What is a ‘Loss Leader’?

The loss leader is a pricing strategy which involves selling products/services at a price that will generate little or no profit and in some cases not even cover all associated costs (marketing, overheads, direct costs, etc).

This may sound crazy but it is a technique that is commonly used to attract customers to their business via a bargain. These bargains will attract customers to your business who may then purchase other products/services even if they don’t buy the product that you have initially reduced. This is where you will make up for the loss as you will be selling other items that generate high profits.

For example, you buy a portable TV from your suppliers at £160 and the additional costs of selling the TV add up to £40, totalling a break-even selling price of £200. You sell the TV for a reduced price of £189 therefore making a loss of £11 for each one sold.This can be seen as an extreme example and in most cases; a business may only decide to lose out on making any profit from the product and therefore ensure that all costs are covered. Before you cut out any contribution to costs, further reducing the price, you should determine that the decision won’t cause any major financial problems should the scheme be unsuccessful. Further, you should have the confidence that the loss can be made back from the sales of other products or services.

With the TV example, you may further offer them insurance, and with your powers of negotiation, you could talk them into making a purchase for a better model TV which will generate a profit.

You may also display and advertise a related product with the TV, say, a video recorder which is compatible because of the same brand or design. You could then price this product with a figure that will make a good profit and also compensate for the loss made on the TV.

Using the Loss Leader for Quick Sale

The loss leader strategy can also be used to encourage sales on those products that are in the decline stages of their life cycle (becoming un-fashionable or out-dated, etc). In which case, you may want to cut the price of such products to sell-off stock that isn’t moving well and therefore be satisfied with the outcome of breaking even with the products (or with a small loss), but an increase in cash flow.

This can be used as a marketing tool for attracting people to your shop by exaggerating the reduction on adverts such as “many items reduced by 25%” and so on…. Remember, reductions must be a genuine reduction from your past selling price.

Attracting Customers from Different Sectors

Customers from different sectors can be attracted to your business by using the loss leader strategy. For example, recently a leading supermarket introduced the sale of jeans from a leading jeans manufacturer. The clothing is purchased from a wholesaler and priced competitively which results in low profit. Although the aim of the scheme may be more specific, it will attract the younger shopper with more disposable income. It is worth noting that the jean manufacturer was not impressed with its brand being used for this purpose!

Benefits of the Loss Leader Strategy

• Gives you a competitive advantage due to reduced prices
• Creates brand building for YOUR business as people will associate you with ‘good quality for less money’
• Potential related sales and return visits for similar goods
• Good for ‘word of mouth’ promotion

Things to Be Aware Of

The loss leader strategy has to be implemented with a high degree of caution as it has in the past led businesses to financial problems. When reducing products, you should consider the likely consequences that could follow. If you reduce, say, top electrical brand products, then you have to accept that they may not be happy that you are selling their products cheap and therefore damaging their image. In which case, it may be an idea that you contact the manufacturers or suppliers before proceeding with the strategy. Failing to do so may result in the manufacturer refusing you to continue selling their products.

Another issue is that other companies, which may include competitors, could take advantage of your bargain and purchase them from you to sell in their own shop. In which case, they could further reduce the price giving them a competitive advantage over you, or sell it at a price with a view to making a small profit.

Further, in some situations, you would be expected to stock the amount of items relevant to match the potential increase in demand. This can be disastrous if the products don’t sell out (or get close to selling them all) especially if you intend to sell at a price that doesn’t even cover costs.