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Loss Leader Pricing – Everything You Need to Know About the Strategy

By Priceva
on June 13, 2022
When we see ridiculously low prices, we may think that the product or service is of poor quality, or the seller is very generous and cares about price-sensitive buyers. The truth is neither — most often, good deals are a part of the loss leader strategy. This is a powerful pricing approach used by retailers and brands to attract customers and boost profit. How does it work?

Read this full guide to loss leading strategies: we will explain what they are used for, show you how they are implemented, go over their pros and cons, describe some examples, and show you ways to perform them with maximum efficiency (and minimum risk).

What Is Loss Leader Pricing?

Loss leader pricing is a common marketing term used to denote an aggressive strategy where a store offers goods below cost and expects to cover expenses by selling profitable complementary products. Such an approach to pricing allows retailers to lure customers from competitors and increase sales volume for selected items.

In the e-commerce sphere, it can work the following way:
  1. A customer finds a very cheap product and wants to order it immediately, but the cost of shipping is above the item’s cost.
  2. That motivates him to add other items to the cart and save on delivery.
  3. Both buyer and retailer win: the first saves money, the second generates profit on complementary products.

Types of Loss Leader Strategies

Although loss leader pricing mainly boils down to offering products below the cost, it can be implemented in several ways. At first glance, some of them are one and the same tactic, but we will outline the major differences below to help you figure things out.

Price Skimming

As a rule, price skimming is used to maximize earnings at the beginning of a product’s life cycle: customers are ready to pay a higher price for outstanding value (exceptional quality, innovative features, cool design, etc.). Thanks to this strategy, retailers ‘skim’ profit from upper market segments.

But how is that applicable in a loss leader pricing strategy? A company offers an expensive product in tandem with low-priced items or services. Cheaper goods are used as bait for buyers to add the new costly item to their cart: as a result, the store charges a high total price at the checkout.

This way, a business is able to sell the new product to the vast majority of market segments. All in all, being an early adopter is a pleasant feeling, and it will be magnified by a good deal. The number of buyers may increase exponentially.

Penetration

Penetration pricing is also commonly used when a brand enters the market and plans to win customers from competitors. But in this case, the product is initially inexpensive, and it does not have to be innovative or outstanding. As a rule, this method is used by startup brands that are striving to get a market share by attracting competitors’ customers. Although a penetration strategy causes you to make less money per buyer, you attract more customers, which in turn transforms into more sales in the long run.

Discrimination

Price discrimination takes places when you charge different prices for the same item depending on the market segment. Here, you aim to make as much as possible off every buyer based on how much they are willing to pay. To implement this tactic, businesses need to find the right pricing point for each market segment, or even each customer.

Product Bundling

Product bundling means selling several items together at a discount. This strategy allows you to attract customers by allowing them to save money when they purchase several products at once rather than order them separately. This is a win-win strategy for both buyers and retailers. Product bundling does not require lowering prices dramatically, so sellers can maintain their profit margin in the long run, not to mention zero risks for brand image.

Price Matching

The next type of loss leader pricing strategy is price matching. It takes place when you match your competitors’ prices for the same product or service. The whole point of this strategy is to offer a better deal than your rivals. By coming up with a better price, you make customers switch to your store because they can save money.

Undercutting

The last type of loss leader strategy, undercutting, is a more aggressive version of price matching. It can be a part of a predatory pricing strategy, where a retailer offers a low-priced product to steal a large market share from its competitors.

This is a very dangerous strategy because a retailer may go below the profit margin. This is why an undercutting campaign can only last for a short period of time – otherwise, the company risks losing money. Besides that, businesses that practice undercutting must be prepared to drop the cost even further when competitors get involved in a price war.

Undercutting can be used by established companies that know how competitive-based pricing works and have resources to sustain their profit margin in case of a serious price drop for one of their products. As a rule, they recover expenses by selling other goods for normal prices.

Advantages of Loss Leader Pricing

A smartly introduced loss leader pricing strategy may have positive outcomes for both company’s revenue and reputation. Let us take a closer look at the benefits of this approach.

More Positions Per Order

When you offer a service or product for a low price, you can tempt visitors to buy something else from your store. After getting a good deal from your business, they are more likely to return in the future. Some of them will do impulsive shopping and buy additional products right away.

Higher Customer Loyalty

The above-mentioned great deals are also the reason for increased customer loyalty. This is your first step on the way to building long-term relationships with buyers. People will be ready to make orders in your store, hoping that you will come up with new affordable products and discounts.

A Growing Number of Buyers

In fact, this is the whole point of launching a loss leader strategy. It serves customer base growth because price is the major factor driving buying decisions. When people see you offering a greatly discounted product or service, they become more likely to buy from you. This is how loss leader pricing can help you multiply your profit in the long run.

Increased Brand Awareness

One more benefit of a loss leader pricing strategy is that it improves brand awareness. Customers are more likely to remember your company and will be likely to buy your products later on. Brand perception is important because it allows you to build a strong reputation — it always pays off.

Revenue Boost

Despite selling a product or service at a loss, you can boost profit by increasing the number of buyers. Besides, after getting acquainted with your brand, customers will consider buying other, regular-priced products from your company. They can be encouraged to order more if you offer good deals. This is how loss leader pricing helps to increase profits and develop a business.

Increased Margins

Loss leader pricing approach allows improving financial results by both increasing sales and attracting buyers. But afterwards, it can also make a positive impact on your margins because you will be able to sell more goods by introducing the right price point – it will be easier to figure out.

Disadvantages of a Loss Leader Pricing Strategy

Offering too much cheap stuff can cause various problems, from customers awaiting low-cost products to running out of stock. Here are the major challenges posed by loss leader pricing strategies.

Effect on Brand Perception

While loss leader pricing raises brand awareness, it does not necessarily allow you to build a positive image. Too cheap pricing can affect customers’ perception of your company: people may start thinking you intend to serve lower market segments and your whole lineup of products is of mediocre quality. Besides that, you risk leaving the impression of unprofessional business, which can also shape a biased attitude towards your brand. Before introducing a loss leader pricing strategy, make sure that you offer products that align with your brand’s image and the value you believe your company deserves.

Risks of Loss of Revenue

The major challenge of loss leader pricing strategies is to maintain your profit margin. If you rely on the sales of the cheap product only, you risk losing money. Make sure to elaborate a plan to recover losses that happen after selling stock below cost. As a rule, retailers cover expenses thanks to customers ordering complementary products together with the underpriced one.

Legal Issues

Depending on the region where you are operating, your loss leading approach can be regarded as a violation of antitrust and price-fixing regulations, especially if you apply predatory pricing. Hence, before you start planning your pricing strategy, study the applicable laws in your country and make sure to follow the guidelines.

Sabotaging the Sales of Other Products in Your Assortment

When you start selling services or products at a loss, this strategy may affect the sales of other positions in your store. Customers might be interested in cheap deals while ignoring the rest of your products — this can be harmful in the long run. Prior to launching loss leader pricing, make sure to analyze how this strategy will influence the whole assortment of your services and products.

Product Devaluation

We have already mentioned that cheap products can affect brand image. Together with that, you risk having your particular product devalued in customers’ eyes. So make sure your products or services are in line with the desired brand positioning.

Examples of Loss Leader Pricing

Retailers often use loss leader pricing strategies to survive through competition and attract an audience. For some of them, this is a temporary measure, while others turn underpricing into a lasting practice. Here are a few examples of loss leader pricing.

Free or Cheap Samples

iHerb, the biggest online pharmacy in the United States, offers underpriced samples of supplements, medications and foods. That not only allows buyers to try a new product before ordering its full-sized version, but also helps iHerb to build loyalty — many buyers become fans of the webstore thanks to great deals (which in no way affect the quality of the products).

Dollar Tree

With its fixed-priced products worth $1.25 ($1 until 2022), Dollar Tree has been a one-stop-shop for Americans for over 30 years. How did the retailer survive with such a long-lasting loss leader strategy?

Store owners save by buying consumer items in bulk. Manufacturers of non-expensive products like snacks, plastic toys or party supplies often have extra inventory left. Buyers can negotiate good deals to retail their surplus via stores like Dollar Tree. In this case, the wholesale cost of products can be reduced to a few pennies, especially if the bulk buyer covers shipping expenses.

This policy is not the only thing making the retailer’s profit margin grow year by year. Dollar Tree visitors are often tempted to make impulsive purchases — who can resist the lowest prices?

Black Friday

Shopping events like Black Friday are getting popular all over the world. A few days before a sale, retailers start advertising low prices on clothing, electronics, toys, and many other items. Generous discounts allow them to attract buyers, get rid of old stock, and sell full-priced products as well.

How to Reap the Maximum Benefits of Loss-Leader Pricing in E-commerce

A loss leader pricing strategy always comes with risks because you can end up losing money by not selling enough complementary items or spoiling product value perception. How to avoid these problems? Here are a few recommendations:
  • Beware of discount hunters who don’t purchase additional products that you plan to earn from. In the e-commerce industry, you can prevent them from doing so by introducing minimal requirements for free delivery or offering product bundling.
  • Make sure to study applicable laws regulating loss-leader strategies and predatory pricing in your region.
  • Perform risk assessment before implementing the strategy. You should have a plan for recovering losses in case people don’t buy full-price products.
  • Avoid building the reputation of a discounter, unless this is your goal. You can prevent it by using a rewards program that will incentivize buyers for spending a certain sum on your assortment or providing discounts for ‘members only’. That might save the value of your products in customers’ eyes.
  • Once you apply a loss leader strategy, you should monitor the market and be ready to adjust prices according to competitors' actions.

How can you keep tabs on price changes on the market and make decisions that won’t sink your business? Opt for repricing software by Priceva. It allows retailers to set up automatic repricing based on competitor analysis and recent market changes. Users can customize rules for price policy optimization and will be notified when it is time to cease dumping prices in order to stay profitable.

Final Words

Loss leader pricing is one of the most efficient strategies for growing your customer base, and one of the riskiest as well. While great deals attract a lot of buyers, you can incur losses by selling products below cost if you fail to encourage sales of other products. Before launching a loss leader pricing strategy, you need to assess whether it is legal in your region, how you can recover losses, and various ways to encourage customers to order regular-priced products.

FAQ

Is Loss Leader Pricing Legal?

It depends on the region. For example, loss leader pricing is completely prohibited in Ireland and half of all American states, including California, Colorado, and Oklahoma (although there is no ban on a federal level). Hence, before you launch this strategy, make sure to study the local legislation of the region where you operate.

What Companies Use Loss Leader Pricing?

Due to its risky nature, loss leader pricing is commonly used by giant retailers that can afford to compromise profit on certain products in hope of having other products added to the cart. Discounters like Dollar Tree (USA) and Lidl (EU) also manage to maintain profit margins with cheap products thanks to making large bulk purchases from manufacturers.

Is Loss Leader Pricing the Same as Predatory Pricing?

Predatory pricing can be viewed as a subcategory of loss leader pricing — it is the most aggressive approach. Unlike other loss-leader strategies, predatory pricing is aimed at pushing competitors out of the market. As a rule, it is used in the short term.

What Is the Difference Between Leader Pricing and a Loss Leader?

The key difference lies in the goals behind these two strategies. Leader pricing is typically used as part of a promotional campaign: a company sells products below cost to raise brand awareness and attract customers. Prices are returned to the normal level soon afterwards. In loss leader strategies, retailers also sell underpriced goods, but they hope to recuperate losses by 1) increasing sales volume; 2) making customers buy other products.

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