The phrase ‘Loss Leader Pricing Strategy’ can sound confusing, tautologous or even verge on doublethink. It is a strategy defined by its aggression, inherently risky nature and being shrouded in questions of ethicality and legality. But nevertheless the strategy exists. Not only does it exist, it’s very common and can be incredibly lucrative when executed properly. What is it? What are its characteristics? How can it be effectively implemented? And how can Omnia help you do so? We will provide answers to these questions during this piece.
Loss leader pricing involves selling products at a loss, below cost, which in itself could seem odd. In actuality, it has strong parallels with the popular High Runner strategy. The idea is that the attractive low prices will reel the customer in and increase sales opportunities elsewhere. In 2018 a survey by Slickdeals.net found that consumers spend on average $5400 a year on impulse buys. Customers these days are driven by value and convenience. So these increased sales might be on other products in store or online, they could be complimentary products or even part of subscription models. It can sometimes be considered a marketing strategy, designed to increase customer traffic and draw attention away from competitors. It’s often geared towards market penetration as part of an ‘introductory’ pricing strategy. However it’s used, the aim is to attract a larger customer base and achieve a larger long term recurring revenue.
Where better to start than the heavyweight of online retail. The mighty Amazon has adopted loss leader pricing to help construct its global empire. The Kindle was sold at a huge loss, with earnings being recouped later down the line with the sale of eBooks. This is actually very common in the gaming world too. The R&D costs that go into developing a new PS5, for example, are astronomical and as such each console is sold at a loss, but the money is made back with the sale of games. Amazon Prime Membership is also offered at an initial loss, but the promise of future prime purchases helps to mitigate that. Amazon entered the Dutch market in March 2020. We anticipated the superpower would offer discounted prime membership, 2.99 euros a month vs 8 elsewhere, to achieve market share in what is a very mature marketplace, with well established incumbents like Bol.com and Coolblue. This not only turned out to be the case, but also a very effective strategy.
More traditional examples include placing a heavy discount on a grocery essential, such as bread or milk and positioning that item at the back of the store. The hope is that something else gets picked up on the way back to the till. Back in 1959, British Motor Corporation decided to run the loss leading on their brand new model - the Mini. The base model was priced at a heavy discount, generating positive headlines. The desire was for those positive headlines to incite sales on the more high end, profitable models. What actually happened... the Mini ended up being the best selling car in Britain and BMC made little or no profit that year. D’Oh! Gillette on the other hand have become a world leader on the back of selling mechanical razors well below cost, but then generating enormous resulting sales from the recurring revenue of replacement blades.
Other more recent examples include Google offering Gmail for free, removing the barriers to entry to adopt the full GSuite. In addition the recent so-called ‘Digital Streaming Wars’ involved Disney gaining a reported 10 million users signing up for Disney+ on day one. Their end goal is to achieve 90 million users by 2024, in a marketplace that already has some pretty big players: Netflix, Amazon Prime Video, Apple TV+ and HBO Max. They plan to reach this target with pure and simple aggressive pricing. Their current offering of $6.99 a month is already cheaper than Netflix’s $8.99.
Starting with the Cons, many of which may already be obvious. Depending on where your business is located, you may not even be able to implement the strategy. Some jurisdictions have interpreted the controversial pricing strategy as being completely against the spirit of a competitive marketplace. As such, many US states have severely limited and others outright banned the practice of selling below cost. In Ireland the practice has also been outlawed within the domain of groceries. As indeed this practice has been outlawed in certain quarters, we have to question its ethicality. Nevertheless, the practice has been made illegal in only a narrow set of circumstances. To make the foregoing examples more accessible we have mentioned some pretty household names, big players. But the fact of the matter is, when it comes to loss leading, it is very often only the big players that are able to sustain such a strategy. Opponents state this strategy is predatory, coming at the expense of small businesses, unable to match the low prices and eventually forced out of the marketplace.
There are of course inherent financial risks involved to the business pursuing such a strategy. The first more tangible demonstration has already been illustrated by the BMC example. You are selling something at a loss, what if your sales for that item skyrocket? Some retailers have mitigated this risk by setting a cap, for example with an offer only applying to the first 100 patrons. Furthermore, the strategy is founded in the belief that earnings will be recouped by the sale of other goods, what if they aren’t? As we know, today’s customer is more discerning than ever, driven by value. Ecommerce has created far more transparency around price - the most important P in the marketing mix. So what if customers simply hop from one website to the next scooping up the best deals? Loss leader pricing can condition consumers to wait and ‘cherry pick’ only the best deals.
Nevertheless, consumers are not only driven by value, but also by convenience - the convenience of facilitating picking up additional and complementary products in the same place. There’s a belief that pricing a part of an assortment below cost will lead customers away from competitors’ websites and lead to more sales on other products. The price of a product is of course a signal, and as such, loss leader pricing can be seen as an investment in Marketing in order to drive customer traffic. The impact can be further improved by SEO if the products sold below cost are ones with high search volume anyway. Indeed displaying products cheaply on a website’s landing page increases the chance of sales elsewhere and is a strong visual merchandising technique. Furthermore, the signal a price emits also has implications on how that retailer might be perceived. One attractive price, can lead to a seller being considered good value in general. However, this could have negative consequences in equal measure. Customers are naturally wary and distrustful of companies offering heavy discounts. They might believe, often understandably, that there’s a trick being hidden behind that price tag that seems a little too good to be true, or that a low price represents low value.
For businesses focused on growth, absorbing initial losses as well as the risks of such a strategy has historically been a small price to pay for growing a customer base and achieving increased customer lifetime value. Indeed, when an organization enters a new market or new stores are opened, a loss leader strategy might be the best way to expand quickly. Amazon’s entrance to the Dutch market as well as Disney+ to the world of online streaming highlight this. There are similarities with introductory pricing, which cable and phone companies have endorsed for years, banking on future cross sales. Additionally, this technique can be an effective means of selling off excess stock or perishables before they go off. This tactic was adopted by Camden Brewery in the UK, who as a result of Corona Virus were left with a huge amount of excess stock. They ran a competition, giving away some of that delicious beer and in return received a huge amount of positive attention!
Doing it Right
To evaluate, there is the potential for negative outcomes with this approach, whether to the company following it, small businesses in the same market as well as to the customers targeted. Nevertheless, in the main, pursuing a loss leader pricing strategy is perfectly reasonable. It is strong when there is a good selection of other products to purchase, it is even stronger when there are complementary products with high margins that are properly merchandised close to the loss leader product. There are of course more subtle ways to reap the rewards of loss leading, and one of those is to have a rewards program. Rewarding the loyalty of customers is a great way to incentivise future purchases and build lifetime customer value. Furthermore, offering free shipping above a certain purchase threshold is another means of subtly implementing the strategy.
Successfully implementing a strategy with so much potential downside is made much easier when you are assisted by a pricing software like Omnia. The basic concept behind loss leader pricing is drawing the attention of a customer with one product, in the hope of selling them others. Omnia can help keep that customer on your site. By designing a strategy that works for you, identifying the right products and the price changes in the sweet spot, can have exponentially better results for your revenue and your margins. It’s vital to not only pick the right product to cost below price, but to price it at the right level. A tool such as Omnia helps you do this by displaying sales data, page views, margins and competitor price levels all in the same place.