What Is a Loss Leader Strategy?
A loss leader strategy involves selling a product or service at a price that is not profitable but is sold to attract new customers or to sell additional products and services to those customers. Loss leading is a common practice when a business first enters a market. A loss leader introduces new customers to a service or product in the hopes of building a customer base and securing future recurring revenue.
- A loss leader strategy prices a product lower than its production cost in order to attract customers or sell other, more expensive products.
- Loss leading is a controversial strategy that is considered predatory.
- Some companies use a loss leading strategy when aiming to penetrate new markets to gain market share.
- Large companies can afford to price a product with no margin because they have other products they can sell profitably to make up for the loss.
- Loss leading strategies can hurt small businesses as well as suppliers, who might be forced to keep their own prices low so that a business can continue with its loss leading strategy.
Understanding a Loss Leader Strategy
Loss leading can be a successful strategy if executed properly. A classic example is razor blades. Gillette, for example, often gives their razor units away for free or at a low price, knowing that customers must buy replacement blades, which is where the company makes its profit.
Another example is Microsoft's Xbox One video game console. The product was sold at a low margin per unit, but Microsoft knew that there was potential to profit from the sale of video games with higher margins and subscriptions to the company's Xbox Live service. The loss leader strategy is common throughout the video game industry and, in most cases, consoles are sold for less than they cost to build.
The loss leader strategy is also known as penetration pricing as the manufacturer attempts to penetrate the market by pricing its products low.
Opponents of loss leader pricing practices argue that the strategy is predatory in nature and designed to force competitors out of business.
Loss Leaders and Retail Shops
Both brick-and-mortar stores and online shops use loss leader pricing strategies. These businesses frequently price a few items so low that there is no profit margin. The hope is that once the shopper buys the product from the store or the website, the shopper will buy other products and become loyal to the brand. Unfortunately, for business owners, consumers sometimes leave without buying other products or subscribing to the brand. This consumer practice of jumping from shop to shop and picking up loss leader items is called cherry picking.
Some retailers place loss leaders at the back of their stores so consumers will have to walk by other, more expensive products to get to them. One of the most practiced examples of this is the sale of milk. Milk, a common household item, is often placed at the back of every grocery store, requiring an individual to pass by almost every other item in a grocery store.
Even if the shopper just came in the store to buy milk, it is very likely they will purchase additional items as they walk by them on their way to the milk section and then back to the register, resulting in increased sales for the shop.
Loss Leaders and Introductory Pricing
Introductory pricing can also be a loss leader. For example, a credit card company may offer a low introductory rate to entice clients to use a card or transfer their existing balances. Then, after snagging the client, the company raises its interest rates. Similarly, cable companies often offer low rates, sometimes at a loss, for an initial period to attract new customers or to lure customers away from competitors.
Disadvantages of a Loss Leader Strategy
For businesses that use a loss leader strategy, the greatest risk is that clients may only take advantage of the loss leader pricing and not use any of the business's other products and services. Additionally, some small-business owners complain that they cannot compete with large corporations who can absorb the losses implicit in this strategy.
Finally, suppliers to companies who follow a loss leader strategy may experience pressure to keep their own prices low so that the company using a loss leader strategy can continue to do so.