A loss leader is a product that retailers put on sale at or below the wholesale price. Pricing an item below cost seems counterintuitive, but the retailers actually have an ingenious strategy here. The point is to drive the sales of other, more expensive items with the promotion of cheaper products.
Not every product can be a loss leader, so retailers need to examine the item before they decide to employ this strategy. The perfect loss leader is the one that a lot of people buy on a regular basis. These people know when these particular items are on sale and will be appreciative of that fact. Since the retailer will need to put a limit on how many of the sale items customers can purchase, they will need to keep coming back to look for more of these particular sales. One good type of loss leader for a grocery store would be something that has an expiration date.
When Does Employing the Loss Leader Strategy Make Sense?
The loss leader strategy is not always the best one to use, but there are times when it makes sense. Sometimes retailers have items that are not very popular with the customers. By slashing the prices of these items, retailers can encourage people to purchase these items. It also works when retailers have purchased too many of a particular item and they are not moving out fast enough. Creating loss leaders out of the overstock also works to help these items sell.
Another time to consider the loss leader strategy is when a store, a discount store, for example, wants to be known as a leader in the low price arena. Retailers can succeed at this when they can advertise their loss leader merchandise at its very low price. The other great consequence of doing this is that more people will become aware of these low prices and the retailer will see an increase in the number of its customers. Continuously employing this strategy makes these new customers permanent customers, because they will never want to stop saving money on quality merchandise.
Example of a Loss Leader
An example of an industry that is using the loss leader strategy very well is the mobile phone industry. These mobile phone companies that offer mobile phone service to their customers give away cell phones for free or at significant discounts. In exchange for the phones, the customers are required to sign a contract for mobile phone service for at least a year. The amount of money paid for this service more than makes up for the losses they incur from giving away phone subsidy.
The best way to make this strategy work is to employ it in the most honest fashion possible. This means that there should be enough of the product in supply to allow a large number of people to take part in the promotion. Because retailers cannot know how long this particular type of promotion may last, when advertising they will need to make sure to have the words “while supplies last” in the article.
If you’re considering utilizing the loss leader strategy, ask yourself: What you can afford to provide at a loss that would drive purchases of highly profitable products?
If you don’t thinking through all the implications of this strategy, it can lead to some serious cashflow problems but if you take everything into account, this can drive a significant amount of purchases in your business.