Have you heard the term ‘losing penny to earn a dollar’ ? Loss leader strategy follows the same principle.
In a loss leader strategy, you price some products low to increase the foot falls. These foot falls translate into additional sales, which more than compensates for the profit shortfall from the loss leader. So the story goes.
However, if you are not thoughtful, you may get additional footfalls but not additional sales. This can become a drag on the profit and also lower the experience of the genuine buyers. So what should be done to design a loss leader effectively?
#1. Items with high price elasticity: For a loss leader choose an item from an assortment that has high price elasticity. It should be something whose price change is noticed by a large number of people.
#2. One item from the group that is bought together: The loss leader should not be an item that is bought as a stand alone product. Otherwise it would generate the foot fall but not additional sale. For example, in apparel industry a sweater is a stand alone purchase where as Jeans and T shirts are often bought together. Similarly, in food industry a coffee is often bought as a stand alone where as lunch is bought with side dish and a drink. This point is often missed out by companies.
#3. Not the most valued product of the bundle: In fast food business, Burger is the most valued item in the bundle made of burger, fries and a soft drink. So having a burger as a loss leader can create footfalls without adequate additional sales. If a company plans to offer burger as a loss leader, then it should be toned down version of a regular burger.
#4. Test market the loss leader: Loss leaders may be seasonal and geography specific. One needs to test the loss leader in the market before launching it in a big way. What works in one place may not work elsewhere. Similarly, there may be a seasonality affect on the loss leader.
If done well loss leader can be an effective strategy for a new player to establish itself in the market. Many executives believe that it works better than advertising.
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