Thursday, July 24, 2014

Unintended Consequences of Loss-Leader Pricing

Staples, the office-supply superstore, used loss-leader pricing to gain New York State as a customer for a three-year period.

To seal the deal, Staples said it would price 219 commonly-purchased office supplies at just one penny each.

One penny for a paper shredder. One penny for a box of blackboard chalk. One penny for six dozen batteries.

What happened next shouldn't surprise any shopper who has gotten up at 4 a.m. to take advantage of a super bargain price on Black Friday.

Government agencies and organizations that qualify under the New York purchasing umbrella rushed to order the one-penny items. Not just one or two, but dozens. One school district in New York state ordered loads of merchandise, total value more than $677,000 at list price (admittedly higher than the usual selling price). The district paid........$299.15, according to a Wall Street Journal article.

Staples isn't the only firm to experience the unintended consequences of loss leaders. Many small businesses see Groupon's daily deal loss-leader as a high-profile way to introduce the business to new customers. But some that offered loss-leader deals through Groupon found themselves overwhelmed by orders that left little if any profit margin. The response far exceeded expectations and strained the business's ability to operate effectively and efficiently, an unintended consequence that soured some firms on the daily-deal pricing model.

Loss-leader pricing can be effective in many situations. Prince used it to launch an album in 2007--he essentially gave CDs away in partnership with a London newspaper, incurring a loss on the deal. But the buzz over this giveaway helped Prince sell out 21 live shows in London, netting the performer a hefty profit. The newspaper saw a bounce from its involvement, as well.

Loss-leader pricing can be excellent for attracting attention, driving publicity and word-of-mouth, and increasing traffic, either to a website or to a retail location. Marketers need to link pricing to overall marketing strategy and understand how the program will affect short- and long-term customer loyalty as well as ongoing profitability.

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