All businesses aim to make profits. However, when applied deliberately and managed well, loss leader strategy may in fact help companies create value for themselves and their customers. This tactical strategy is known as loss leader pricing.
What is a loss leader pricing strategy?
Businesses that adopt this strategy sell a product at below cost to drive sales of more profitable goods or services. In this way, the discounted item is a ‘loss leader’ that stimulates sales. In fact, this is also known as the razor-and-blades or razor-razor blade business model, and is based on the practice of King C Gillette, the founder of the eponymous razor blade company. Gillette’s strategy was to give away their razors for free and make money from their blades.
When can a business use it?
When adopting an introductory pricing strategy
A new or unknown e-commerce site may offer discounted products on social media sites such as Facebook to attract customers. This is used in tandem with ‘customers also looked at these products’ messages or a display at the right-hand margin of the webpage, which offers a distracting list of options that are not discounted. This can tempt the customer to combine the initial purchase with full-price items.
When moving unwanted merchandise
When a popular brand such as Apple’s iMac or iPhone reduces its price, it’s generally because a product is going to be superseded by a new release that is just around the corner. Bi-annual store sales and seasonal sales are a great way for retailers to move outdated stock.
What are its uses?
It helps track advertising
Businesses can learn how effective their ad spend is when it comes to attracting customers. If a loss-leader product is coupled with a coupon, then one would be able to easily tell how well the ads are targeting customers by the amount of merchandise sold in one promotion.
It is effective in image building
Over time, consistently offering hot deals can help build customer loyalty. Costco, the retail warehouse, is known to sell certain staples at a discount other places cannot match. Having purchased a membership, a customer may return frequently to buy their rotisserie chicken, milk or hot dog and drink combo, which are famous for being cheap. However, shoppers might also be buying high-margin items such as electronics without comparing prices because Costco has already established itself as a high-value, low-price brand in the minds of customers.
How does it impact businesses?
It can cause company-supplier friction
Suppliers may experience issues with the erratic nature of demand created when a product is selling unusually fast. Or relations may sour if a business begins to put pressure on the supplier to drop prices.
It can affect brand value
If discounted goods are on sale too frequently, customers will adapt their behaviour to only shop when those items are on sale. This means a dip in retail over the long term.
It causes customers to switch loyalty
Credit card companies or mobile telephone companies often offer a lower interest or call charge rate for an initial period enticing customers to change brands.
Customers could end up ‘cherry picking’ and only choosing to buy the discounted goods but not the profitable ones. Loss-leader strategy works best when it is in combination with something else to avoid customers buying only what’s on discount. For example, inkjet printers routinely sell at below-cost prices because customers are forced to buy their ink cartridges, which are sold at good margins.
Customers may bulk-buy the loss-making product at a personal profit and put pressure on the company to maintain stocks
A loss leader strategy can give a business a chance to attract, steal away and retain customers in a new or existing market. After all, Amazon and eBay’s business models involved starting off with a selection of discounted items. To be successful, a business must consider whether it can absorb the financial impact of such a strategy and whether it has the required processes in place to benefit from it.