Business Dictionary defines Loss Leader as a "Good or service advertised and sold at below cost price. Its purpose is to bring in (lead) customers in the retail store (usually a supermarket) on the assumption that, once inside the store, the customers will be stimulated to buy full priced items as well.
Loss Leader Characteristics
- A loss leader may be placed in an inconvenient part of the store, such as at the rear of the store, so that purchasers must walk past other goods that have higher profit margins.
- A loss leader is usually a product that customers purchase frequently—thus they are aware that its unusually low price is a bargain.
- Loss leaders are often scarce or provided with limits (e.g., maximum 10 bottles) to discourage stockpiling and to limit purchases by small businesses. The seller must use loss leaders regularly if they expect their customers to come back.
- Some loss leader items, such as fruits, vegetables and pastries, are perishable and cannot be easily stockpiled by customers.
- Some loss leaders, rather than being advertised as bargains, are high-end, costly products offered below profit margin to enhance the company's prestige and/or to attract "lookers" or "window shoppers" who may buy other less expensive but more profitable merchandise. For example, if a pawnshop offers a Harley-Davidson motorcycle in its display window at below the normal profit-making cost, this motorcycle will generate a lot of walk-in traffic during the period before it is sold. These shoppers may end up using the store's other services or making other purchases.
Rationale Behind Loss Leader Pricing
At a glance, it may seem that such a pricing strategy would destroy the profitability of a store. However, the loss leader pricing strategy works effectively if executed properly.
The rationale behind the strategy is to price certain products below costs to draw more traffic from other competitors and ultimately generate more sales on other products. The strategy is common in the marketplace as businesses introduce new customers to an extremely cheap product or service in the hope of building a large customer base and long-term recurring revenue.
For example, consider businesses that use “introductory” pricing for their products and services. Several cable and phone companies offer low rates for their services in an attempt to “capture” the customer and ultimately cross-sell other products and services. Although in the example, the service may not be priced below cost, the rationale of adopting such pricing remains the same.
Loss Leader Examples
The loss leader can be a successful strategy if executed properly. A classic example is that of razor blades. Companies like Gillette essentially give their razor units away for free, knowing that customers have to buy their replacement blades, which is where the company makes its profit. Another example is Microsoft's Xbox One video game console, which was sold at a very thin margin per unit to create more potential to profit from the sale of higher-margin video games and subscriptions to the company's Xbox Live service. In fact, the loss leader strategy is common throughout the video game industry, and in most cases, consoles are sold for less than the cost of building them. Traditionally, this loss doesn't even take into account design costs, a testament to how much the industry believes in this strategy. In some cases, when manufacturers use the loss leader strategy, it takes the name penetration pricing, as the manufacturer attempts to penetrate the market.