Common sense tells us that you make money selling something for more than it costs. However, like everything in life, there are exceptions. One of these exceptions is the use of ‘loss leaders.’ This term relates to the tactic of setting the price of the product very low – hook prices. This price is so low that it may not even cover the cost of purchase.
Why sell something at a price that generates losses instead of profits? The expectation is that the customer who ends up buying the cheapest product will also buy other products, which are in turn sold for a profit. Besides generating these additional sales, using a hook price can attract new customers to your business and eliminate unwanted inventory.
The use of hook prices and hook products is suitable for many types of merchandise. Retailers use them to remove obsolete or unwanted inventory. Restaurants offer discounts on certain appetizers or ‘2 for 1’ coupons during times of the day when business is slow. But employing this tactic is not always advantageous. It should only be used with appropriate products.
4 tips for using hook prices
1. Do not use hook prices to move new or unique products
Hook prices should only be used in goods that are already considered old or where a lot of competition and few opportunities for large profit margins exist. Do not use them with unique, new or innovative products. If you use a hook price on a new product, you are sacrificing the best chance you have to generate high profits with that product.
When something is new, the demand to buy is high. People who want to be the first to possess the new item are typically not as sensitive to changes in prices and are willing to pay high prices. It would be a waste to use this type of product with this kind of pricing strategy.
2. Keep enough cash handy
You should also think twice before using hook prices if your company has low cash flow. If the tactic works very well and has many people buying the discounted product, you can generate sales at a loss, too. If this happens, you need to have enough cash available to cover losses and everyday business expenses.
3. Watch out for professional discount shoppers
Like any good pricing strategy, you run certain risks when you use hook prices. Some consumers are experts in looking for hook items and have the discipline to limit themselves to just buying that item and nothing else. Then they go from store to store (if it is a chain) doing the same thing. Many share information by email and Internet groups to alert their virtual friends about these offers. These consumer habits reduce the cost effectiveness of using hook prices.
4. Consult with the manufacturer first
Finally, if you plan to put a hook price on a product that comes with the manufacturer’s brand, consult with the manufacturer first. Some manufacturers do not allow their products to be sold below a certain price.
This is done to protect the product brand. Using a hook price falls below the minimum price permitted by the manufacturer. So if you choose to use a hook price without the manufacturer’s permission, the company could decide to stop doing business with you.