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.
Getting Started
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?
Final Note…
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.
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Loss Leaders aren’t a marketing strategy, they’re a retail strategy, and one that damages the perceived value of the price-cut brand, at that. The grocery store sell-by date example is about the only acceptable use, because the flaw used for scapegoating the reduction makes it a clearance item, but that implementation actually does nothing to drive to the premium like the concept would lead you to believe. A bargain hunter will find the clearance food, buy it happily and never look at the premium. A premium buyer would never have looked at the clearance food in the first place, and pay the full price like they would have had loss leader not been used at all. Its just a recursive way of looking at established multi-tiered shopping habits and trying to take credit for a premium sale that would have happened regardless. The only benefit is to make *A* sale instead of having to take a complete loss on unsellable stock.
The cell phone example is a great demonstration as to why loss leaders aren’t. Cell phones are the *actual* asset value. The service plan is fraught with bloated bundles, options plans that aren’t user friendly OR focused, and pricing structures that revolve around carriers reacting late to buying trends and a sad game of “Me too!” so the pricing gap between competitors is thin at best. The service has HUGE margin, but little to no actual value other than the phone using it to connect for calls and data. It can’t be saved, resold or traded. The service you pay for monthly is a non-asset. The phone, however can be reused, sold, or traded. It is a one-time purchase, and so long as it can find a compatible network to its tech, it actually doesn’t really need a specific carrier to operate. The capabilities of the device gets greater with each model or software release, yet, the provider system has somehow managed to kill the perceived market value –of the product that makes their service useable at all– by subsidizing the phone with ever-present markdowns, instant or mail-in rebates and resubscription upgrade credits. The provider makes money hand over fist, but the manufacturers who bring a phone to market for $300 have providers giving them away for “$49.99 with 2-year contract”. It instills in a consumer that its the phone that isn’t worth anything NEAR actual retail price, helping the cell service providers assure that the phone manufacturers will never have an equal footing or decent margin on their product. And the response is a weak one. They pad the paper-thin margins on their phones because they fell into the trap of relying on huge provider bulk orders of phones instead of building a consumer-savvy strategy to push the value of the phone and the carrier plan as a dumb pipe.
Except for Apple.
The iPhone was never allowed to be subsidized below a certain price point. iPhone was never allowed to be placed as a secondary to a provider in advertising materials. iPhone was not GUI customizable to a carriers whims. The apps only come from Apple’s App Store. Music, Movies, and ringtones from Apple’s iTunes.
Don’t like it? No iPhone for you.
Instead, the provider behaves like a dumb pipe and they bite their tongues and curse Apple behind closed doors, but their margin is still huge and they make mandatory data plan dollars on top of it. The result is massive perceived product value, and the entrenched competing manufacturers flail vainly against the broken system they helped create, trying to catch up. The iPhone margins and profits are huge because they never played Loss Leader, or allowed it to be played with the iPhone. They play Value Leader, and it pays off without question.
Loss leading is a distractive reaction, nothing more. It is a token given to a consumer as an apology for a flaw that doesn’t actually reduce the value inherent in the product. The retailer wins, but at the expense of the reputation and perception of that product. Any distribution or vendor contract that does not specifically prohibit loss leader tactics should be considered to be throwing brand strategy and marketing dollars out a window, and companies that haven’t learned to prohibit it by now deserve the loss in market footprint they’ll earn from embracing lazy sales tactics.