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.

RELATED TERMS
  1. Competitive Pricing

    Competitive pricing is the process of selecting strategic price ...
  2. Market Leader

    A company with the largest market share in an industry that can ...
  3. Market Challenger

    A market challenger is a firm that has a market share below that ...
  4. Recognized Loss

    Recognized loss is when investments are sold for less than their ...
  5. Loss Management

    Loss management describes how businesses detect, identify and ...
  6. Customer Service

    Customer service is the process of ensuring customer satisfaction ...
Related Articles
  1. Taxes

    Capital Losses and Tax

    Capital losses are never fun to incur, but they can reduce your taxable income. Knowing the rules for capital losses can help you maximize your deductions and make better choices about when to ...
  2. Financial Advisor

    Top Tips for Deducting Stock Losses

    Investors who know the rules can turn their losing picks into tax savings. Here's how to deduct your stock losses.
  3. Taxes

    How to deduct stock losses from your tax bill

    Learn the proper procedure for deducting investment losses and get some tips on how to strategically structure them to lower your income tax bill.
  4. Small Business

    Is Gillette's Market Edge Becoming Razor-Thin?

    Despite Gillette's success with the razor-and-blades strategy, the increasing popularity of beards and new competition may slow the brand's growth.
  5. Investing

    Stop Loss Order Strategy

    A stop loss order is an order placed with a broker to sell a stock immediately if it drops to a certain price. It's a common way for investors to protect themselves from the possibility of a ...
  6. Investing

    Microsoft Turns to Subscription Model for Xbox

    Microsoft shifts away from one-time hardware buys, instead seeking to generate recurring revenue.
  7. Small Business

    4 Pricing Strategies That Increase Your Spending

    Find out whether you're actually saving money, or if you're being duped into unnecessary spending.
  8. Tech

    Microsoft to Enable Game Gifting in the Xbox One Store

    Microsoft revealed in a tweet that it will soon let customers gift games via the Xbox One Store.
  9. Investing

    Power Up Your Portfolio With Video Game Stocks

    Level up your winnings by investing in this fast-paced, highly skilled industry.
  10. Investing

    Microsoft's Xbox Game Pass Is Coming June 1

    Microsoft's streaming gaming service Xbox Game Pass is coming to the masses on June 1.
RELATED FAQS
  1. What Is the Razor/Razorblade Business Model?

    The Razor/Razorblade business model comes from King Gillette, founder of the razor blade company. Learn how this business ... Read Answer >>
Trading Center