What if we told you it’s possible to increase your sales by offering products at or below cost? That’s the idea behind “loss leaders,” which are products that are deeply discounted simply to attract new business. The strategy involves more than just slapping a discount sticker on a product and hoping for the best. Here’s how to do it right to ensure success.
Why Consider Loss-Leader Pricing?
The ultimate goal of this pricing strategy is to attract customers to your store by offering a deeply discounted product, then either upselling them to a more expensive item, or selling add-ons or other products that go with the discounted item. For instance, when you bought an inkjet printer for an unbelievably low price, the manufacturer was counting on the fact that you would need to buy printer cartridges for the life of the printer. And that free service checkup for your air-conditioner? The owner of that business lost profit on the checkup, but likely tried to sell you a repair or a yearly maintenance program to keep your unit in shape. In other words, when business owners offer loss leaders, they are counting on the fact that you will make purchases in addition to the discounted item, which will make up for the loss.
Determine Which Product to Offer
You’ll need to put a lot of thought into choosing just the right product, and then decide on its price. First, it’s a good idea to identify your goal. Here are three of the most common reasons business use loss-leader pricing:
- To attract new customers. One way to build your client base is to expose potential customers to your business via a loss leader. Grocery stores use this model all the time when they advertise items below the regular price. Once those customers are in the door, they’ll likely buy other items, and then come back again because they’ll view the store as one that offers great deals. If this is your goal, you’ll want to use a product that has mass appeal and will attract a variety of shoppers.
- To bring back previous customers. One of the quickest ways to increase sales is to get previous customers to start doing business with you again. Do this by offering a product that is unique to your business — something that they can’t get anywhere else — and give it to them at a bargain price. This should rekindle their interest in you and turn them into repeat customers.
- Generate future sales. If you have a base product that counts on other products to make it work, you can use the base product as your loss leader. The Founder and CEO of Amazon Jeff Bezos has stated that Kindles are sold at cost, and that profits come from accessories, Kindle books, and other forms of online content. Using a similar strategy not only ensures future sales, but could help you build your customer base.
Set the Discount Price
There are a few factors you’ll need to take into consider before setting the price. First, and perhaps the most important, is your current cash flow position. It would be counterproductive to engage in this pricing technique if you are low on cash because, with loss-leader pricing, you must be willing to take a loss now to ensure future sales.
Next, you’ll need to set the price. To do this, first determine the break-even cost of the product, and then find out what your competitors charge for it. You’ll need to determine whether you want to offer the product at your cost, for a very small profit margin, or at a loss. This will depend on your goals for the sale. For instance, if you have an abundance of products that are about to become obsolete, you may sell them below cost in order to clear them out and generate some cash flow. If you want to lure customers away from your competition, price the product slightly above cost, but below their price, and establish your reputation as a business with better prices. Or you could sell a product that needs companion products to make it work below cost and bank on those future sales. Included in all of these techniques should be the goal of getting consumers into your store and buying more than just the loss leader. Do this by displaying the sale item along with other, more profitable products.
What Are the Drawbacks?
There are a few things you need to be aware of when using this pricing strategy. They are:
- Cherry pickers: These are consumers who go from store to store only buying the items on sale. If you attract too many of these, you may not be able to recoup your losses and make a profit from other sales.
- Manufacturer blowback: Some manufacturers may not like you selling their products at such a discounted price. Talk to them before running your sale to ensure that it won’t sour your relationship.
- State law: Twenty-two states have general sales below cost (SBC) laws that prohibit retailers from selling products below cost. FindLaw offers a state-by-state list of the rules. The Federal Trade Commission also has antitrust laws that deal with below-cost pricing.
- Stockpiling. To prevent people from buying up all of your stock, it’s a good idea to limit the amount each person can purchase. And be sure to make it clear that the sale is only good “while supplies last,” so you won’t be liable if you sell out.
Loss leaders can help you grow your business if you apply this pricing tactic intelligently. Think about which of your products and services would be ideal, then set the strategy in motion.