Penetration Pricing Explained: What It Is, How It Works, Advantages, and Disadvantages
In this article, we will examine the penetration pricing strategy definition and benefits of penetration pricing, as well as enumerate strategies that are commonly confused with it. You will learn how to establish your company in a new market and capture market share, while maintaining long term profitability.
Penetration Pricing Definition
Penetration pricing is a marketing strategy employed by companies to attract customers in markets with strong competition. Generally used by new entrants, it presupposes offering lower prices compared to other competitors. The small initial cost allows the company to make a potential customer aware of their product or service. The extreme use of the penetration pricing formula is called predatory pricing strategy.
How Penetration Pricing Works?
By setting the price below competitors’ offerings, businesses improve their recognition in the eyes of a customer. This helps to accumulate a customer base quickly. Essentially, penetration pricing method empowers companies to get new customers not through the inherent value, but through price point.
As time passes, it is common to raise the price, the rationale being that a customer will be willing to pay more for a product or service they have some experience with. However, the process is quite complicated, and doesn’t always go smoothly. A customer who was attracted by the low price tends to choose a cheaper alternative once the price starts to increase. The key strategy is to build customer loyalty.
Primary Purpose of Penetration Pricing
The main goal is to enter a new market. A penetration pricing policy is easy to adopt and is a sure way to stand out. The low introductory price gives results in the form of new customers and differentiates the brand from others. Advantages of penetration pricing strategy are manifold, but let’s briefly examine some of the key ones:
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Enticing new customers in a market teeming with competitors. If the clients like the product or service, they will be willing to pay more once they lose the initial discount.
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Building loyalty through educating consumers about what the company has to offer. Customers will be more willing to try the company's other offerings if they are impressed with what they’ve already tried.
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Generating demand by selling products in high volume and in short-term. Achieving high inventory turnover improves the perception of your brand and leads to cost advantages, like the ability to effectively use economies of scale to reduce production costs.
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Luring customers. The low price point is a bait taken easily in highly saturated markets. By playing your cards right, it is possible to even drive competitors out completely and capture a huge portion of the market share.
Advantages and Disadvantages of Penetration Pricing
Relying on a penetration pricing model enables your business to enter competitive markets and increase sales. Despite being an easy-to-implement strategy, it has its share of drawbacks. Offering a product or service at a low price may send a message to potential clients that its quality and value are not on par with those of competitors. It’s essential to know more about penetration pricing advantages and disadvantages before committing to this approach.
Disadvantages of Penetration Pricing
The exchange of lower initial prices for market share gains is a delicate matter. A low initial price point is a good thing for customers, but does not bode well for a business in the long-term perspective. It’s just not possible to offer the same price indefinitely, since the main goal is to make a profit. Therefore, the strategy prolongs the time when the entry in a new market becomes profitable.
Risk to the image of the brand is an important aspect to consider. In simple terms, customers might believe that products or services offered at a lower price have less value and are of lesser quality than their more expensive counterparts. This idea is difficult to combat when the price point is increased, meaning it is necessary to take this aspect into account.
After the price has been raised, customers might simply abandon the company and their offerings. There is also a possibility that consumers may be enticed by another business and their penetration pricing strategy. It is essential to thoroughly consider the advantages and disadvantages of making changes to the contract with existing clients.
As soon as a business enters the market, its established players may match the low price or even further reduce it to undercut the competition. This could start a vicious cycle of lowering prices that in the end will take a toll on all actors. The profitability will be decreased, and the companies left standing will not be those that just tried to enter the market.
Advantages of Penetration Pricing
The main advantage of penetration pricing stems from the fact that it empowers a company to attract many new clients quickly. Most people are not loyal to a particular company, and so it is easy to get their attention by simply offering a lower price. A good example of a penetration pricing strategy is Netflix. This OTT streaming service had affordable subscription fees at the start. It gained a substantial customer base, resulting in problems for traditional cable service providers.
Companies can opt for a slow penetration pricing strategy and accumulate customers without a significant cost on the promotion of the product. Of course, this will take time, but will yield results in the long run. Once the customers are acquired, businesses can try to cross-sell or upsell to increase revenue. This works well for enterprises that have subscription models, with monthly fees.
Reliance on penetration pricing strategies can build economies of scale. If prices are acceptable, it is possible to convert a considerable number of customers, which in turn increases sales volume. This influx of finances results in cost savings in manufacturing, marketing, and distribution. The edge in high sales volume means that new players would be less likely to enter the market.
One of the most important penetration pricing benefits is its role in disrupting existing actors in markets. Lower prices are a real threat for established brands and can necessitate rethinking of their pricing models. As a result, a company that penetrates the market has a chance of forcing weak competitors out and increasing market share.
Penetration Pricing Strategy Pros and Cons
To summarize pros and cons of penetration pricing, let’s enumerate them.
Pros:
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Good way to attract many new consumers
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Can facilitate brand recognition and improve customer loyalty
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Strategy lends itself to creating economies of scale
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Plays an important role in causing trouble for other players in the market
Cons:
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Can lead to short-terms losses in terms of profit margins
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May damage the brand perception in the market
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Customers might switch to another product when the price increases
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Can incite a price war that will damage the new entrant
Strategies Mistaken for Penetration Pricing
Once we’ve examined penetration pricing strategy advantages and disadvantages, it’s crucial to discuss in which ways it differs from other pricing approaches. A clear understanding of similarities and differences will help to decide on what strategy best fits business’s purpose.
Introductory Pricing
In both introductory pricing and penetration pricing, low prices are a key mechanism that drives the attraction of customers. However, the introductory price period typically lasts for a month or a year, and if the company deems it appropriate the trial can be extended further. This is impossible with penetration pricing as its main goal to gain market share, then bump the price to make a profit.
Price Skimming
In penetration pricing strategy the idea is to sell products at low prices to attract customers. Price skimming, on the other hand, presupposes promoting products at high prices. This approach works best for companies in the luxury sector since typical customers are willing to pay more. The goal here is to increase profit margins. In the long term, prices will be lowered to align with comparable prices on the market.
Loss Leader Pricing
The rationale behind penetration pricing and loss leader pricing is the same: to gain a larger market share. The latter is employed by brands with two complementary products. Companies sell one item at a loss and try to persuade customers to purchase a more expensive complementary product.
Summary
Penetration pricing is a marketing strategy used by companies, especially new entrants, to get a share in a competitive market by offering low prices. This attracts clients to purchase their products or services and helps businesses build a customer base quickly. Over time, prices are increased, and the hope is that customers having experienced the product will stay loyal.
There are penetration pricing pros and cons. The former include the attraction of new customers, building loyalty, generating demand, and disrupting competition, while the latter encompasses harm to the brand image, customers leaving when prices for products eventually go up and the possibility of a price war that affects profitability.
Penetration pricing is often mixed up with introductory pricing, price skimming, and loss leader pricing, but it’s different in its long-term goal of getting market share and then raising prices for products to make a profit. The strategy is good but requires careful balance of market gains versus profit and brand perception.
Want to make a big impact in a crowded market? Penetration pricing is the way to go. Offer a great price and build your customer base in record time.
Advantages:
- High adoption: Lower prices make the product more appealing.
- High inventory turnover: Increased sales volume helps to move products quickly.
- Economies of scale: High sales volumes reduce production costs.
- Increased recognition: Exposure to new customers boosts brand visibility.
- Threat to competitors: Lower prices can put a pressure on competitors.
Disadvantages:
- Expectation of low prices: Customers may resist inevitable price increases.
- Harm to the brand perception: Low prices can make the brand seem lower quality.
- Low customer loyalty: Price-sensitive customers may switch to competitors.
- Price war: Competitors may lower their prices, triggering a domino effect.
- Inefficient in the long term: Sustaining low prices hurts profitability.
Price skimming: A business launches a product on a market with a higher initial price compared to competitors, then lowers it. Consider how Apple is selling new models of iPhone.
Penetration pricing: A company sets an initial price lower than its competitors, then raises it after attracting new customers. Pricing strategy of Netflix is a good example.
Netflix is the most famous example of market penetration pricing. Netflix quickly entered the streaming market with its low subscription costs and accumulated a considerable amount of loyal customers.
- Internet and cable providers
- Streaming companies
- Smartphone suppliers
- Hospitality services
- Financial institutions
- Airline companies
- Grocery stores
- Product manufacturers
- Food manufacturers
- Video game publishers
Penetration pricing strategy is typically adopted by companies who want to enter a market with established players. As newcomers, it is not easy to persuade customers to switch to their product.
