Loss Leader Pricing

Loss Leader Pricing is an aggressive strategy of pricing where a business will sell its product at a cost much lower than its market price to attract more customers and eventually account for those losses by selling other additional products to the same set of targeted customers and hence earn the profit in this case and make the business profitable.

They are the strategy adopted by new entities trying to enter the market for the first time or expand among very tough competition. It is an important marketing tip that companies use to make customers not only buy what they want but also shop for other products in the process.

• Loss Leader Pricing is an aggressive pricing strategy. A business sells its product at a lower market price to captivate more customers. Eventually, it considers the losses by selling other extra effects to the same target customers, earning a profit, and doing a successful business.
• The loss leader pricing aims to penetrate the market and get a customer base. Therefore, the ideas aim to fascinate customers through the price to combat competitors. 
• The business first sells products at zero or negative profit margins in this strategy. It later sells others at a much higher profit margin to compensate for the preliminary losses.

A loss leader pricing strategy requires a planned execution. When a business enters a market, this is a very common strategy. By making initial losses, the loss leader will first introduce the customers to his product or services and build up a customer base to help the business secure a source of recurring revenue for the future.

Opponents of this strategy may complain it’s predatory and wipe other businesses out of the market. Considering this loss leader strategy is banned in fifty percent of states of the US and some countries in Europe. Loss leader strategy is also popular among large companies because they have a wide range of products. Thus, they always make an effort to sell all the varities. Since this kind of pricing method not only help in raising the sales of the concerned product but also instigate customers to buy goods that they have not previous thought of buying, the companies end up making good revenue inspite of lowering the prices.

If they make losses in a particular segment of the product, they earn the margin lost from other profitable parts of the product they have. Loss leader strategy is widespread in the video games industry. Companies offer the consoles at rock bottom prices, keeping a very low-profit margin but charging more for the video games by keeping a much higher margin and compensating for the losses.

Let us understand why loss leader pricing strategy is used in companies.

• The prime purpose of loss leader pricing is to gain market penetration and attain a customer base that will help them to expand the business through increase in sales.
• The strategy is mainly targeted to attract customers by using the price to fight competitors.
• It aims to target customers, make them buy their product, spread through a word of mouth pattern, retain the customers, and eventually sell them other products or complimentary products by keeping a higher profit margin. Thus, the business first sells certain products at zero or negative profit margin and afterward sells some other products at a much higher profit margin to compensate for the initial losses.
• Companies that use loss leader pricing should keep in mind that this strategy needs to be properly executed as it may lead to the business's bankruptcy if there is no proper business model or planning.
• The main purpose of this strategy is to draw more traffic from the competitors and, in this way, generate more sales.
• This strategy works best to introduce the customer to the cheapest product or services with the hope of building a bigger customer base and generating recurring revenue in the future.

The strategy works with the sole aim of building a customer base by selling a few products at a zero or negative margin initially and then generating recurring revenue by selling other products or complementary products to the same set of customers shortly. This strategy is common in the razor industry, where the razors are sold at rock bottom prices. Still, in the same way, the company makes up for the moss or earns even more profit margin by selling blades associated with the razor to customers repeatedly.

At times pricing a product at a loss can eventually lead to profit if the customer can be influenced or persuaded to buy other items at a higher margin during the same shopping trip. Thus, this depends on how the business markets its loss-making product and, in the same way, markets other products that can help compensate for the initial loss made. So this strategy is designed to woo customers from the competitors using price as a weapon and then build up a customer base and generate future recurring revenues.

Below are the examples of companies that use loss leader pricing –

Example #1

Microsoft launched its gaming console XBox by keeping a very low margin of profit to give competition to already established players in the Sony Play-station market. They designed the pricing so that customers were bound to purchase the console as it was available so cheaply. But, that was not the end of the story, as the console was useless without games. Here is where Microsoft played their card by pricing their games at a higher margin and making up for the losses they made during the sale of consoles.

Example #2

A very popular example that comes to mind for every loss leader strategy is the world-famous razor maker Gillette. Gillette initially sold its razor at rock bottom prices. They were selling their mechanical or basic razors at a much lower cost than their competitors, calling it an introductory offer to get hold of a bigger customer base. Eventually, a razor needs blades and requires a constant change of the blades after some usage. Gillette made up for the losses and eventually earned a higher profit margin as Gillette blades were of enhanced quality and thus a bit expensive. Customers thus who had already bought a Gillette razor preferred to use the company blade itself, and in this way, Gillette earned both customer base and profitability.

Let us look at some benefits of loss leader pricing along with its limitations.

Advantages

• It helps the business to eliminate the competitors using the price as the weapon.
• It is a proven way to attract and build a customer base as customers are price sensitive and tend to go for quality products of good companies which are at the sak=me time available at lower prices.
• It can be useful to help the business not just sell a single product but also related or complementary products.
• This strategy is one of the most effective strategies for new business entrants to penetrate the market.
• Customers can enjoy some cheap deals and make a lot of savings in the same process.
• Loss leader pricing is an alternate form of marketing strategy where the seller pays the customers by the losses it incurs to enter the store or try their products.
• The seller can use the benefits of loss leader pricing strategy to clear out old merchandise and restock the store with a newer product.

Disadvantages

• It can disrupt the industry by eliminating other competitors using price as the factor.
• The loss leader pricing method requires good execution; others may lead to bankruptcy.
• Pricing perception can be because of significant worry as the customer expects the product to be priced the same way forever, and any change to the price impacts consumer behavior.
• If the business is applying this strategy on a necessary good, stockpiling problems may occur where customers may buy all the products at once and stockpile them for future use.
• Cherry-picking may be an issue which means customers buy only the loss-making product and leave the store without buying any product, which will make the business earn profit.

• The former is less expensive than the latter because the latter lowers the prices to a greater extent.
• The loss leader pricing method is simply selling the goods and services at a low price compared to the competitors to attract the market. In contrast, predatory pricing aims at driving away competition and weakening them.
• The former is adopted to sell more goods and services whereas the latter is adopted to capture the market and ultimately raise the prices.

This has been a guide to what is Loss Leader Pricing. We explain it with example, strategy, advantage, disadvantage & purpose. You may refer to the following articles to learn more about finance –

• Limit Pricing
• Shrinkflation
• Value Based Pricing
• Shadow Pricing
• Cost Plus Pricing