Loss leading

by Admin
Updated: May 9, 2019

Loss leading is an questionable but powerful strategy for gaining market penetration

Market penetration is a challenge for all new businesses. It can also be problematic for established businesses offering new products or services that represent a departure from what their customers expect from them. Offering a product or service for an incredibly low price - or for free - is an effective way of gaining new customers and converting existing ones. Everyone loves a bargain!

Loss leading is most powerful when the business profits from continued relationships with its customers. This means that the strategy really amounts to a “Thank You” paid in advance rather than a device to trick customers into overpaying down the line.

Loss

By “Loss” is meant sub-optimal margin. It doesn’t have to mean a negative gross margin (where a unit’s selling price is less than its direct cost) but it does mean a net loss, at least for the operations concerned if not the business as a whole.

Typically, the loss will be covered by some related activity such as improved sales of refills or add-ons.

Leading

The loss strategy is usually employed when trying to gain traction for a new product - you lead with the low price and hope to upsell to the customers you’ve attracted with the bargain.

Leverage

Loss leading is only useful as part of a greater strategy involving products or services that are profitable:

  • Limited time only - this is the simplest approach where the customers love the product and/or service so much they are happy to continue buying even though the price increases.
  • Maintenance required - the loss leader is something that requires refills or an ongoing fee. This works really well with a customer loyalty program.
  • Upgrade options - the base price is low or zero but highly desirable extra features can be added on.
  • Better version - a base version is shown in comparison to a deluxe version which is much more desirable.
  • “You may also like...” - take the opportunity to introduce additional products or services.

The better version strategy is one of my favorites. When the base version has such a low price, it suggests the deluxe version is also a bargain. Since it’s an attractive alternative, the loss leader is often bypassed. This works especially well when the base version can be upgraded to the deluxe version but this is considerably more expensive than the original price difference.

Watch out, it can be illegal!

Because of the possibility that larger businesses can crush smaller competitors by using loss leading (without necessarily much emphasis on leading) to price them out of the market, some states have regulations in place to prevent it.

More info

“What Is a Loss Leader and How Does It Work?” at thebalancecareers.com.

A good overview - “Loss Leader Strategy” - can be found at investopedia.com.

“Loss Leader Pricing Law and Legal Definition” at definitions.uslegal.com.

Internal links

Cash flow Price vs quality Go to Articles
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