Loss Leader Strategy Definition
It is a pricing strategy used by the retail stores to bring in customers in their store. In this strategy, they offer products or services at below market price to attract the customers with an assumption that once the customers are inside the store, they will end up buying other normally priced products and services as well. A typical customer often buys other items along with the ‘loss leader’, and the seller expects to make an overall profit from this purchase. The same strategy is also used by e-commerce sites to attract customers to their website.
A Little More on What is a Loss Leader Strategy
The sellers implement the loss leader strategy with an expectation of greater profit. An item, the loss leader is offered at a reduced price in order to lead the customers to the store. It is offered at a price which is below the minimum profit margin but not essentially below the cost. The companies generally maintain a current analysis to estimate the impact of the strategy on the company’s overall sale.
Supermarkets and restaurants often use this strategy to attract new customers to their store. The new players in the market also use this strategy to penetrate the market. This is also known as penetration pricing.
The loss leader is an effective policy to stimulate the business of a company. It helps in expanding the overall market share of a company and leads to a greater profit. In the retail store, the loss leader is often positioned in a way that a customer needs to walk past other profitable items to reach it. The lost leaders are usually those items which the customers buy frequently, and the price is known to all. Thus, the customers will easily understand that they are getting the item at a much lower price than usual. The stores often sell the loss leaders in a small number or with a limit to prevent stockpiling. The perishable items which cannot be stockpiled are also sold as loss leaders.
A store may also sell an expensive item as a loss leader at a reduced price to attract the customers. Those customers may not buy the actual loss leader, but they might end up buying other products from the store. Like the Target may decide to offer a TV set at $50 to attract the customers. The customer will visit the store to see the product and then purchase other necessities from the store.
The sellers expect the customers will become loyal to them once they buy their products. However, the loss leader strategy may also fail to generate profit for the company. The customers may leave the store without buying anything other than the loss leader. This practice of jumping from one store to another to pick up the loss leader products is called cherry picking.
References for Loss Leader Strategy
Academic Research on Loss Leader
- • Loss leader pricing and rain check policy, Hess, J. D., & Gerstner, E. (1987). Marketing Science, 6(4), 358-374. The paper studies the impact of the loss leader pricing and rain check policies on the profits and market outcome. If a store can accurately predict the demand will they still run out of stock? The paper investigates whether this is a plausible result when the store can offer rain checks. The paper also discusses the FTC rule that prohibits stock-outs of advertised sale items and analyzes whether this rule should be repealed.
- • The loss leader is a turkey: Targeted discounts from multi-product competitors, DeGraba, P. (2006). International journal of industrial organization, 24(3), 613-628. This paper argues that the firms selling multiple items can use the strategy of lowering their profit margins on the items bought primarily by the more profitable customers in order to attract them. These discounts are effectively offered to the more profitable customers and the less profitable customers do not get the discount. In this theory of multi-product pricing, the profit margin is inversely related to the profitability of the customers who buy it. This theory explains why stores offer lower prices to larger customers. The theory also confirms that loss leader pricing helps the stores to attract more profitable customers. This provides an explanation of why the Turkeys are sold as a loss leader during Thanksgiving, but flowers are not offered at a reduced price on Mother’s Day.
- • The effect of loss leader pricing on restaurant menus’ product portfolio analysis, Cohen, E., Ghiselli, R., & Schwartz, Z. (2007). Journal of Foodservice Business Research, 9(1), 21-38. This paper asserts that the menu related product portfolio analysis violates the assumption of item independency and sites four theoretical reasons for menu item dependency. It analyzes restaurant figures from two consecutive periods to show how the loss leader pricing strategy affects the portrayal of the performance of several dishes both by the matrix-based approach and the multidimensional menu mix model. The paper argues, there is a need for better menu product portfolio model to adequately address the interdependent nature of the restaurant’s product portfolio.
- • Price dispersion and loss–leader pricing: Evidence from the online book industry, Li, X., Gu, B., & Liu, H. (2013). Management Science, 59(6), 1290-1308. This paper develops a theoretical model for analyzing the pricing strategies adopted by competing retailers with unequal cross-selling capabilities on the occasions of product demand change. The analysis concludes that retailers with higher cross-selling capabilities make more profit from loss-leader pricing on high demand products than the retailers who have lower cross-selling capabilities. Thus, when the demand for a product increases its price disparity across retailers also gets increased. This prediction supports empirical evidence from the online book retailing industry.
- • Loss–leader pricing and upgrades, In, Y., & Wright, J. (2014). Economics Letters, 122(1), 19-22. This paper provides a new theory of loss-leader pricing that suggests the retailers advertise below-cost prices for certain items to indicate their other unadvertised (substitute) items are not priced too high. The theory is tested on the pricing of upgrades. The results contradict most of the loss-leader theories in that the companies make a loss on the customers who buy the basic version and earn a profit on the customer buying the upgraded versions.
- • An appraisal of loss leader selling, Kemp, M. C. (1955). Canadian Journal of Economics and Political Science/Revue canadienne de economiques et science politique, 21(2), 245-250. This paper evaluates the loss leader pricing strategy and assesses its effect on public interest. The paper argues although under certain circumstances loss-leader pricing is detrimental to the public interest but outlawing it all together is a mistaken policy. It rather argues for safeguarding the public interest keeping the loss leader in place.
- • Demand Uncertainty, Niche Competition, and the Loss Leader Enigma, Deneckere, R., & Marvek, H. P. (1994). This paper attempts to understand the loss-leader pricing phenomena in the lights of demand uncertainty and niche competition.
- Loss leader or money maker? Pricing a salad bar for profit, Buchanan, R. (1982). Food service marketing.• The paper discusses the loss leader policy and the pricing strategy of a salad bar for making a profit. It says the cost of a serving of salad depends on different variables like the price and arrangement of the ingredients, size, and shape of the container where it is displayed, nature of serving implement, size of the serving plate and customers returns. The cost of each ingredient (ready to eat per ounce) is most important among these. The cost also includes the labor cost, both productive and non-productive and service costs. Market strategy, competition, amount of sales and customer acceptance affect the profit objectives. It suggests pricing the salad by ounce allows the prices to fluctuate with costs.
- • When a Loss is a Gain and When It’s Just a Loss: The Effect of Loss Leader Strategy in Online Marketplaces, Choi, K., Ryu, S., & Cho, D. (2017). The paper studies how the loss leader pricing affects the sales of core products in an online marketplace. Information on individual-level transactions and product-specific characteristics are used in this study. It examines how the loss-leading items’ relation to the core products affects the sales differently. The paper further studies the moderating role of the informational cues such as peer reviews and product prices. Based on its results the paper concludes, introducing a loss-leading product increases the sale of the core products only when the loss leader is not a substitute for the core product. It further examines that informational cues can strengthen or weaken the association of such loss leaders and core product.
- • Loss–Leader Pricing, Norman, G. (2014). In Dictionary of Industrial Organization. Edward Elgar Publishing Limited. This paper discusses the adoption of the loss leader pricing strategy in the field of industrial organization. It discusses the concept, models, methodology, and application of loss leader pricing.
- • Deutsche Bank chief risk officer: derivatives becoming loss leader, Wood, D., Devasabai, K., & Madigan, P. (2014). Risk, 9. This article discusses the opinions expressed by Stuart Lewis, the group chief risk officer at Deutsche Bank at the Risk USA conference in New York. In this Lewis compared the contemporary interest derivatives to the loan business a decade ago. He said in that time banks recognized the loan business was value-destroying when viewed on its own, but it would give them access to their clients’ wallet. Lewis said, “We’re heading that way on something like core rates, where you allocate that instrument to key clients that you can execute other products with, and therefore overall your return will be productive,”.
- • Impact of a loss leader strategy on supply chain pricing and stocking, Kurata, H., & Nam, S. H. (2007). This paper analyzes the impact of the loss leader strategy on the two-stage supply chain. The paper suggests that the short-term effect of loss leaders is positive for both the supplier and retailer, but the long run advantages depend on several factors. It also concludes that loss leader competition between two retailers is always beneficial for the suppliers, but it may negatively affect the performance of the retailers.
- • Loss Leader or Low Margin Leader? Advertising, Simbanegavi, W. (2008). This paper tries to identify the different conditions that lead to the rise of loss leader pricing. The study shows when the distance between two competing firms is low, the advertised item is priced below the cost. No matter if they advertise the same or different products. The paper argues, whether the advertised product is a loss leader or a low margin leader primarily depends on the extent of differentiation between competing firms.