Loss leader strategy

What is a loss leader strategy?

Loss leader strategy is a business tactic in which companies sell a product at very cheap or free to attract a large number of customers or to cross-sell other high-margin products. This strategy is generally used by businesses to capture a new market or as a starting point to introduce their product ecosystems.

For example, a grocery shop may keep the milk prices very low with hardly any profit margins. Milk is a daily used commodity purchased by everyone. The intention of keeping it at a low cost is that when a customer enters to buy milk in the shop, he would also be introduced to the other products which are placed inside and hence increase the chances of buying other products apart from milk as well. Often we tend to purchase things when seen in abundance, like in the grocery shop or a mall, that may or may not be used. This impulsive shopping and eventually building a loyal customer base is the main intention.

Opportunities associated

1. A new product can penetrate the market at a faster rate with a loss leader strategy. It gets the initial break-in momentum.
2. An existing company can add more new customers along with its existing ones
3. With cross-selling or up-selling other products that have high margins, a business has more opportunity to increase revenue.
4. A company can get important customer data with a huge number of customers buying the product or service. This data can be used in a strategic way to favor ways to increase revenue and profits.
5. Inventory-heavy businesses can clear up the excess inventory and outdated products
6. A company can build a strong brand as more and more customers purchase the products and are satisfied with them. This provides an opportunity for building strong brand loyalty.

Risks associated

1. Loss leader strategy at a scale can be implemented only by businesses with deep pockets. There is a huge cash burn involved at the first to gain customers, as there are very less or no profit margins.
2. Loss leader strategy is a high-risk and high-reward type of game. If the strategy is not well executed, the losses are very high.
3. Even if the strategy is executed well and customers purchase the products as expected, if they are not satisfied with the product or service, it can reduce the brand value and hence customer loyalty.
4. There is always a risk associated with the value perception by customers. If this loss leader pricing is used frequently or for a long time, customers might think the value of the product to be less than the actual value. This can impact the revenue when the increased price is set after the market gain.
5. This strategy can force the competitors to reduce their prices as well. This condition can lead to a price-cutting game and is not beneficial to either of the competitors in the market.

Example

My favorite example of the loss leader strategy is for the OTT platform market.

Netflix was an established market leader started in 1997. Amazon, who intended to be in the OTT space, launched its service Prime Video in 2006. The pricing, however, was not at all on a par with Netflix and was very low compared to it. This was the strategy by Amazon, where it used this service to attract consumers to the e-commerce market. With the consumers purchasing Prime Video service they would get an Amazon Prime membership by default, which had attractive propositions of one-day delivery and early access to products. This helped Amazon to compete with Netflix and cross-sell other services. The customer base as of Q3 2023 of Amazon Prime Video is 200 million as compared to that of Netflix’s 247 million