What is a Loss Leader Strategy
A loss leader is a product or service that is offered at a price that is not profitable, but is sold or offered in order to attract new customers or to sell additional products and services to those customers. This is a common practice when a business first enters a market. Essentially, a loss leader introduces new customers to a service or product in the hope of building a customer base and securing future recurring revenue.
BREAKING DOWN Loss Leader Strategy
The loss leader can be a successful strategy if executed properly. A classic example is that of razor blades. Companies like Gillette essentially give their razor units away for free, knowing that customers have to buy their replacement blades, which is where the company makes its profit.
Another example is Microsoft's Xbox One video game console, which was sold at a very thin margin per unit to create more potential to profit from the sale of higher-margin video games and subscriptions to the company's Xbox Live service. In fact, the loss leader strategy is common throughout the video game industry, and in most cases, consoles are sold for less than the cost of building them. Traditionally, this loss doesn't even take into account design costs, a testament to how much the industry believes in this strategy. In some cases, when manufacturers use the loss leader strategy, it takes the name penetration pricing, as the manufacturer attempts to penetrate the market.
Loss Leaders and Retail Shops
Both brick-and-mortar stores and online shops use loss leader pricing. These businesses frequently price a few items so low that there is no profit margin. The hope is that once the shopper is in the store or on the website buying the advertised loss leader, he stays and buys more. Unfortunately, for business owners, consumers sometimes leave without buying anything else. The practice of jumping from shop to shop and picking up loss leader items is called "cherry picking."
Loss Leaders and Introductory Pricing
Introductory pricing can also be a loss leader. For example, a credit card company may offer a very low introductory rate to entice clients to open a card or transfer their existing balances. Then, after snagging the client, the company eventually 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 the Loss Leader Strategy
For businesses who use the loss leader strategy, the biggest 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 are able to absorb the losses implicit in this strategy. Finally, suppliers may also experience issues with the loss leader strategy, particularly if a business begins to put pressure on the supplier to drop prices so that the business can continue to offer loss leader pricing.