Loss leaders are goods or services offered at steep discounts (generally below cost) in order to attract new customers to a store. It is a time-honored practice that has been met with much success, especially by large discount retailers. The intent of this pricing strategy is to not only have the customer buy the (loss leader) sale item, but other products that are not discounted.
When to Use Loss Leader Pricing
Move Overstock: If you have inventory that isn't moving or if you're overstocked on a particular item, a loss leader can move it. By cutting the price of such an item, you'll not only free up the shelf space and reduce inventory, but you'll also increase cash flow.
Brand Awareness: If you would like to be known for having low prices then the loss leader pricing strategy will help associate your business with that belief. Keep in mind that people want good quality merchandise for less money and not junk.
Increased Traffic: Using loss leaders as a marketing tool can help gain new customers and increase return visits. People like a bargain and will likely come back to shop.
Loss Leader Precautions
There can be success in loss leader pricing, but be aware of some obstacles to the process. If done incorrectly, loss leaders can actually cause the business to lose money. Also, not all manufacturers and suppliers will allow their products to be priced under their minimum advertised price or less than what their other dealers are selling the same item. It is also limited or forbidden to sell products below cost in some states. In recent years, lawsuits have emerged (not all successful) claiming some loss leader pricing strategies are the equivalent to illegal business practices.
If you decide to use a loss leader, consider using loss leaders only when it's clear that the lost profit can be countered by the sales of other products or services. Avoid doing something illegal by following good pricing practices. Always make sure that there is a significant quantity of the sale item in stock and use 'while supplies last' in any and all advertisements. Buying larger-than-normal quantities from suppliers may allow you a quantity discount, increasing the margin on the discounted price.