In a recent video from "AI, SaaS & Agentic Pricing with Monetizely," pricing expert Ajit Pal Ghuman explains the fascinating strategy of loss leader pricing and the psychological principles that make it so effective. The video, "Pricing Psychology Ep 5: Why Costco Looses $$$ on Chicken," breaks down how major retailers like Costco and Walmart strategically lose money on certain products to drive overall revenue growth.
What Is Loss Leader Pricing?
Loss leader pricing is a strategic approach where retailers intentionally sell specific products at a loss to attract customers, with the goal of increasing overall basket size and driving repeat business. As Ghuman points out in the video, this isn't just a random discount strategy—it's a calculated psychological play.
"In 2023, Costco sold 137 million rotisserie chickens for $4.99, when the actual price inflation adjusted should have been more than $8. They lost roughly in the range of 30 to $40 million on this product," Ghuman explains. Yet despite this seemingly poor business decision, retailers that implement loss leader strategies typically "increase their basket size from anywhere from 12 to 16%."
The Three Psychological Principles Behind Loss Leader Pricing
According to Ghuman, three key psychological concepts make loss leader pricing so effective:
1. Anchoring
Consumers tend to remember the prices of items they purchase frequently—things like gas, milk, and rotisserie chickens. These memorable prices create an "anchor" in customers' minds that shapes their overall perception of a store's value.
"What tends to happen is if you have ever gone into a Costco store, you'll notice that Costco front loads their most expensive items in front of you," explains Ghuman. "And then as you enter the store, you're presented with all of these options with the idea that you're at Costco. So definitely the price for this would be more palatable."
This strategic layout capitalizes on the anchoring effect. Once customers believe a store offers good value based on the items whose prices they remember, they're more likely to assume everything else in the store is also reasonably priced.
2. Cognitive Load
Shopping decisions require mental energy. When customers already trust a store's overall value proposition, they're less likely to comparison shop for every item.
"If you need a new thing, you're probably not going to think too much about buying that thing at Costco, believing that Costco gives you a good deal in general," says Ghuman. "You're likely going to buy something and you're really going to reduce the cognitive load of finding another store and getting that discount of five to ten dollars."
By reducing this cognitive load, retailers make it easier for customers to make additional purchases without overthinking each decision.
3. Habit Formation
Perhaps the most powerful aspect of loss leader pricing is its ability to create shopping habits. When consumers know they can consistently find great deals on specific items, they develop regular shopping patterns.
"The way Costco operates is to get you in the store again and again. So you form a habit. You remember that, hey, the rotisserie chicken is cheaper," Ghuman explains.
This habit formation creates a reliable customer base that returns regularly, which is far more valuable than one-time purchases.
Real-World Examples Beyond Costco
While Costco's $4.99 rotisserie chicken is perhaps the most famous example of loss leader pricing, Ghuman points out that this strategy is widespread in retail.
"Even Walmart does it. All grocery stores keep the price for milk somewhat lower. Some grocery stores do it less, some do it more," he notes.
Another prominent example is Costco's food court pricing. As Ghuman mentions, "if you've ever been to a Costco store, you'll notice that they have not increased the price of their hot dog in years… The hot dog is $2 so that you come into the store, you buy stuff, and then they're happy to sell you cheap hot dogs as long as you're buying those things."
The Strategic Long Game
What makes loss leader pricing particularly effective is that it's not a single-tactic approach but rather part of a comprehensive strategy to build customer loyalty and increase overall spending.
"Brands know consumer psychology. Brands know that there's not just any one pricing psychology hack that's going to work. And there's probably going to be a mix of things that are going to get you in and become a repeatable business," Ghuman concludes.
For businesses looking to implement their own version of loss leader pricing, the key takeaway is to think strategically about which products could serve as effective loss leaders. These should be items that customers purchase frequently, remember the price of, and that can help establish a value perception that extends to your entire product line.
By understanding the psychological principles of anchoring, cognitive load, and habit formation, businesses can transform occasional shoppers into loyal customers who not only return regularly but also spend more on each visit.