What is Loss Leader Pricing?
A loss leader pricing strategy, a term common in marketing, refers to an aggressive pricing strategy in which a store prices its goods below cost to stimulate sales of other, profitable goods. With such a pricing strategy, a business is selling its goods at a loss to lure customer traffic away from competitors. In contrast to predatory pricing, loss leader pricing is aimed toward stimulating other sales of more profitable goods. Learn more about business strategy in CFI’s Business Strategy Course.
Rationale Behind Loss Leader Pricing
At first glance, it may seem that such a pricing strategy would destroy the profitability of a store. However, the loss leader pricing strategy actually works quite effectively if executed properly.
The rationale behind the strategy is the belief that pricing certain products below cost will draw more traffic from other competitors and, therefore, ultimately generate more sales on other products. Businesses attract new customers with an extremely cheap product or service in the hope of building a larger customer base and increasing long-term recurring revenue.
For example, consider businesses that use “introductory” pricing for their products and services. Several cable and phone companies offer low rates for their services in an attempt to “capture” the customer and ultimately cross-sell other products and services. Although in this particular example the service may not be priced below cost, the rationale is essentially the same.
Example of Loss Leader Pricing: British Motor Corporation
In 1959, the British Motor Corporation’s (BMC) Mini car was sold at a price of $496 for its base model. It was estimated that BMC lost $30 on each sale of the Mini car. The only competitor to BMC’s car at the time was the Ford Anglia, which was marginally cheaper but that lacked many features included in BMC’s Mini car.
Although BMC lost money on its basic model, the company anticipated that the base model car would not account for significant sales since it lacked features such as rear windows, heaters, etc. In essence, BMC used the base model car as a loss-leader to generate positive headlines and then promote their higher-model cars (which generated a small profit per sale).
With that being said, the loss leader pricing strategy did not work entirely for BMC. The base model mini car proved to be very popular among customers, and the company sold more base model cars then it initially anticipated. Therefore, despite being the best-selling car company in Britain and other markets, BMC made little to no profits due to the high sales of their base models. This illustrates that a business has to be very careful when executing a loss leader pricing strategy, or it will damage, rather than benefit, its bottom line.
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Example of Loss Leader Pricing: Gillette
Gillette is a famous example of a company that employed a loss leader pricing strategy in their business model. Several years ago, Gillette became the leader in selling razor blades by following an ingenious strategy: selling their mechanical razor well below cost to draw new customers. Consider the move as “introductory” pricing – Gillette wanted to build a customer base and stimulate future sales of their products.
This was a clever strategy to employ because Gillette generated much more revenue from the recurring sales of replacement blades than it did from the initial sale of a razor. Gaining a new razor customer also opened the door for Gillette to sell the new customer its other products, such as deodorant and aftershave, which carried high profit margins for the company.
Main Drawback of Loss Leader Pricing
The biggest risk to a business that uses the loss leader pricing strategy is illustrated in the example of British Motor Corporation: customers may only take advantage of the loss leader pricing and not purchase any other of the business’s products and/or services. It is easy to see how problematic it might be for a business if customers only purchase the products/services that generate a negative profit.
In addition, there’s been a major debate around whether loss leader pricing is ethical. In Ireland, the use of loss leader pricing is banned. Businesses cannot sell products/services lower than their cost. Small business owners are at a significant disadvantage when it comes to pricing if a large corporation is able to price products at a significantly low price. Eventually, these small business owners would be driven out of the marketplace, and the large corporations would be able to establish a monopoly and raise prices as they see fit.
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