Loss leaders are products that retailers sell at a loss – below the cost of sourcing, transporting and storing them.1 Such below-cost pricing is a tactic used to attract price-conscious consumers into stores, in the hope that they will also spend money on more profitable goods. However, such a practice is banned in a number of European countries (including France and Belgium2) and selling below cost-price is also restricted in several US states, notably California3. Ireland banned loss leaders in supermarkets from 1987 until 2005, when the legislation was repealed4. This seemingly minor strategy has far-reaching and debateable effects. Those concerned include: consumer rights groups who ask if loss leaders exploit consumers; anti-trust groups, who weigh the pros and cons of prohibiting lost leaders on market competition; and, economists who examine the effects of loss leader laws on the prices of goods. Ultimately this is a debate about weighing those concerns and addressing the proper role of government in the economy.
The practice of loss leaders is bad for suppliers. Farmers and manufacturers are often forced by the dominant retail giants to participate in discount schemes, sharing the losses at the dictate of the retailer. If they refuse they will be dropped by the retailer and cut off from the marketplace. The American Antitrust Institute has concluded that these "Resale price maintenance (RPM)" agreements—which are agreed upon because retailers have all of the leverage—are usually illegal.1 Prohibiting loss leaders will prevent this abuse of market dominance by the big retail companies and ensure a fair deal for our farmers.
1John B. Kirkwood, Albert Foer, and Richard Burnell, “The American Antitrust Institute On the European Commission’s Proposed Block Exemption Regulation and Guidelines on Vertical Restraints,” American Antitrust Institute, September 27, 2009, page 5-6.
The use of loss leaders in marketing campaigns can benefit both retailers and producers. Below-cost price offers are typically used at the introduction of new products in order to encourage consumers to try something for the first time. Whether it is a new vegetable or cheese, a different breakfast cereal or an improved type of soap powder, it is in the interest of farmers and manufacturers to build consumer awareness and market share quickly. In the long run, if consumers like the new product, prices will rise and both producers and retailers will profit from it, so it is quite reasonable that producers are asked to share in the costs of launching it at a discount.
Typically it is less healthy products that are heavily discounted, such as alcohol and fatty, sugary and salty processed food. Heavily processed food should cost more than fresh food, but supermarkets don't use fresh fruit or vegetables as loss leaders. The practice tends to distort the shopping behaviour of many of the poorest in society, pushing them into poor diets that lead to obesity, bad dental health and poor nutrition. Banning the practice would make it easier to encourage healthier diets and lifestyles. Selling alcohol below cost price leads to large social harms caused by alcoholism and binge-drinking. The use of alcohol as a loss leader has already been identified as a problem in some countries. In New Zealand, for example, Foodstuffs and Progressive Enterprises—the two companies that own all of the major supermarket chains in the country—agreed not to use alcohol as a loss leader.1 Of course companies in most countries would not agree to such a promise without being prohibited by law, and even New Zealand should go a step further by prohibiting all loss leaders, as alcohol is not the only good that can cause social harm when it is artificially inexpensive.
If retailers need to unload an item, it is totally within their rights to do that, as long as they don't use that item to trick consumers into buying more expensive items. Selling off goods at a low price, when not planned, would also not harm producers because it would not be a case of "retail price management (RPM)," in which producers agree to sell the product for less to the retailer.
Loss leader strategies exploit consumers by providing partial, misleading information. Giant retailers are not charities; they do not offer heavily discounted goods in order to help the poor. Instead they have calculated that they can attract price-conscious shoppers in with headline deals on a few loss-leading basics, and then persuade them to pay over the odds on a wider range of goods with big profit margins. In this way, loss leaders are a con trick on consumers who are bewildered by deliberately confusing marketing–an onslaught of advertising and ever-changing promotions to the point that they are unable to compare the prices of rival firms and make a rational choice about where to shop. In their paper, “Loss Leading as an Exploitative Practice,” Zhijun Chen and Patrick Rey show how retailers use loss leaders to trick consumers by giving them incomplete information.1 And in the long term, by driving out smaller retailers and reducing competition in the retail sector, the practice can drive up the overall cost of essentials for everyone.
The use of loss leaders allows greater competition in the retail sector. It helps to drive the overall level of prices down by allowing much greater variation in pricing than would be possible if all goods had to be offered at cost price plus a small profit margin. Loss leaders also allow new entrants to make an immediate impact upon a mature marketplace dominated by a small number of entrenched incumbents, and so they are a valuable tool in maintaining price competition over the long term.
Selling items at a loss is a predatory strategy used by large retailers to drive out smaller businesses, and so prohibiting them would protect competition. The practice is especially bad for small businesses, which cannot compete with the massive retail firms behind huge hypermarkets. These dominant corporations have the deep pockets to make a short-term loss in order to increase the volume of their sales. The whole basis of this policy is to drive smaller firms that cannot afford to offer loss leaders out of business. France has regulated its retail sector to prevent this kind of abuse of market dominance, in order to preserve its traditional shopping streets with family businesses. Other countries should follow the French example and ban loss leaders to protect small business and boost competition.
It should be up to business what it charges for its goods; if it decides to charge less than the cost price, it must have a market-based reason to do so, and it is not the place of government to intervene. It is well-known that consumers focus on the prices of a few staple goods, such as bread, milk, baked beans, etc. So it is rational for retailers with high fixed costs (in wages, rents, power etc.) to set the prices for these key products very low, and even make a loss on selling them, because it will entice more shoppers into their stores. These consumers will also buy other products on which the store does make a profit, and overall sales volumes and profits will rise.
The government should be able to stop large retailers from exploiting consumers and producers. There is no doubt that retailers have a reason for selling items below market value, but they are only able to profit from such an illogical strategy by exploiting consumers and producers. They trick consumers into buying more expensive items and they force producers who have minimal leverage to lower the wholesale price in order to take the loss leader price into account.
The use of heavily discounted loss-leaders is good for shoppers, especially low-income consumers, who are most appreciative of a bargain that will help them stretch their limited budget. Customers are not stupid but instead canny consumers who are well able to see through the marketing ploys of the big retailers. Often price-conscious shoppers will stock up on the most heavily discounted items, but then go elsewhere for the rest of their shop. On the other hand, attempts in countries like France to regulate retailers have just resulted in protection for the existing firms that dominate the marketplace, and in a lack of competition, which drives up the cost of the weekly groceries for everyone. The same items can cost 30% more in France, where loss leading is banned, than in Germany where it is not and discount stores flourish1. Prohibiting this strategy will hurt consumers.
1: Economist, "Purchasing-power disparity: French shoppers want lower prices, but not more competition," May 15, 2008.
Loss leaders do not help lower-income customers because they are aimed at people who will buy a lot of expensive goods at the store. Patrick DeGraba of the U.S. Federal Trade Commission argues that, when retailers act strategically, loss leaders are aimed at highly profitable customers1. Retailers have no interest in targeting less well-off consumers, because they won't then spend a lot of money in the store. Therefore, they are more likely to offer a high-quality item below its true cost; this will still be too expensive for many people, though. For example, stores will offer discounts on high-quality turkeys at Thanksgiving, because people who buy them are likely to buy a lot of food. Loss leaders may provide discounts for some consumers, but prohibiting the strategy would not hurt lower-income customers.
1: Patrick DeGraba, "Volume Discounts, Loss Leaders, and Competition for More Profitable Customers," Federal Trade Commission Bureau of Economics (Working Paper 260), 2003.
By requiring retailers to sell items at least at cost level, the government is creating an artificial price floor, which will cause prices to rise and create a net loss for society. Basic economics explains that artificial price floors upset the free market, costing a net economic loss for society, which will eventually be paid by all sectors involved.
The harm that prohibiting loss leaders causes to prices is well documented. According to a study by the French newspaper La Tribune, a basket of identical items costs 30% more in France than it does in Germany, partly because of the ban on loss leaders1. In fact, this is the very reason why Ireland repealed its loss leaders ban. The Minister for Enterprise, Trade & Employment said at the time, "The single most important reason for getting rid of the [law] is that it has kept prices of groceries in Ireland at an artificially high level." Indeed, a study published in the British Food Journal concluded that the Irish law had caused prices to rise, and a separate study came to the same conclusion regarding France's loss leader prohibition. More generally, a report from the American Anti-Trust Institute shows that throughout history, such price laws have typically raised prices to consumers.
1Economist. "Purchasing-power disparity: French shoppers want lower prices, but not more competition." May 15, 2008.
It is not the government's place to force lifestyles on people. There is plenty of information around on what constitutes a balanced and healthy diet; people should be left to make up their own minds about what they buy with their own money. In any case, loss leaders make very little difference to the overall price comparison between processed and fresh food. Fresh food like fruit, vegetables and raw meat is expensive because it will soon rot and so it incurs higher transport and storage costs than processed food with a long shelf life. If governments want to change the balance in costs, they would be better off putting a tax on the unhealthiest foods rather than interfering arbitrarily in the realm of the marketing.
Retailers find themselves all the time with stock that they need to unload, that nobody is buying. This is especially a concern with items that have a sell-by date after which they may not be sold and so become worthless. In such a situation, selling below cost price is economically rational, as it means that the retailer realises some money on their stock rather than none at all. Visit any open-air market at 3.00 p.m. and you will see traders slashing the prices of unsold perishable goods for just this reason. If a retailer is going to sell an item below price level, it might as well use that item as a marketing device. Can you imagine the same market trader slashing his prices, but not shouting them to passersby? Sometimes retailers need to sell items below the price level, and they should be allowed to market them cleverly in order to make up for some of the loss in revenue.
There is a good and a bad side to loss leaders for consumers, but prohibiting the practice will always be worse. The obvious benefit to consumers of loss leaders is that they are inexpensive goods to buy. While it is possible that some people will then buy more expensive products because they have entered the store, every item has a price tag, so the customer is always aware of his decision, which means this is not a predatory practice.
Banning loss leaders, on the other hand, is catastrophic for consumers, as it will always result in prices rising. When announcing the repeal of Ireland's loss leaders prohibition, Irish Minister for Enterprise, Trade & Employment Micheál Martin said, “Very simply, the [law] acted against the interests of consumers for the past 18 years.”1 Loss leaders have positive and negative effects on consumers, but a ban is all bad.
Biscourp, Pierre, Xavier Boutin, and Thibaud Verge. "The Effects of Banning Below-Invoice Prices: An Empirical Investigation" (paper presented at the European Economic Association European Meeting of the Econometric Society congress, Budapest, Hungary, 2007). February 15, 2007.
Chen, Zhijun, and Patrick Rey. "Loss Leading as an Exploitative Practice." Institut d'Economie Industrielle. (IDEI Working Paper #658).
Collins, Alan, Steve Burt, and Kostas Oustapassidis. "Below-cost legislation and retail conduct: evidence from the Republic of Ireland." British Food Journal. Vol. 103 Iss. 9 (2001): 607-622.
DeGraba, Patrick. "Volume Discounts, Loss Leaders, and Competition for More Profitable Customers." Federal Trade Commission Bureau of Economics (Working Paper 260) 2003.
Dresslar, John H., "California Antitrust Law: General Overview." The 'Lectric Law Library. Accessed July 7, 2011
Economist. "Shop-worn arguments: What strict national rules on shopping hours and sales reveal about European views of competition." January 3, 2008.
Economist. "Purchasing-power disparity: French shoppers want lower prices, but not more competition." May 15, 2008.
Kirkwood, John K., Albert Foer, and Richard Burnell. "The American Antitrust Institute On the European Commission's Proposed Block Exemption Regulation and Guidelines on Vertical Restraints." American Antitrust Institute. September 27, 2009.
Ireland Business News. "Groceries Order abolition goes into effect." March 20, 2006.
US Legal. "Loss Leader Pricing Law & Leal Definition." Accessed July 7, 2011.