A loss leader is a product or service that is purposefully sold at a loss or for less than market value. It’s commonly used in the grocery industry to attract new customers or gain additional revenue on other items. Loss leaders are part of well-cultivated business strategies and often generate far more revenue than their cost.
It’s important to note that with recent high inflation rates, supply chain issues, and production difficulties, grocery retailers must be even more careful when cutting profit margins on items. A loss leader that once generated a positive return may now hurt profits.
Below, we outline some of the key benefits, considerations, and risks for using loss leaders in grocery.
The key driver of a loss leader strategy is to drive profitability of the shopper’s basket (and ultimately the consumer) by increasing basket size and sales of higher margin items, despite taking a loss or reduced margin on specific products.
Additionally, grocers looking to penetrate a new market may utilize loss leader strategies to attract new customers. Cheaper prices on essential items like eggs or milk appeal to all consumer bases and can help to solidify an entry into a particular market. Both new and existing stores can use loss leaders to retain shoppers by introducing periodic sales that create brand loyalty even after prices revert.
Grocery retailers can also utilize loss leaders to introduce new brands, lead customers to purchase extra products, or liquidate old inventory. These tactics generate higher revenues, attract and retain customers, and can clear needed shelf space. Retailers should also collaborate with their CPG partners in formulating their strategies on utilizing loss leaders. Through data, manufacturers should be able to demonstrate how their brand or product can drive mutual profitability for both the retailer and manufacturer through category growth and/or basket growth.
Utilizing Loss Leaders in Grocery
It’s important to remember that loss leaders can be periodic sales or permanent fixtures. An early November sale on Halloween candy would be an example of a loss leader that clears shelf space for more pertinent items. A permanent mark down on eggs would be part of a grocery store’s long-term consumer strategy because a rise in price could push customers to shop at competitors.
The best products for loss leaders in periodic sales are those that revolve around major annual events and holidays. While many of these may be national, such as for Independence Day or Thanksgiving, periodic sales can also be localized. For example, a grocery chain in Texas may cut prices on meat near barbeque festivals. This drives local customers into stores who are hopefully retained long after the festival ends.
A grocery retailer’s long-term loss leader strategy often includes essential items that appeal to most shoppers. These staples are regularly milk, eggs, rotisserie chicken, and bread. Costco, for example, loses roughly $30-40 million per year by selling their rotisserie chicken for $4.99, a price that hasn’t changed since 2009 despite heavy inflation. This chicken is one of the best-known loss leaders in grocery and helps Costco’s 90% retention rate of current members. Costco also knows that they generate higher revenues from shoppers who enter the store for chicken and buy far more than anticipated.
Placement of loss leaders within the grocery store is also important. Shoppers may notice that food staples are often placed in the rear of the store which forces them to walk through aisles of other products. This strategy is important for capturing additional revenue from impulsive shoppers. Common items may also be placed near complementary products to induce additional spending (as well as correlated products which may not always seem complementary – like the classic example of beer and diaper sales). Continuing the previous example of a Texas grocery chain, seasonings and spices may be strategically positioned in the meat aisle during key grilling seasons since spices are a low-velocity/high-margin item for the grocer.
Finally, eCommerce is a rapidly growing market segmentation within grocery. Online grocery sales are predicted to account for 20% of the overall market by 2026. This means that loss leader strategies can also be employed online. For example, a grocery retailer’s landing page may display their most prominent mark downs or their low prices for staple goods. This attracts new customers and also captures additional revenue from curbside shoppers who still purchase impulsively despite never entering the store.
Uncertainties in production, supply chains, and inflation from the pandemic weigh heavily on loss leader strategies. But aside from unpredictable fluctuations, there are consistent risks that must be considered by any grocery retailer.
Cherry picking is when consumers only shop for the loss leaders. For example, an individual only buys the marked down eggs, milk, and bread from one store and shops elsewhere for other products. While these shoppers are not representative of most consumers, they can eat into profit margins.
Bulk purchasing is when consumers may purchase so much of a loss leader that supply runs out. While some benefits may still be captured on those few shoppers, it may generate an overall loss because only a fraction of the potential consumers are leveraged. This can be mediated by introducing product limits. For example, shoppers are only allowed to purchase two cartons of eggs on each visit to the store.
Pricing perception is when an item has been a loss leader for so long that shoppers think the market price is actually that low. When a grocery retailer is forced to raise prices, sales can be negatively affected because customers believe they’re being overcharged.
In order to measure the effectiveness and optimize their loss leader strategies, retailers need the right technology to capture the shoppers’ data and the analytics capabilities to make decisions. What items are driving larger baskets? How does product placement of the loss leaders and associated products impact the basket size and profitability? How do shoppers’ behaviors change from in-store to online?
With the rise of mobile apps for grocery stores and geolocation technology, retailers can even see how their shoppers navigate the store when purchasing a loss leader. Leveraging data, retailers can better understand who is buying the loss-leading product and how profitable that shopper is to the store. They can also use the analysis to better position and promote higher margin items that accompany the purchase of loss leaders, driving increased overall profitability of the basket and the shopper. Having the right technology is crucial for grocery retailers to make data-driven decisions on incorporating loss leaders into their pricing, promotion, and merchandising strategies.
Effectively determining which products should be loss leaders and where to price them may require the help of an industry leading strategy partner. Retailers should not shave profit margins too slim or introduce unsustainable loss leaders that could backfire if prices are forced to rise.
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Contributions from Jake Park-Walters