Loss Leaders Risky Gamble for Small Web Hosts

It’s not unusual for the smaller players in an industry to look at what the bigger players are doing for inspiration. By mimicking the larger companies, they hope to drum up more interest, more customers, and more profits. The web hosting industry is no different. But the problem is that some things just don’t scale down well.
Let’s take loss leaders as an example. You’ve probably encountered them in other fields. To take an example from Florida’s busy real estate market, when I moved into an apartment down here, the firm I chose to rent from gave me a discount on my first year’s rent, spread out over all 12 months. When that first year ended, and the rent went up, it was a modest enough increase (and I was happy enough with the service I’d received during the year) that I chose to stay. The hassle it would have been to move was also a consideration, true, but the point is that the company renting me the apartment had done so at a loss to itself in the hope that I would stay on at the full price.
There are a couple of ways loss leaders can work in the web hosting industry. One of them is to sell a service below your own cost in the hope that someone who purchases that service will also purchase your full price products. In some cases, a company may offer something for a very low price or even free, provided the customer buys something else at the full price (for example, a cheap domain name if the customer agrees to buy web hosting from the company).
A web hosting company might hedge its loss leader with limits to avoid losing too much money. In the case of domain names, it might offer the deal to only a certain number of customers, or “for a limited time,” or allow customers to buy only a certain number of domain names. In general, domain names are not the riskiest loss leader for a web hosting company; anyone who purchases a domain name will presumably have a web site in mind, and need web hosting for that site. For many customers, it would make sense to buy a domain name and web hosting from the same company, just for the sake of convenience.
But there are certain things that larger web hosting companies offer as loss leaders which could put a smaller company out of business. The temptation is understandable, given what most companies hope this kind of high stakes gamble will accomplish for them. Let’s take a hard look at this kind of loss leader.
Some web hosting companies use web hosting itself as a loss leader. They will offer inexpensive web hosting in the hope that the customer will appreciate their service enough to sign up for another year at the full price. Or they will offer an inexpensive web hosting account and try at a later time to move the customer into one of their more feature-rich (and expensive) packages.
To give you some examples, Dream Host has offered coupons for deep discounts on hosting service, far more than 50 percent in many cases. For example, when the user enters one code for a particular monthly plan that ordinarily costs $59.90, he or she will pay only $9.90. The same code entered for a yearly plan that ordinarily costs $119.40 will let the user receive the plan for only $22.40. Recalling what I said about large hosting companies, Dream Host recently doubled the number of domain names they hosted in the past year, to 400,000. So using a loss leader may be working for them.
Another company that has used loss leaders effectively is 1&1 Internet. Back in 2004, when the company launched its U.S. division, it started selling domains at a loss, for $5.99 each. It also began offering a $29 a month hosting plan to customers for free for three years – in short, it was giving away a $1,000 value to those who were willing to try its service. Many customers who tried out the plan were so happy with the service that they purchased other services from 1&1 Internet. The web hosting company hopes, those trying the plan will be willing to pay to stay beyond the original three years. Needless to say, 1&1 Internet is also a large company; at the time it started the promotion, it was Europe’s largest web host.
It makes sense for a larger company to run a loss leader campaign, but it may not make sense for a smaller company. Large companies don’t undertake such a campaign unless they have the cash flow to support it and can absorb the loss. They also have specific goals in mind when running a loss leader campaign, and while smaller companies may have similar goals, loss leaders may not be an appropriate way for a smaller web hosting company to achieve those goals.
Why would a web hosting company, or indeed any company, use a loss leader campaign? There are a number of reasons. Mainly, loss leader campaigns are used when the company is trying to achieve something that it can’t do simply from selling its product at the usual price. Loss leaders capture customer attention; what a company hopes to do with that attention varies.
Perhaps the most obvious thing to do with that attention is attract more customers. “Hosting companies use loss leaders to grow the customer base exponentially, with the ultimate goal being to up-sell these customers to more profitable business,” notes Barbara Branaman, vice president and general manager of the hosting unit at XO Communications. That’s a good thing for large companies to do if they can handle the explosive increase in their customer base, but if you’re a small company, your customer service will probably suffer under such an onslaught.
Web hosting companies also use the attention generated by loss leaders to help them break into markets where their brand is not very prominent (or practically non-existent). That’s why 1&1 Internet offered such a dramatic loss leader when it entered the U.S. web hosting market. That kind of promotion was bound to generate buzz and raise the company’s profile.
A third reason web hosting companies might want to use loss leaders to get attention should be familiar to everyone in the field: the cutthroat competition. Everybody is trying to offer the lowest prices to attract customers who aren’t afraid to shop around and switch hosts to find the best possible deal. It’s worth keeping in mind that the customers attracted by loss leaders are just as likely to leave as soon as they find a better deal. Once your prices go up after that first year or promotion period, they’ll switch to the next company that offers them a loss leader. Sure, there is some effort involved in changing web hosts, but it’s not as much effort as, for example, trying to move an entire apartment’s worth of furniture and personal effects (to say nothing of 50+ boxes of books!).
I’ve hinted at some of the reasons why loss leaders are risky for a small web hosting company, particularly the kind of loss leaders that larger web hosts can afford to offer. Let’s take a closer look at some of the problems a small web host may experience when it tries to emulate the big boys in this area.
What will happen if you offer a year of free web hosting as a loss leader and experience the kind of growth in your customer base that you only dream about? Well, that dream can turn into a nightmare pretty quickly. More customers mean more customer support calls, and if you don’t have the staff to respond, your disgruntled customers will complain – loudly, and to anyone who will listen, not just your staff. Dream Host may have fallen prey to that very problem, if the web site dreamhost-sucks.com is any indication. In that case, your loss leader will seriously backfire, attracting the kind of attention you don’t want.
Also, as noted above, you may not really want the kind of customers that would be attracted by loss leaders. Branaman has observed that loss leaders “attract the wrong type of audience.” You don’t want to have a “base of customers that are not loyal to the services or interested in additional services, therefore making the overall business unprofitable.”
Looking at the web hosting industry as a whole, loss leaders as a marketing strategy may be doing more harm than good. While they force web hosts to increase their efficiency, they also create expectations of unnaturally low prices in web hosting customers, commoditizing the market. It may not be too harmful to offer domain names as loss leaders, but before you offer free web hosting as a loss leader, take a close look at your business and figure out whether the customers you gain (and the income you lose) will be worth it.
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