Setting prices can be a mind-boggling exercise for retailers. Pricing often feels like a high-stakes decision that directly influences brand perception, but hinges on guesswork.
When comparing pricing strategies (each with its own distinct benefits and drawbacks), it’s important to remember that these decisions don’t exist in isolation. Pricing also impacts merchandising, margins, supply chain operations, and execution strategies. In this article, we’ll review one of the most interesting pricing strategies out there: the loss leader.
Understanding why and how this strategy works helps retailers reach the right customers, maximize profitability, and differentiate their brand, while laying the groundwork for evaluating other pricing strategies.
Related Reading: Importance of Effective Demand Planning
Loss Leader Pricing Explained
Costco is well-known for launching its $1.50 hot dog in the 1980s. But what’s more impressive is that over 40 years later, the $1.50 price remains firm despite inflation, rising food costs, and more.
You might wonder how Costco generates revenue from hot dog sales with such a low price point. The short answer? They don’t.
Costco uses a loss-leader strategy to justify its $1.50 hot dog. Loss leader pricing is a strategy that entices customers by offering an item at a very low price, sometimes at a loss, to attract customers and increase sales. Essentially, retailers price items intentionally below product costs because they know the revenue will be recovered elsewhere in the company. In Costco’s case, the hot dog prices get customers in the door, who then stick around to shop and purchase other items in the store.
Five Ways to Implement the Loss Leader Pricing Strategy
While the general concept of the loss-leader pricing strategy is simple, there are several ways businesses put it into practice.
Here are some of the most common strategies used for loss leader pricing:
Introductory Pricing
This strategy offers a discount or a free period upfront (like Apple TV’s 30-day trial or low introductory credit card rates) to attract new clients and generate long-term recurring revenue. This is often used in b2b pricing strategies for software and professional services.
Store Placement
Retailers almost always sell milk and eggs at a loss. By placing these items at the very back of the store, they prompt customers to pass by regularly priced and high-margin items. This increases sales by encouraging impulse purchasing.
Inventory Management
When facing seasonal and end-of-year inventory, many retailers rely on loss leaders to create room for higher-margin items. A common example is the automotive industry, where dealerships price older inventory at steeply discounted rates in December. This creates room for the newest models, which can be sold at a higher profit margin.
Related Reading: Key Inventory Management Strategies
Free Samples
Free samples are a common way grocery retailers leverage loss leaders. Samples rely on the "reciprocity principle," a theory of human behavior that holds that customers feel more socially obligated to purchase a product after taking a free sample.
Trader Joe’s regularly uses free samples in store, and also allows customers to return any product, any time. While this may affect margins, this strategy is a brand play that keeps customers coming backlong term.
Service Cross-Sells
A final way retailers leverage loss leader pricing is through service cross-sells, where a free item is paired with another item. For example, CVS often offers free flu shots with an in-store purchase, or liquor retailers might pair a loss leader like a cocktail shaker with a purchase of high-end, high-margin liquor. This allows them to move inventory and increase sales by using a loss leader.
Practical Examples of the Loss Leader Strategy
We’ve covered how the loss leader strategy hinges on the core idea that it’s okay to lose money on certain products if the revenue can be made up elsewhere.
Here’s how a few well-known brands put the loss leader strategy in action:
Brand | Loss Leader Item | Revenue Reasoning |
Gillette | Mechanical Razors | Replacement blades and shaving cream are extremely high-margin. |
Microsoft | Xbox consoles | High-margin video game sales in combination with Xbox Live subscriptions. |
Amazon | Kindle eReader | Loses money on the product, but generates revenue from digital subscriptions and eBook sales. |
IKEA | Swedish Meatballs | Low food prices encourage physical presence in stores. The store layout encourages impulse and add-on buys. |
Dangers of the Loss Leader Method
As with any pricing strategy, there are real dangers when loss leader pricing is misused. The method only works if the revenue lost on the discounted item is recovered elsewhere in the business. Many retailers and brands rely on shoppers buying more than just the sale item, adding more products to their cart, or suppliers helping cover promotion. If those things don’t occur or sales are lower than expected, the strategy falls apart. In this section, we’ll cover a few key points to keep in mind when implementing the loss-leader pricing method.
Execution
Execution matters just as much as the price itself. If the discounted product is out of stock, customers can’t add anything else to their basket. If shipments arrive late or incomplete, the promotion underperforms. These issues quietly eat away at the already thin margins the strategy relies on. Discounting a product without tracking how well the promotion ran is a gamble, so retailers should ensure all promotions are supported by strong organizational execution.
Related Reading: Understanding Supply Chain Management
Customer Behavior
Customer behavior introduces another major risk. One common problem is cherry picking, where shoppers come in only for the discounted item and leave without buying anything else. When that happens, the loss is never recovered. Over time, frequent promotions can also train customers to wait for sales rather than pay full price. This weakens pricing power and can make the brand feel cheap or inconsistent.
Accidental Discounting Damage
Discounting can also hurt profits in less obvious ways. A sale item may replace purchases of more profitable products rather than increase overall sales. Subway’s $5 footlong is a good example: Itbecame so popular that it reduced sales of higher-priced sandwiches and contributed to long-term profit problems. For higher-end brands, deep discounts can do even more damage by signaling lower quality and pushing away loyal customers.
Operational Issues
There are operational risks as well. Promotions that aren’t carefully planned can lead to empty shelves, excess strain on staff, and unexpected shortages of popular full-price items. Retailers may also pressure suppliers to lower their prices to keep the promotion going, which can strain relationships and create long-term reliability issues.
Related Reading: How to Tame Volatile Manufacturing Supply Chains
Legal and Competitive Concerns
Finally, loss leader pricing raises legal and competitive concerns. Large retailers can afford to sell items at a loss that smaller businesses cannot, raising concerns about fairness. Because of this, selling below cost is restricted or regulated in several U.S. states (notably California, Oklahoma, and Colorado) and in other countries. Retailers that ignore these rules risk fines, legal action, and reputational damage.
Loss leader pricing isn’t automatically bad, but it isn’t simple either. Without careful planning, strong follow-through, and a clear way to make the money back, it can quickly do more harm than good.
Other Essential Pricing Strategies
Loss leaders are a common pricing strategy, but they’re certainly not the only method. Below are some other common pricing strategies levered by retailers and suppliers.
Market skimming
Market skimming is a common pricing strategy that adjusts a product’s price over time to maximize profits. Stores set new products at high prices to attract customers who are willing to pay extra to get them first. When that wave of purchases is complete, stores lower prices through sales or discounts to capture more budget-conscious customers.
Cost-plus pricing
Cost-plus pricing is considered the most common and straightforward retail pricing strategy, best suited for simple products with predictable supplier and input costs. Retailers often use this model for lower-cost items with high stock turnover, since the lower margin per item matters less when so many are sold. Cost-plus pricing is also an effective way for a business to set an initial price for a unique product with little existing competition.
Value-based pricing
A common strategy with luxury brands, this approach involves setting prices based on "perceived value" rather than production costs. For example, a luxury-brand purse is made with the same materials as a lower-end brand. However, because the brand's company value is included, a higher price point is chosen, as customers perceive the name as higher quality.
Competition-based pricing
This pricing method involves benchmarking prices against rivals to either undercut them or position the brand as a premium alternative. Leading retailers like Amazon and Walmart use complex algorithms to monitor and match each other’s prices down to the specific delivery zip code.
To combat the trend of customers browsing in-store but buying online elsewhere, Best Buy implemented a price-match guarantee. This strategy allows them to maintain competitive pricing on core products by matching prices with Amazon and other major online competitors.
Penetration pricing
Penetration pricing involves deliberately undercutting competitors to quickly gain market share in a crowded field, even if it means operating at a loss initially. A typical example is introductory hooks, frequently used by financial and utility services. Credit card companies often offer 0% APR for 1-2 years, but then apply traditional interest rates when that period expires. Penetration pricing hinges on providing an initial low price that increases over time, once the customer is established.
Related Reading: Win at Retail With the Right Metrics
Tiered Quality Pricing
A final common pricing strategy is to offer different price points for various products, depending on the retailer and type of customer. For example, a trash bag supplier might sell to three different retailers but adjust the number of bags per box to meet each retailer's pricing needs (such as 30 bags per box for a dollar store versus 65 bags per box for Target). Suppliers can also explore remanufacturing and reusing products to create various quality levels to capture broader market segments. This can also be used as an eco-friendly marketing strategy to increase sales.
Related Reading: What is a Supply Plan?
Implementing a Successful Pricing Policy Strategy
To implement a pricing strategy effectively, it’s important to remember that point-of-sale (POS) data is the key to determining whether the plan is successful. Have clear goals in mind, such as brand identity, inventory management, or boosting sales. This helps you select the right pricing strategy for your goal.
The key to successful pricing lies in regular refreshing. In a constantly changing market and retail supply chain, it’s essential for retailers to stay flexible and regularly refresh strategies to remain relevant. Finding the right pricing strategy results in a sustainable competitive advantage that manages customer perception and trust, and ultimately, should keep sales numbers in the positive.
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