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Loss leaders

A loss leader is a marketing strategy under which an item or service is priced at less than cost to bring in customers.

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Retailers can feature loss leaders in their advertizing. For a grocery store, a jar of mayonaise sold for $1 below cost might bring in customers who on average will spend $100 on groceries. In addition to generating traffic, the deal also helps project the image that store X has lower prices.

This is all part of merchandizing. The store offers a mix of products some of which are highly profitable. They hope to induce you to buy your high margin needs at their store too. That makes the whole venture profitable. That is the classical supermarket strategy where a percentage of items are priced with a thin promotional margin while other items have a higher margin. Ditto the pharmacy with the plain product racks, projecting a discount store image, while charging full retail prices.

In investing, the teaser rates on ARMs are one example. The initial interest rate is below market and may even be a loss leader. But once the ARM resets, the loan becomes profitable.

Stories are told of annuities sold by banks as an alternative to CDs. The annuity offers 6% yield guaranteed for the first year. But then after that first year, the yield settles down to 3% or so. Again, a special come-on rate was offered to get the business.

A loss leader differs from false advertizing in that the item advertized must be on sale for that price. To arrive at the store to find that item not available might be false advertizing. Similarly, the bate and switch is another strategy. The salesman tries to talk you out of buying the advertized item because it is of poor quality or not suitable for your needs. Instead he tries to switch you to a higher priced item.

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