enticing people to subscribe with the promise of free copies initially, you are in fact getting consumers to make a recurring expense in the long run.

The Disadvantages of this Pricing Strategy:

There are many advantages that a loss leader’s pricing brings with it, but there are several disadvantages that marketers should be aware of before they choose to employ it.

#1. The risk of loss:

While the point of the loss leader strategy is to encourage people to buy both marked down and regularly priced items in higher volumes, this is by no means foolproof.

This means that while it is possible that the marked down object, for instance, a plasma screen TV may get sold, the complementary good, like surround sound system may not.

This phenomenon is known as cherry-picking and can lead to huge losses for companies who are not closely monitoring their sales.

Also, while discounts may drive customers to your stores, if people get accustomed to it, then it is possible that they might simply wait for the next sale to pop up.

#2. Not having enough items in stock:

If you have chosen to make a particular item the loss leader, then it is imperative that you have enough of the goods in stock.

If the item you are advertising to draw in the crowds runs out of stock at an unprecedented rate, then you will not be making as much profit as you envisioned, and the sale on complimentary items will witness a similar downturn.

#3. Hoarding the marked down item:

If you are pricing a really desirable item below market price, then it is possible that consumers can buy it in bulk and simply hoard it.

A simple solution for this potential issue is to limit the quantity for one person to buy.

You can also mitigate this issue by selling items that are perishable, or that have a limited shelf life, thereby negating the need in people to stockpile the good.

#4. Creating a negative pricing perception:

By continuously pricing certain items low, it can give consumers the impression that some items should always be priced lower than their actual price.

This kind of perception can negatively impact the sale of an item in the long run. It can even impact the overall outlook of the store, as goods which are priced normally could be seen as extremely expensive, when in fact, they are not.

#5. Not for the little guy:

While this pricing strategy can easily be employed for large corporations like Walmart and Target, smaller businesses are not able to afford the same luxury.

This is because larger retailers are able to negotiate to buy a larger amount of stock in return for cheaper costs, while smaller businesses are unable to build up similar stocks.

Small businesses are also extremely reliable on any and all items in store which means they cannot afford to take a hit by offering lower prices.

Formulating a strategy:

While this penetrating price strategy may seem highly simple, the fact remains that it needs a practiced and experienced marketer to carry it out successfully.

It is important to remember that there are no guarantees that you will end up making a profit.

In fact, if you are not closely monitoring the situation, then you won’t know how effective your strategy is, and by allowing it to run for an extended period of time, you would steadily be racking up your losses.

#1. Creating a rewards program:

One strategy that companies utilize is by creating a rewards program. This can make the customer feel that they are saving in the long run, while in actuality they may not be.

For instance, if you are required to buy a specific number of goods in order to gain “points” you may end up shopping at the same store several times, even for things you don’t necessarily require.

Makeup stores like Sephora have a rewards program, and as makeup is so expensive, many people sign up to the program in order to avail discounts after they have purchased enough items to have gained sufficient points.

Another example of reward programs is the frequent flyer discount, which airlines use to encourage customer loyalty to their brand.

#2. Making sure the right products are being marked down:

It is important for businesses to ensure that the product they are assigning as the loss leader is not too obscure for your average Joe to buy.

Because even if a product’s price has been slashed significantly if the product itself is deemed to be too niche, then you won’t actually be able to cash in using this strategy.

It is therefore important that the item you are marking down is essential enough for the consumer to purchase, making it even more desirable if it is marked down.

#3. Price it right:

While this may seem like an obvious step, at times, inexperienced marketers assume that pricing something down even a little bit will allow them to make a sizeable profit.

The price of your marked down item should not be so low that even bulk buying won’t generate a profit, nor should it be such a small pricing difference that people are not attracted to the offer at all.

Usually, the sweet spot for marking down the prices is by ensuring that you are making enough profit by selling the item plus its complementary goods in a high enough volume.

Conclusion to Loss Leader:

This pricing strategy comes with many advantages, which can include a loyal customer base, a higher volume of goods being bought, and standing out amongst the competition.

However, this strategy is still quite risky, and if it is not monitored properly from the day it is put into place, businesses might end up incurring losses.

Another main disadvantage of this method is that smaller businesses do not have the luxury of utilizing this method, while bigger businesses can get ahold of a larger market share if they use it.

All in all, this pricing strategy comes with its own set of ups and downs, but if done correctly, it can result in an overwhelmingly positive result for a given business.