A loss leader is a product that is sold at less than cost. The firm sells this product at a loss as a way to encourage consumers to shop and buy other goods. The firm hopes to recoup the lost profit by increased sales of more profitable items.
A good example of a loss leader is a supermarket selling flowers at less than cost. A display of flowers in the shop window and eye-catching low price could encourage shoppers to go into the shop. If they do their weekly shop and spend £50, it will more than compensate for the negative profit margin on flowers of say £1.
In the past, supermarkets have had price wars on selected goods. For example, in 1996, supermarkets, such as Tesco, Asda and Kwik Save were selling baked beans for 3pence per can.
Tesco admitted that selling its Value Beans at 3p per can meant that it was making a loss. But, it hoped that it would attract customers into the shop. The campaign was so popular that Tesco had to limit the number of cans customers could but to four. (Baked Beans at Independent, 1996)
Below cost pricing and predatory pricing
Selling below cost is not illegal per se. However, if the aim of selling below cost is to force rival firms out of business, then it can be classified as predatory pricing, and this is illegal.
For example, if a supermarket sold baked beans below cost, this is not likely to force any other supermarket out of business, so is legal.
However, if a supermarket sold flowers below cost – it might be seen as an attempt to force florists out of business – because the price of flowers is critical for their business. This might be prosecuted under laws regulating predatory pricing.
Pros and cons of loss leaders for firms
- Attract customers into a shop which can help build market share and loyal customer base.
- Eye-catching loss-leaders can lead to ‘free advertising,’ e.g. the press coverage over cheap baked beans
Cons of loss leaders for firms
- The firm makes a loss on the product, which is not guaranteed to be recouped.
- If rival firms follow suit and also copy the price cuts, it may be ineffective in increasing market share – but only cause a mutual loss of profit.
- It could devalue some brands if they are seen as a ‘cost-cutter’. However, this is not an issue for supermarkets, like Tesco, Aldi because ‘cost-cutter is a good reputation to have.