A loss leader is a product or service sold at a substantial discount, or at a loss, in order to generate additional sales.
Firms use loss leaders to attract customers to enter a retail outlet in the hope that they will purchase other products sold at a profit.
For example, a games console may be sold at below cost price to attract people to buy that particular console. The games for it will then be sold at a higher margin and this will more than compensate for the losses made on the console (if the console manufacturer is also the games publisher).
A loss leader pricing strategy should only be used on products where demand is price elastic (responsive to price changes). It is a strategy that will often be used by retail stores - supermarkets and hypermarkets in particular. A common approach is to focus large discounts on products that are termed 'known price items' (KPIs); in other words where customers have a good price perception and, therefore, recognise the excellent value.
Known price item
A known price item is a product that is regularly purchased by a consumer and where the price is very familiar to them.
By using known price items as loss leaders, firms will make them appear more attractive to consumers and encourage them to purchase. If they then purchase other products along with the loss leaders then the firm should more than recover the loss on the loss leader with the purchase of other products where the consumer is less familiar with the price. Attracting consumers into the store may also create customer loyalty.