Six circumstances in which price may be fixed below variable cost

The general rule

In the short run, a selling price should at least cover marginal (variable) cost, so that each unit makes some contribution towards fixed costs. In some circumstances, however, a firm may deliberately fix a price below variable cost for a limited period.

Circumstances

1. Introducing a new product. To create demand and make customers try a new product, a firm may sell it below variable cost for a short time.
2. Driving out or meeting competition. To keep a market against a weaker rival or to match an aggressive price cut, a firm may temporarily price below variable cost.
3. Selling perishable or obsolete goods. Goods that will spoil or go out of fashion may be sold for whatever they will fetch, even below variable cost, since otherwise their value would be lost altogether.
4. Promoting other products (loss leader). A product may be sold below cost to attract customers who also buy other profitable items, as supermarkets do.
5. Keeping workers employed and plant running. To avoid retrenching skilled workers or the cost of closing and restarting a plant, a firm may accept orders below variable cost during a slump.
6. Clearing heavy stocks and generating cash. To reduce stocks and storage costs or to raise urgently needed cash, goods may be sold below variable cost.
7. Entering a foreign market or an export order that will bring future benefits or government incentives.

These are short-run, tactical decisions. The loss on each unit sold below variable cost is accepted because the firm expects a larger gain elsewhere, either later or on other products, or because stopping would cost more.

Caution

Such prices are justified only for a short period and for clear strategic reasons; continued sales below variable cost increase losses with every unit sold.