What is a Loss Leader Strategy?
A loss leader strategy involves selling a product or service at a price that is not profitable to draw in new customers or encourage them to purchase additional products or services. This tactic is frequently employed when a business is entering a new market, aiming to build a customer base and secure future recurring revenue.
Key Takeaways
- A loss leader strategy prices a product below its production cost to attract customers and potentially boost the sales of other, more expensive products.
- This approach is considered controversial and sometimes labeled as predatory.
- Many businesses use this strategy to gain market share when entering new markets.
- Large companies can sustain low-margin products because they compensate with higher profits from other products.
- While effective for large companies, it can harm small businesses and suppliers pressured to lower their prices too.
Understanding a Loss Leader Strategy
Loss leading can be highly effective if executed correctly. For instance, let’s consider razor blades. Gillette often offers their razor units at minimal cost, knowing customers will need to buy replacement blades, which is where their profit margin is highest.
Another notable example is Microsoft’s Xbox One video game console. The console was initially sold at a low margin, but Microsoft generated substantial profits from high-margin video game sales and Xbox Live subscriptions. This strategy is fairly common in the video game industry, with consoles often sold below production cost to drive game sales.
Loss Leaders in Retail Shops
Both brick-and-mortar stores and online retailers employ loss leader pricing strategies, frequently pricing certain items so low that no profit margin exists. The objective is to entice customers to buy these products, in turn leading them to purchase other items and develop brand loyalty.
A common practice involves placing loss leaders at the back of the store. For example, milk, a staple in most households, is often located at the rear. Shoppers are likely to make additional purchases as they navigate through the store to reach the milk.
Loss Leaders and Introductory Pricing
Introductory pricing can also serve as a loss leader. For instance, credit card companies might offer low introductory rates to attract new customers. Once the customers are signed up, the companies can then raise the interest rates. Similarly, cable providers often offer reduced rates initially to draw customers from competitors.
Disadvantages of a Loss Leader Strategy
The primary risk for businesses employing a loss leader strategy lies in customers taking advantage of the low prices without purchasing additional items or services. Furthermore, small businesses often cannot sustain the losses associated with this strategy as readily as large corporations can. Suppliers might also experience pressure to lower their prices to allow businesses to maintain their loss leader approach.
Related Terms: penetration pricing, profit margin, introductory pricing, cherry picking.
References
- Harvard Business Review. “Gillette’s Strange History with Razor and Blade Strategy”.
- PC Magazine. “Like the PS4, XBox One Being Built at a Loss”.
