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Loss Leader Pricing

Updated on March 19, 2024
Article byWallstreetmojo Team
Edited byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

What Is 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.

Loss Leader Pricing

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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.

Key Takeaways

  • 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.

Loss Leader Pricing Explained

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 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

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

Strategy

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 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.

Advantages And Disadvantages

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

Advantages

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.

Loss Leader Pricing Vs Predatory Pricing

  • 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.

Frequently Asked Questions (FAQs)

Is Loss Leader Pricing Illegal?

The Loss Leading Pricing strategy is illegal in a few European countries and Australia. In the US, it is restricted in states such as Oklahoma, California, and Colorado. Moreover, the Loss Leading pricing strategy is anti-competitive and may negatively influence customers.



Why do retailers use Loss Leader Pricing?

Loss Leader Pricing is a marketing approach that prices products are less than the cost to create them to attract product’s new customers or sell additional products to them. Usually, companies utilize Loss Leader Pricing when entering new markets or trying to elevate their market share.

What companies use Loss Leader Pricing?

Gillette has utilized a Loss Leader Pricing strategy in the business structure. Earlier, Gillette was the leader in selling razor blades through a creative method of selling the mechanical razor below the cost to attract new customers.



Is loss leader pricing reasonable?

A good discount on loss leaders eliminates customer risk when buying a new brand. In addition, it means that the customers may opt for the new brand and take a chance.

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