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Loss Leader Pricing

Pricing goods at below cost to stimulate sales of other profitable goods

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. In 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 towards stimulating other sales of more profitable goods. Learn more about strategy in CFI’s Business Strategy Course.

 

Loss Leader Pricing

 

Rationale Behind Loss Leader Pricing

At a glance, it may seem that such a pricing strategy would destroy the profitability of a store. However, the loss leader pricing strategy works effectively if executed properly.

The rationale behind the strategy is to price certain products below costs to draw more traffic from other competitors and ultimately generate more sales on other products. The strategy is common in the marketplace as businesses introduce new customers to an extremely cheap product or service in the hope of building a large customer base and 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 the example, the service may not be priced below cost, the rationale of adopting such pricing remains 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 only marginally cheaper but 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 generate 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 to 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 markers, BMC made little to no profits due to the high sales of their base models.

 

Learn more about strategy in CFI’s Business Strategy Course.

 

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 was 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.

In fact, the blades sold or given away by Gillette did not last very long. Customers who finished using Gillette’s razor typically ended up buying a replacement razor and/or other products of Gillette. The business model played out successfully for Gillette, which saw high recurring sales 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 to a business If customers only purchase the products/services that generate a negative profit.

In addition, there’s been major debate around whether loss leader pricing is ethical. In Europe, namely Ireland, the use of loss leader pricing strategy is banned, and 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.

 

Additional Resources

CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

  • 5 P’s of Marketing
  • Buyer Types
  • Market Positioning
  • Total Addressable Market (TAM)

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