Loss Leader Pricing

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Loss Leader Pricing

Loss leader pricing is an aggressive pricing strategy in which a store sells selected goods below cost in order to attract customers who will, according to the loss leader philosophy, make up for the losses on highlighted products with additional purchases of profitable goods. Loss leader pricing is employed by retail businesses; a somewhat similar strategy sometimes employed by manufacturers is known as penetration pricing. Loss leader pricing is, in essence, a bid to lure customer traffic away from the businesses of retail competitors. Retail stores employing this pricing strategy know that they will not make a profit on those goods that are earmarked as loss leaders. But such businesses reason that the use of such pricing mechanisms can sometimes attract large numbers of consumers who would otherwise make their purchases elsewhere. In the world of e-commerce, loss leader strategies are intended to draw consumer traffic to an online retailer's Web site. The technique is also used for product introduction—thus several free copies of a magazine to induce purchase of a subscription, low rates for cable services, and other "introductory" pricing which, if not always priced at a loss, function in the same way.

In recent years, loss leader pricing has been practiced with considerable success, especially by large national discount retailers. The strategy is not without its critics, however. Indeed, many states have passed laws that severely limit—or explicitly forbid—selling products below cost. Very similar trends have emerged in Europe as well, with a ban on loss lead pricing in Irish groceries being a case in point. Lawsuits alleging that some loss leader pricing strategies amount to illegal business practices have also increased, although plaintiffs have not always been victorious. Opponents of such pricing practices argue that the strategy is basically predatory in nature, designed to ultimately force competitors out of business.

Defenders of the practice contend that loss leader pricing is simply one of many measures that retail establishments take to increase in-store traffic and, ultimately, their financial well-being. They note that U.S. antitrust and trade regulation statutes are designed to protect competition, not individual competitors, and that legitimate marketplace competition inevitably results in economic winners and losers. The furor over the practice is not expected to subside any time soon, however, because many small businesses, with strong support in many state legislatures, have been economically damaged over the past several years by larger competitors willing to take losses or razor-thin profit margins on some products in order to expand their customer bases.

Business experts note that suppliers sometimes object to loss leader pricing as well, despite the greater volume of sales that the practice often spurs within a given store. These increases may be offset by drops in sales at other stores where the brand is still priced high. Such developments can strain relations between supplier and customer, and in worst case scenarios, bring pressure on the supplier to lower its price for the good(s) in question. The practice is most debated among retailers. Some see loss leader pricing potentially inducing downward spirals of pricing which hurt everyone—except the chuckling consumer carrying 10 cans of peanut butter or instant coffee out to the car at 7:05 in the morning, five minutes after the store's opening.

Indeed, in recent years, retail industries have acknowledged a side effect of loss leader pricing. It's known as "cherry picking." This is a practice wherein customers move from store to store, making purchases only on those products that are priced near or below acquisition cost. Such purchasing patterns effectively foil the strategy underlying loss leader pricing—to lure customers who will also buy products with healthier profit margins—but to date the practice is not deemed to be sufficiently widespread as to be of concern.

see also Pricing

BIBLIOGRAPHY

Garvey, Anthony. "Ireland's Below-Cost Ban Could Still Be Abolished." Grocer. 7 May 2005.

Hirschman, Celia. "Decoding Retailer's Disk Mojo." Daily Variety. 5 January 2006.

Hamilton, David P. "The Price Isn't Right: Internet Pricing Has Turned Out to Be a Lot Trickier Than Retailers Expected." Wall Street Journal. 12 February 2001.

Turen, Richard. "Loss Leader is No Loss." Travel Weekly. 13 December 2001.

Zettelmeyer, Florian. "Expanding to the Internet: Pricing and Communications Strategies When Firms Compete on Multiple Channels." Journal of Marketing Research. August 2000.

Hillstrom, Northern Lights