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Loss Leader

The term loss leaderhip defines a pricing strategy, where a product is sold below costs or distributed for free1). The aim of this model is, to lead customers to buy the other products from a company. Thus the product is not priced for the profit but only to attract customers and to stimulate the sales of other goods. It is a common strategy when a company first enters a market or business and wishes to build brand loyalty and other goodwill. By selling the product with a lower price, a competitive advantage results, but this has to be monitored with high precaution, as this strategy might lead to financial problems.

General Loss Leader Strategy

One major target when using the loss leader strategy is to lead customers into the stores2) or to the company, because when they are already inside, they will potentially buy also other items and goods. By that, overall profit is generated. With the loss-leader, the sale of other items is driven to accommodate the loss of the article, which is distributed below costs. Companies need to monitor the sales as quickly as possible in order to not suffer an overall loss. Sometimes, stock-piling might be riskful as this can harness the long term strategy. There are different ways to do a loss-leader strategy:

  • Placing the loss leader article, so that customers have to walk through the shelves with goods that have higher margins
  • Sell one part of a product for nearly nothing, but in order to use it, another product is needed which has a higher margin, or binds the customer to a company 3)
  • Sell products of frequent purchase at lower prices, as customers know the normal prices
  • Nespresso coffee maker are like the printers sold at low price, to sell their capsules.

Software Loss Leader

In terms of software, a loss-leader, often an open source product, is distributed as a market positioner. Value is not generated by the product itself, sometimes donating is available, but is generated by selling additional services or tools to extend the functionality of the free software. Another method is also to have the open-source tool and the commercial tool, which is based on the open source version, to get customers used to the software concept; the commercial tool has much more functionality and the same look-and-feel as the open-source product 4). The free software is used to lead customers to the product range or the company, so that they start to buy the additional items or services provided by the company.

In terms of open soruce software, there are several benefits for companies following this model. Due to the community, the development is speed up and closer to the customers needs, as the programmers probably want to use the tool for themselves. Due to the outsourcing of the programming, the product can be developed cheaper than in a traditional approach. For the business model there are four well known models for generating value of the open source model5)

  1. Support Sellers (otherwise known as “Give Away the Recipe, Open A Restaurant”): In this model, you (effectively) give away the software product, but sell distribution, branding, and after-sale service. This is what (for example) Red Hat does.
  2. Loss Leader: In this model, you give away open-source as a loss-leader and market positioner for closed software. This is what Netscape is doing.
  3. Widget Frosting: In this model, a hardware company (for which software is a necessary adjunct but strictly a cost rather than profit center) goes open-source in order to get better drivers and interface tools cheaper. Silicon Graphics, for example, supports and ships Samba.
  4. Accessorizing: Selling accessories – books, compatible hardware, complete systems with open-source software pre-installed. It's easy to trivialize this (open-source T-shirts, coffee mugs, Linux penguin dolls) but at least the books and hardware underly some clear successes: O'Reilly Associates, SSC, and VA Research are among them.

Examples of Loss-Leaders

  • Mobile phones are often sold for free with a contract, in order to get more customers for a longer period6).
  • Sony7) and Microsoft8) sold their consoles at loss, to attract customers and to sell more games and accessory, which is much more profitable
  • Netscape tried to position itself on the market with the free netscape communicator internet browser 9)
  • Adobe hands out the pdf reader for free, but to build pdfs a commercial tool is needed
  • Printers are often sold very cheap to earn profits by selling the corresponding ink.

References

1)
“Setting Up Shop.” Frank Hecker. Web. 30 Dec. 2010. <http://hecker.org/writings/setting-up-shop>.
2) , 4)
“Loss Leader Definition - What Is Loss Leader?” Investor Glossary - Defining the World of Investing - InvestorGlossary.com. Web. 30 Dec. 2010. <http://www.investorglossary.com/loss-leader.htm>.
3)
“Loss Leader.” Cambridge University Press Professional English Online. Web. 30 Dec. 2010. <http://peo.cambridge.org/index.php?option=com_content&view=article&id=186:loss-leader&catid=10:jargon-buster&Itemid=4>.
5)
“Open Source Initiative OSI - Open Source Case for Business:Advocacy.” Samuraj Data AB - Välkommen. Web. 13 Jan. 2011. <http://www.samurajdata.se/opensource/mirror/advocacy/case_for_business.php>.
6)
“IPhone Makes Worldwide Loss, Says Report | Business | Guardian.co.uk.” Latest News, Comment and Reviews from the Guardian | Guardian.co.uk. Web. 30 Dec. 2010. <http://www.guardian.co.uk/business/2009/sep/06/telecoms-iphone>.
7)
“PlayStation 3.” Wikipedia, the Free Encyclopedia. Web. 30 Dec. 2010. <http://en.wikipedia.org/wiki/Playstation_3#Sales_and_production_costs>.
8)
2008, By March. “Xbox 360.” Wikipedia, the Free Encyclopedia. Web. 30 Dec. 2010. <http://en.wikipedia.org/wiki/Xbox_360#Sales>.
9)
“Open Source Case for Business:Advocacy | Open Source Initiative.” Mission | Open Source Initiative. Web. 30 Dec. 2010. <http://www.opensource.org/advocacy/case_for_business.php>.
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strategies/loss_leader.txt · Last modified: 2014/10/19 13:28 (external edit)