The Expense That Benefits
Chances are if you have ever shopped at Costco , you have heard of their famous $1.50 Hotdog & soda combo meal. However, with such a deal can such a product be a benefit to the business?
The answer is no… but also yes.
"Costco sold 128 million hotdogs last year at its food court. That's purportedly four times as many as major league ballparks sold last year combined."
- The Motley Fool (2016)
With a product sold at such a low price, Costco makes little if any profit on such a sale, yet they sell well over 100 million every year.
As you can see, the expenses can add up quite quickly, especially with such a large international company like Costco. However, they are not the only ones doing something of this nature. In fact many of the most successful businesses you see today are doing something like this, whether it is a free test drive of the latest Mercedes Automobile or the samples that you try at your local Deli, many businesses are offering some form of a free/cheap product or service, with the expense falling to the company.
The above is a common yet very successful pricing strategy referred to as the Loss leader.
The Strategy
The Loss Leader uses low prices or free products/services to lure shoppers to their physical and eCommerce stores or even to specific products. Many appliance companies we see today, can sell their machines with low-profit margins to attract shoppers who will then go on to continuously purchase their coffee pods which is where they can make up for the initial loss of profit.
The Risk
The Loss leader pricing strategy is a bold strategy, because you run the risk of shoppers stopping at your Loss Leader product/service and then leaving without purchasing a product/service that has a profit margin value. So, in the end, you could risk just breaking even or even lose money.
The Reward
The risks are often worth the reward because it is one of the best pricing strategies for building your brand, rapport and it also encourages your shoppers to return, either to restock on coffee pods or to get another $1.50 hotdog meal. Big companies like Swiffer , Keurig , Tassimo , XBox , PlayStation , Walmart , Amazon , and Gillette have used similar pricing strategies to great success.
"Pricing a product at a loss can still be profitable if the customer can be persuaded to purchase other items at full price during the same shopping trip."
- Shopify Business Encyclopedia
The science behind it is simple. People will go where there are reasonable offers. This pricing strategy also plays on a significant part of human nature that Psychologists know as the Rule of Reciprocity.
"According to sociologist Alvin Gouldner, not only is this rule active in all cultures, but it permeates the social exchange of every kind. The rule dictates that we try to repay, in kind, what another person has provided to us."
In business, this means doing something for your customers, such as giving them a fantastic deal on a Loss Leader product or even giving it to them for free. Having built up a rapport, your customers will be much more likely to do business with you.
The tiniest example of the rule of reciprocity is found in the day to day restaurant environment. The waiter's hands you the bill, often accompanied by mints or lollipops, in hopes to encourage you to come again and possibly even to up their chances of getting a tip.
Products that are sold at a loss, but then require additional products to function, of which you sell as well, where you make up profit margins, would not necessarily fall under the Rule of Reciprocity, but would still fall under the successful Loss Leader pricing strategy.
Summary
One of the essential rules of persuasion is reciprocity; invest in your customers, and in turn, they will be much more likely to invest in you. Many of the world's most popular brands do this by using the Loss Leader pricing tactic. How are you providing value to your customers? Moreover, how do you distinguish yourself from the competition?
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