How the Loss Leader Strategy Attracts Customers and Boosts Retail Sales
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What Is a Loss Leader Strategy?
A loss leader strategy intentionally prices products below cost to attract new customers and boost sales of other products. This common practice helps businesses, especially when entering new markets, to build a customer base and encourage recurring revenue. Both online and physical retailers use this approach to drive customer traffic with the hope of increased brand loyalty and sales.
Key Takeaways
- The loss leader strategy involves selling a product below its production cost to attract customers and boost the sales of more profitable items.
- This strategy is common in both brick-and-mortar and online retail environments, often enticing customers to buy additional products as they shop.
- Large companies, like Gillette and Microsoft, use loss leading to penetrate markets by relying on profits from complementary goods or services.
- Loss leader pricing can pressure smaller competitors, and suppliers may be forced to lower their prices to accommodate a retailer’s strategy.
- Risks for businesses using a loss leader strategy include customers only purchasing loss-leading items without buying additional products.
Investopedia / NoNo Flores
How the Loss Leader Strategy Works
Loss leading can be a successful strategy if executed properly. A classic example is razor blades. Gillette, for example, often gives their razor units away for free or at a low price, knowing that customers must buy replacement blades, which is where the company makes its profit.
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.
The loss leader strategy is also known as penetration pricing as the manufacturer attempts to penetrate the market by pricing its products low.
Opponents of loss leader pricing practices argue that the strategy is predatory in nature and designed to force competitors out of business.
Implementing Loss Leader Strategies in Retail
Both brick-and-mortar stores and online shops use loss leader pricing strategies. These businesses frequently price a few items so low that there is no profit margin. The goal is that after buying the loss leader, customers will purchase more items and become brand loyal. Unfortunately for businesses, consumers sometimes leave without buying anything else or subscribing. This practice of moving from shop to shop to pick up loss leaders is known as cherry picking.
Retailers often place loss leaders at the back of stores, making consumers pass other, pricier items. One of the most practiced examples of this is the sale of milk. Milk, a common household item, is often placed at the back of every grocery store, requiring an individual to pass by almost every other item in a grocery store.
Shoppers coming in for milk often buy more items as they walk through the store, boosting sales.
The Role of Introductory Pricing in Loss Leader Strategies
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.
Challenges and Risks of Using Loss Leader Pricing
For businesses that use a 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.
The Bottom Line
The loss leader strategy, while prevalent and effective in gaining market share and customer loyalty, poses risks and challenges. Businesses using this strategy sell products at a loss to attract customers, hoping these customers will purchase additional items with higher profit margins. Notable examples include Gillette’s razor and blade model and the gaming console industry.
However, its sustainability is questionable, particularly for small businesses that can’t afford continuous losses, and it often pressures suppliers to lower their prices. This strategy can also be perceived as predatory, potentially pushing competitors out of the market. Companies considering a loss leader strategy must weigh its benefits against the potential drawbacks, ensuring it aligns with their overall business goals and market conditions.
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