Loss Leader Pricing Definition Examples How Does It Work

Loss Leader Pricing Definition

Explanation

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. If they make losses in a certain segment of the product, they earn the margin lost from other profitable segments of the product they have. Loss leader strategy is very common in the video games industry. Companies offer the consoles at rock bottom prices, keeping a very low-profit marginProfit MarginProfit Margin is a metric that the management, financial analysts, & investors use to measure the profitability of a business relative to its sales. It is determined as the ratio of Generated Profit Amount to the Generated Revenue Amount. read more but charging more for the video games by keeping a much higher margin and compensating for the losses.

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Purpose

The prime purpose of loss leader pricing is to gain market penetrationMarket PenetrationMarket penetration is calculated as how much the customers are using the product or service compared to the total market for that product or service.read more and attain a customer base.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.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 revenueRecurring RevenueRecurring Revenue is a part of the Company’s total revenue or income constantly generated in the future at regular intervals (monthly or yearly). This type of revenue is relatively stable as you can predict its occurrence with reasonable confidence. read more in the future.

How does Loss Leader Pricing Work?

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.

Examples

Below are the examples of Loss Leader Pricing –

Example #1 – Microsoft XBox Gaming Console

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 – Gillette Razors

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.

Loss Leader Price Advantages and Disadvantages

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 sensitivePrice SensitivePrice Sensitivity, also known and calculated by Price Elasticity of Demand, is a measure of change (in percentage term) in the demand of the product or service compared to the changes in the price. It is used widely in the business world to decide the pricing of a product or study consumer behavior.read more.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 this 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 strategy requires good execution; others may lead to bankruptcy.Pricing perception can be because of major 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.

Conclusion

Loss leader pricing is an effective strategy for new entrants to penetrate the market. However, it also requires proper execution and planning; otherwise, it may lead to bankruptcy. It is really good for customers to find such high discounted deals. Still, the business should keep in mind that the ultimate motive is customer base building and eventually retaining the same customers.