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Loss Leadership & Price Perception: Why Retailers Sell Products at a Loss

Posted by PriceBeam on September 19, 2017

loss leadership

Despite increasing proficiency in logistics and operations in supermarket giants, some prices they set are so low that they seem almost too good to be true. How can one possibly make money selling a gallon of milk at $4?
In some cases, you can’t. In the pursuit of loss leadership, retailers have actually cut prices to a point where they’re making a loss. A recent report on Walmart’s pricing suggested that the retailer made a loss of around 10% on eggs, and as much as 25% on milk.
While selling products at a loss contradicts common business sense, most people will, of course, buy several items, many of which are high-margin products.

However, there is more to loss leadership than having the lowest prices – if low prices were all it took, the race to the bottom would simply be won by the retailer with the strongest finances. And there are several examples where the retailer with the lowest price-level is not perceived as such: in 2016, The Independent reported that the UK upscale-retailer Waitrose made the top of their list of best-value supermarkets in the UK – however, Waitrose is perceived as being one of the most pricey supermarkets in the UK.

Ergo, price level is far from the only determinant of loss leadership; what is equally important is selecting the right items. In this regard, we talk about items that drive price perception, i.e. items that have a relatively strong influence on how expensive or inexpensive supermarkets are perceived to be by customers. These are typically value-items such as dairy, snacks, value-packs, but also other everyday products such as ground beef and frozen food items.


However, identifying items that drive price perception is not as easy as it used to be since the increasingly intelligent and sophisticated selection of these items have resulted in a wider range of products being used to drive price perception and pursue loss leadership. Simply using your intuition is no longer sufficient.

 

What type of products drive price perception?

If you are trying to create a low-price perception, it’s because you’re hoping to attract price sensitive customers who would go to the competitor if he finds them cheaper. Price sensitivity is key, and it will depend both on the customer’s general price sensitivity (e.g. determined by his income level and wealth), but also the item that he is buying. You can read more about the variables that determine what determines the price elasticity of a certain product in this article.

Essentially, you want to identify products with high price elasticity that are purchased by price sensitive customers. It is useless to drop prices of a product with high price elasticity if it is purchased by customers with low price sensitivity.

 

Driving Price Perception With Data

In order to identify what products price sensitive customers buy, and the corresponding price elasticity of the given products, it requires the use of customer data and experimenting with slightly altering prices. How does Customer A react to the higher price level of goods he commonly consume? And what goods does he commonly consume? These are questions that you need to extract from loyalty card data and the like, and that is exactly what retailers such as Walmart do.

 

Read more about price perception here

Written by PriceBeam

PriceBeam
PriceBeam posts regular guides, articles and news related to pricing and strategy. Go have a look!