Loss Leader Strategy

A loss leader is a product or service that is offered at a price that is not profitable, but it 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.

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.

Loss leading can be a successful strategy if executed properly. A classic example is razor blades. Gillette, for example, gives their razor units away for free knowing that customers must buy their replacement blades, which is where the company makes its profit.

[Important: Opponents of loss leader pricing practices argue that the strategy is predatory in nature and designed to force competitors out of business.]

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.

Traditionally, the loss does not account for design costs. The loss leader strategy is also known as penetration pricing as the manufacturer attempts to penetrate the market by pricing its products low.

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 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.

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.

[Fast Fact: According to the American Economic Association, pricing items below cost has been banned in some European countries and half of all U.S. states.]

• A loss leader strategy prices a product at a level that is lower than the product costs to produce.
• Loss leading is considered a controversial strategy and has been banned in 50% of U.S. states and some European countries.
• Some companies use the strategy when penetrating new markets to gain market share.
• Large companies can afford to price a product with no margin because they have other products that they can sell profitably to make up for the loss.

For businesses who use the 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.