The Pros and Cons of Loss Leader Pricing for Online Retailers

November 2, 2017
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Have you ever come across a sale that seemed  too good to be true? Maybe your local grocery store had an eye catching deal on milk, or your favorite apparel site offered a discount on jeans that made you do a double take. I’d be willing to bet we’ve all seen some offers in the past that have made us want to stop, drop, and shop.

Some of these sales might have been so good that they left you thinking  the brand couldn’t possibly be making money on the items at those prices - and a lot of the time you’d be right. Brands frequently price certain products at (or even below) cost to create “too good to be true” deals. This pricing strategy is commonly known as loss leader pricing.

Sometimes when a brand puts a product on sale for a price that seems too good to be true, they're using it as a loss leader.

 

Loss leader pricing is one of the most commonly used pricing tactics in contemporary commerce, but it’s not without its downfalls. So, how does loss leader pricing work? What are its pros and cons, and how can you use this strategy to better your brand? Well, have we got a deal for you!

What is Loss Leader Pricing?

Our friends over at inc.com define loss leader pricing as “a pricing strategy where a store sells select goods below cost to attract customers who will make up for the losses with additional purchases of profitable goods.” Simply put, loss leader pricing brings customers into a store using aggressive discounts on select items (the loss leaders) in hopes that once customers are in the store, their other purchases make up for the profit hit taken on the loss leader.

"Loss leader pricing is an aggressive pricing strategy in which a store sells selected goods below cost in order to attract customers who will, according to the loss leader philosophy, make up for the losses on highlighted products with additional purchases of profitable goods."
Inc.com

This strategy works because today’s customer is extremely driven by two things that the loss leader strategy offers: value and convenience. A brand using loss leader pricing provides value to customers by allowing them to enjoy “too good to be true” discounts through prices that often don’t exist anywhere else on the market. These brands also offer convenience by allowing customers to pick up complimentary products in one location, rather than running around from store to store.

The combination of an aggressive deal and the resulting supplemental purchases benefit everyone involved! When used correctly, loss leader pricing can be a win-win tactic for both brands and their customers.

 

What Are Some Examples of Loss Leader Pricing?

You encounter loss leader pricing more frequently than you might think - often without you even knowing it. To bring this strategy to life, let’s take a look at a few examples of loss leadership strategies in the market today.

Video Game Consoles are Unexpected Loss Leaders

If you’ve ever bought a game console, I know you’re probably thinking that they’re too expensive to be loss leaders  but it’s not that simple. While purchasing a video game console can make a pretty big dent in our wallets, the truth is that those prices are often still at or below cost. This makes sense when you consider the design, development, and marketing investments that go into creating a gaming system.

Even though they can be expensive, video game consoles are a great example of a loss leader because they are frequently sold at or below cost to encourage game sales.

Gaming consoles are strategically priced as loss leaders to encourage the purchase of video games, a complementary good to the console. When customers purchase the higher margin games that frequently follow the console, a gaming company can start to recoup some of the losses they bore initially.

Grocery Store Essentials Make Excellent Loss Leaders

There’s a reason I referenced your local supermarket as one of the examples in the introduction. Grocery stores are great examples of loss leader pricing, and staples like milk and meat are some of their favorite targets!

Commodities work well as loss leaders because their necessity makes them universally applicable.

Commodities typically work well as loss leaders because their necessity makes deals on milk, meat, and other essentials valuable to the greatest amount of potential customers. Think about it: a discount on dragon fruit might excite a few super-fans, but a discount on chicken is sure to pack the aisles.

Big Brands Like Walmart and Amazon Have Built Empires on Loss Leader Pricing

Amazon is the most dominant force in ecommerce today, and they also happen to be one of the most famous examples of loss leader pricing. Amazon has used  this pricing strategy with their Kindles (making money on the sale of the ebooks), their prime membership (offset by the hope of additional prime purchases) and many of the regular products on their site  all in hopes that customers will toss a couple more items into the cart before check-out.

Brands like Amazon and Walmart use the loss leader strategy in the hopes that customers will throw more items in their cart once they are on-site.

In much the same way, Walmart has made a habit of loss leader pricing as well. From items like the aforementioned grocery essentials and gaming consoles, to products like power tools and BBQ’s no product category is exempt from the loss leader strategy! While low prices have always been part of Walmart’s strategy, offering deep discounts on specialty items is a great way to get customers into the store and throw a few more items into their cart on the way out.

 

What Are the Advantages of Loss Leader Pricing?

As you can see, loss leader pricing is a popular tool in the toolkit of successful, modern brands.  Let’s take a look at the reasons why.

1) Loss Leader Pricing is a Great Way to Enter a New Market

When a brand is just starting out, it can be difficult to convince customers to give your products a shot  especially if the market  is full of established competitors. People are creatures of habit, and persuading them to switch from a competitor can present an interesting challenge. Luckily, loss leader pricing allows emerging brands to drive customers through their doors and onto their sites with jaw-dropping loss leader deals.

The deep discount on loss leaders remove the risk a customer faces when trying a new brand.

Selling a product at or below cost removes a lot of the risk an individual faces when trying out a new brand, meaning customers will be more likely to give your brand a chance. Once a customer is in your store, you can wow them with your unique value proposition (and hopefully make up for your losses along the way)!

2) Loss Leader Pricing Can Help You Promote Other Products in Your Store

While the general strategy of loss leader pricing relies on the fulfillment of contingent purchases, you don’t have to leave those additional purchases to chance. By strategically choosing your loss leaders and complementary products, you can actually use loss leaders to stimulate purchases of other items in your store.

By strategically selecting your loss leader products you can use them to stimulate sales of other complementary products.

To illustrate, let’s say you’re an online clothing retailer and you’re looking to stimulate sales of  particular line of fall coats. You can use complementary products like gloves or scarves as loss leaders to get customers onto your site, while presenting additional opportunities to convert them on the sale of the coat. Tactics like custom CTA’s that say “customers who bought these gloves also looked at this coat” or displays of the coat, gloves, and scarf as an ensemble are sure to increase the impressions and conversions on the target item.

 

What Are the Risks of Loss Leader Pricing?

With all the benefits and examples of loss leader pricing we’ve already discussed, you might be wondering why every brand isn’t waving around targeted discounts. Well, there are two sides to every coin, and even the loss leader strategy isn’t without its pitfalls.

1) Deep Loss Leader Discounts Can Hurt Your Brand Perception

Discounts are a double-edged sword. They can help a brand just as easily as they can hurt one, and when a brand uses deep discounts like the ones in the loss leader strategy, that sword gets a lot sharper... on both sides. We’ve written about the dangers of excessive discounting before, so we’ll keep it brief here.

Deep discounts can cause customers to confuse low prices for low quality.

Discounts, especially deeps ones, can affect your customer’s perception of your product quality. The old adage “you get what you pay for” is extremely prevalent in today’s culture, and while customers love cheap prices, they don’t love cheap products. Overusing the loss leader strategy can blur the lines between a great deal and a cheap product. Once these lines are blurred, instead of a customer rushing in to take advantage of a low price, they’ll be steering clear of a product they believe to be low quality.

2) Loss Leader Strategies Can Condition Customers to Wait for Discounts

If a brand misuses the loss leader strategy, they can actually end up “training” their customers to wait for discounts before they purchase. It’s an extension of the logic that makes customers wait until November 1st to buy Halloween candy or to wait for the fall to buy a new BBQ.

Overusing loss leader discounts can train customers to wait for deep discounts before they purchase.

When customers are trained to expect discounts, they will wait for them. This waiting will throw off their purchase rhythm, lowering their purchase frequency and in turn their customer lifetime value. These customers begin to view discounts as an expectation rather than an exception, meaning the positive feelings that should come with the announcement of a special offer are lost on these customers entirely.

 

How Can You Make the Most of Loss Leader Pricing in eCommerce?

A great way to combat the issues that loss leader pricing can present is the use of a rewards program. When customers are encouraged to earn a discount, or if a discount is made exclusive to “members only”, the product behind the discount retains its value. This helps  eliminate the perception that cheaper pricing is the result of cheap products, because a customer knows that the discount is a special offer that they’ve earned themselves.

Tying loss leader discounts to a rewards program can help brands make the most of low prices and high quality simultaneously.

By using the structure of a points or VIP program to support your loss leader strategy, you can make the most of low prices and high quality. Rewards programs are - by their very definition - designed to encourage repeat purchases. Instead of training customers to wait for special offers, brands can instead train them to create these offers for themselves through purchases and program specific-actions, like social shares. In this way, both the product and the discounts retain their intrinsic value because they are the result of a hard-earned reward!

 

Lead The Way With Loss Leadership

The loss leader pricing strategy has many interesting applications in today’s market. We’ve discussed examples ranging from fresh food to fresh tech and even how big brands like Walmart and Amazon get in on the tactic from time to time.

Like all tools, loss leadership can be useful or harmful to a brand depending on how it is used. However, tying deep discounts to a rewards program can help brands get the most of their special offers by maintaining the perception of brand quality. While it’s up to you to figure out if this strategy works for your brand, you’ll never know until you try   the combination of creative discounting and a rewards program just might make you the loss leader of the pack!