Can companies adopting product life-cycle management strategies actually grow market share by selling at a loss? Well, while conventional wisdom states that products and services must derive a profit, there are some cases where companies intentionally sell at a loss. However, this implies that these companies must at some point either raise prices or lower costs, right? Well, not exactly. While some companies know they’ll eventually be able to lower costs through increased manufacturing volumes, some companies merely sell at a loss in the hopes that their customers will later accept a price increase. Unfortunately, this leads to customers buying on price, and not on a product’s features and benefits. However, there are instances where selling to lose money makes sense, even if the company never changes its price or reduces its costs.
Product Life-Cycle Management (PLCM) Strategies
Understanding why a company would sell at a loss starts by understanding product life-cycle management, or otherwise known as PLCM. Within a product's life-cycle there is an introduction stage, a growth stage, a peak stage and a decline stage. In some cases, there’s a fifth stage of life-cycle management where a product experiences a rebirth. That stage is described in the table and video below. However, for the most part, a product has these four aforementioned stages.
The introduction stage is typically associated with high pricing as consumers have yet to adopt the product offering. Costs are high due to low production volumes. As the product gains acceptance, pricing decreases in the growth stage and then stabilizes during the third peak stage. During the decline stage, a product’s pricing is lowered as the product is fast approaching its end of life. It's usually during the third (peak) and fourth (decline) stage where a company introduces its new product offering in order to coincide with the current product's decline.
In the above graph the Y-axis (vertical) could represent millions of units sold, while the X-axis (horizontal) could represent number of years of sales
Sony's Loss-Leader Pricing Strategy
As mentioned, most life-cycle management models state that a product’s introduction stage is characterized by high prices. However, in some cases, a company may actually fix its price to sell at a loss in order to grab market share. So, why would a company do such a thing?
To answer this aforementioned question, think of how Sony priced its PS2 and PS3 gaming consoles. In these cases, Sony purposely priced these items to sell at a loss in order to secure market share. More importantly, the company did it in order to control, drive and dictate content. Sony’s goal wasn’t to make a profit on its consoles, but to ensure that as many consoles were sold in order to make a profit on its games.
The company used its consoles as a “loss-leader” product line in order to guarantee its future sales on gaming software. As such, it ignored conventional wisdom by concentrating on its real goal of gross profit through game sales. In this case, the company treated one product as a loss-leader and the other as its profit driver.
Sony's Manipulation of PLCM
Sony sped up the introduction stage of both product lines in its life- cycle strategy. However, the company rationalized that the losses incurred on its consoles would more than be made up by the growth on software sales. So, how could Sony go about making such a decision?
First, they would need to be market experts and be aware of the number of games sold per console. Of course, they can rely upon historical data from previous console sales.
Second, they would have to calculate their losses relative to the gross profit on the number of games each console owner would purchase during the product's life-cycle.
Third, the company would simply deduct its gross profit on games, from its losses on the consoles, in order to determine its total gross profit. Here’s what these this might look like.
The table below provides some insight into how this loss-leader strategy might play out.
Sony knows that for every console sold, their customers will likely purchase approximately 60 games during the PS3's life-cycle. Again, this market information would likely be gathered from its historical sales of earlier console models like PS1’s & PS2’s. Every game sold produces $15.00 of gross profit. 60 games sold means every console would product $900.00 of gross profit. This $900.00 would be used to offset the loss of $450 from the sale of the PS3 consoles themselves.
While this is merely an example, it’s important to note that Sony's PS3’s initially had a high failure rate where 50 percent of consoles failed inspection. While they’ve improved upon the performance of their Blu-ray system, it is still prone to failures and therefore, its costs to manufacture are still quite high.
Of course you could simply take the profit from the games ($900.00) minus the loss on each console ($450.00) and then multiply this sum by the number of units sold (55,000). This would be $450.00 x 55000 or $24,750,000.00.
When Does This Strategy Work?
While Sony’s approach may seem unique, the simple fact remains that it was largely forced into this move by competitors like X-Box and Nintendo. In this case, the impetus was to control content. Since PS3 games can’t play on X-Box, or Nintendo, the importance of getting the product adopted by the market was paramount to success. Therefore, if a company wanted to emulate Sony’s approach, it should only do it under the following conditions.
- Importance of Early Adoption: The faster the product gets to the market, the more likely it is to become the number one choice of customers. However, the conditions for capitalizing on early adoption must be present. This is why it’s essential your company understand your market. Too soon and the product doesn’t catch on. Too late and you’ve missed your opportunity. Timing is everything and requires your company become market experts.
- Strong Market Competition: Market competition is one thing, but when that market is dominated by few players, it becomes much more important to protect market share. Companies in this situation are not only market experts, but more importantly, they are product life-cycle experts. They know what stage their product is in, and they match new product introductions to coincide with the end of a product’s useful life.
- Proprietary Design: Most importantly, these companies drive future demand by providing a proprietary design. Once customers purchase their product, they are forever linked to purchasing future consumables, spare parts or raw materials. In essence, the product in question dictates future consumption.
To grow market share by selling at a loss requires the ability to anticipate customer demand and have a thorough understanding of life-cycle management strategies. The impetus must be on product introductions that coincide with the eventual end of life of existing product lines.
Selling at a loss to capture market share is a reasonable strategy, provided the company assures itself of future gross profit. It’s never ideal to low-ball pricing to grab market share, merely to try and raise pricing at a later date. Unfortunately, this does nothing more than train customers to buy on price. In the end, this leads to the dreaded price war and declining returns as customers dictate pricing and service conditions.
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