Loss Leader Pricing: Explained
In the world, everything comes at a price and it is monetarily determined by a lot of factors. Basically, there are two forces which decide the price of any product or service – demand and supply. If demand rises and supply remains low, the price escalates. Whereas when supply is abundant and demand remains low, prices fall sharply.
The third and another important force influencing the pricing pattern of products is competition. If there is no competition for the item, then pricing could be autocratic. Thus, manufacturers producing the product could control the pricing entirely or it is highly likely that they become the sole decision makers of the price of the product. However, if there are a lot of competitors producing the same item, then every manufacturer tries to sell at a competitive price which might be much lower than others. Here is when loss leader pricing comes in.
Let Us Understand What Loss Leader Pricing Really Is
Juxtaposed to normal pricing of items, loss leader pricing relates to pricing of any products, even lower than their production cost with the sole motive of attracting more customers and boosting sales of other products. Thus, loss leader pricing might be loss-making to the seller of that particular product or some products, but that loss is compensated by attracting more buyers who are then introduced into other products at the store and in turn persuaded to buy other products as well. Therefore, where loss leader pricing makes the sale of a particular product as a loss-making, but it boosts sales of other products. This is practiced in order to increase market penetration and win the trust of customers.
Examples Of Loss Leader Pricing
Two of the most characteristic examples are the sale of razors and Microsoft's Xbox One video game console. Razor product manufacturing giant Gillette sells razor units at an ultra-low price or sometimes for free, as the company believes that people would need replacement razor blades in the future which is the main product of the company.
Similarly, Microsoft sells Microsoft's Xbox One video game consoles at very low prices with low margin, assuming that in order to play on the consoles, people would be buying Xbox Live service subscriptions. These subscriptions are their main product.
Working Process Of Loss Leader Pricing
Loss leader pricing basically aims at one thing – to drive customers in the door. This is achieved by offering some products at such ultra-low prices that customers get attracted by them and step in the store to buy them and end up purchasing a lot of other products as well which are reasonably priced.
It is quite possible that the store might have to bear losses in the sale of milk and potato, but this loss would be compensated by the sale of other products such as bread, butter or daily utilities, fruits, groceries bought by the customers.
Loss Leader Pricing Users
Loss leader pricing is occasionally used by stores, supermarkets etc. for products such as toilet paper, milk, eggs, some vegetables, fruits in order to increase footfall. It also used to offer the existing customers some huge offers thereby making them permanent customers. However, these discounted priced items are often placed at the back corner of the store. This is done so that customers come across and end a number of products before reaching the loss leader priced products at the store.
Pros And Cons Of LLP
Advantages of LLP are the same: Higher sales of items stimulated by the loss leader pricing of any product.
It is a win-win situation for the customers: They are the ones who get items at low prices.
Symbiotic Relationship: Overall, it creates a symbiotic relation between the customers and the stores as both get benefitted by loss leader pricing.
Stores need to be on the vigil always: Stores need to keep sales of other items in check. Following discounted pricing of some items, the store could end up in substantial loss if the store fails to keep a watch on the sale of other target items. At times, smart customers purchase discounted products only leading to loss of sale of other items and increased pressure on inventory of the discounted products.
Disadvantageous to small retailers: On the other hand, this practice is considered to be against small businesses which are often seen to incur huge losses if some store offers the same products as they are selling, at rock bottom prices.
State of Confusion: Loss leader pricing of the same product by different stores often confuses the customers. It is then the store which offers a high rebate on other items wins the trust of the customers.
Legality Of Loss Leader Pricing
Since it is not a general practice and is intended to sway the market and purchase patterns of customers, a lot of countries have banned it. It is illegal to practice loss leader pricing in some countries in Europe and in some parts of the USA. In these countries, the law term loss leader pricing practice to be against healthy customer practices and terms it to be a loss for the customers as some customers might end up stockpiling things available at throw-away prices.
Thus, we can see that where loss leader pricing is really an effective strategy to influence and attract customers it might have catastrophic effects on small businesses and buying patterns of customers. Also, its legality is challenged in some countries of the world.