Food Pricing: Loss Leader Price Method

Instructor: Ian Lord

Ian has an MBA and is a real estate investor, former health professions educator, and Air Force veteran.

In this lesson, we will review what the loss leader pricing method is and how it can be used to generate profits in the restaurant industry; despite the paradoxical situation of selling some items at a loss.

Loss Leader Pricing

Businesses have a number of strategies to use for how to price goods for sale. Sometimes the goal of pricing is not necessarily to make the most profit on any given item, but to generate a profit as a whole on the entire business activity. Let's take a look at how a restaurant might use a loss leader pricing strategy to increase profitability for the business as a whole.

Definition

Loss leader pricing means that some products in a specific business are priced such that the company doesn't make a profit on the sale of that product. The business might break even, but more often than not it loses money on the sale, which is where the term comes from. How does this actually result in a restaurant making money? The trick is that while making that purchase, the diner also purchases menu items that have a higher margin, which is the difference between the cost of obtaining and selling the item compared to the sale price.

Loss leader pricing can work with a few different approaches. With strong advertising of the deal, it can result in increased traffic flow to the business. It can also be used to promote a new product. If a restaurant decides for example to introduce an unusual new menu item, more customers might be persuaded to try it if the price looked like an incredible bargain. On the same order, customers would likely make higher margin purchases such as soft drinks. This could serve as a proof of concept and if successful, the business could permanently offer the menu item at a profitable price.

Calculation Example

Let's take a look at a hypothetical loss leader pricing strategy with some numbers involved. Let's say Jerry's Wings decides to offer a special for 10 Buffalo wings for $2.00. Some limits are put in place to minimize the restaurant's risk of loss, such as making the offer good for dine in only and limiting it to one order per person. Jerry has a cost of goods of $3.00 for a plate of 10 wings.

If the average receipt has two diners, and each person ordered the special, Jerry's Wings would take a $2.00 loss on the order. From experience, the restaurant knows that 90% of its customers purchase a fountain drink such as soda, ice tea, or lemonade. A drink sells for $3.00, although it only costs $0.20 cents to for the cup, straw, water, and soda syrup, so the profit margin on a single drink is $2.80.

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