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Web Hosts That Sell Hosting Plans at a Loss Tread Dangerous Ground

by Rachel Ringler

Loss leading is not a new phenomenon in the web hosting industry. For those unaware what the technical term actually refers to, loss leading is where a company sells a product at a loss in order to attract customers in the hope they will purchase other full priced products from the company. The sale of domain names at less than $10 by industry giants such as EV1Servers two years ago was just a precursor to recent marketing attempts by HostGator and Dreamhost; to name but a few.

Selling domain names at a loss is not a high risk strategy. The low costs associated with domain names mean web hosting companies are able to absorb the losses they make on the domains. The idea is to quickly build brand equity and at the same time achieve the zenith of loss leading as domain names on their own are of course useless. Their use is dependent on the purchase of hosting space as well. By offering the domain names in conjunction with the hosting, hosts are theoretically able to profit.

Recent marketing attempts by web hosts now include selling the web hosting itself as a loss leader. Dreamhost is an example of such a host. By offering coupon codes and other associated discounts for the first year of service, consumers can purchase extremely beefy shared hosting accounts for rock bottom prices. The business model relies on customer loyalty due to outstanding support being enough of an incentive to retain customers in the second year. The added effect of viral marketing surrounding the extremely low priced accounts is expected to increase Dreamhosts brand value whilst a slew of higher priced accounts and dedicated server upgrades to up-sell to the customer are expected to cover the loss-leading costs of the first year.

Of the three objectives mentioned in the previous paragraph, only two have exhibited any signs of being realized. Clever marketing in the form of a refreshingly honest company blog and the willingness to admit to their own mistakes during recent downtime has meant the company is beginning to gather solid backing from their client base. Customer loyalty is not always forthcoming when it comes to loss-leading. The client base attracted by the pricing are those that do not associate higher priced products with less risk and are more likely to host-hop in search of further savings. The brand equity for Dreamhost however has unquestionably increased. Almost all webmaster discussion forums on the Internet are laden with posts discussing Dreamhosts exceptional pricing strategy.

Dreamhost will be banking on the brand equity to help pull them through once their pricing strategy is normalized. They are the most cited example in this article because of the fact they were one of the first hosts to adopt such an aggressive loss leading pricing strategy. However, the myth that being the first on the market preludes to some sort of advantage has been debunked long ago. There are now several different hosting players offering similar priced hosting services however whilst the number of hosts continues to snow ball consumer demand has not kept up.

However, it would be entirely over ambitious of a web hosting company to believe that by adopting a loss-leading strategy on such a grand scale they will be able to sustain the losses for a number of years until competitors have been killed off, consumers are hooked onto the service offered by the company and subsequently they can raise their prices. The velocity of the approach undertaken by Dreamhost is different to that of the host which pursued the under $10 domain name loss leader strategy. The model is the same, switch for the price stay for the service however in the case of the latter, domain names presented a slow lower cost build up in comparison to Dreamhosts grandiose efforts

A greater problem exists for smaller web hosts who look at the Dreamhost business model and seek to emulate it. Rapid growth and the adding of so many new accounts in a short space of time is an attractive proposition. However, loss leading on a shoestring is also a recipe for disaster. Loss leading can be conducted by a host the size of Dreamhost or HostGator. These hosts have a reliable cash flow and their deep pockets can fund such operations in the tougher early years. A start up / small host does not have this luxury. Not to mention the competitive scene which many hosts will find themselves in - early adopters of this pricing strategy were running in an open field, now the market is a lot more crowded.

If customer loyalty is in doubt and brand equity temperamental to sudden changes then surely the key to profitability is up-selling? By moving a customer from a single shared hosting account to virtual private server or even a dedicated server realizes the dream of every host indulging in loss leading. Each advertising dollar spent on acquiring the customer is automatically vindicated as the higher profit margins of the up-sold product cover such losses. However, the fact that a great shared hosting service provider might not be a great dedicated server provider remains an issue. Certainly one key problem is the actual method of overselling. Many hosts have played on the server resource card. Sir, you are fine as far as space and bandwidth consumption goes, but Im afraid you are monopolizing CPU minutes; its time to give us more money!

As mentioned before, the type of client attracted by this pricing is always on the lookout for savings and is more than likely to jump hosts and repeat the process elsewhere. Dreamhost to their credit have marketed their up selling a slight deal better than your average host. By removing the notion of discriminating accounts based on CPU minutes usage, vowing instead to move resource intensive sites to servers with lesser loads they are in effect flattering customers into purchasing full priced solutions. An intelligent way of applying a loss leading strategy however even in the Internet age it takes time to build successful products and Dreamhosts other full priced products have yet to achieve the same recognition as their loss leader.

The industry has come to a stage where consumers are used to lower priced offerings for a service that costs the service provider a lot more to put out on the market. When a consumer is used to a $3/month account its difficult to purchase $5/month account. If the consumer is used to a $5/month account it is easier to switch them to $10/month account. Its basic pricing psychology. When it comes to loss leading, smaller hosts cannot afford to play the same game as the giants of the industry (but will attempt to do so anyway) and larger hosts are not guaranteed long term success in executing these strategies. The signs point to a rocky future for web hosts thus extra scrutiny being placed on the likes of Dreamhost to see if they will ever realize their ambitions. Obituaries will come thick and fast if they fail, however if they do succeed it will be nothing short of a miracle and the likes of Dallas Kashuba and Josh Jones will be regarded as modern day magicians!

Thursday, Oct 19th, 2006