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What Is Penetration Pricing
Penetration pricing is a type of pricing strategy where a company offers its goods and services at prices lower than the market to attract new clients.
Typically, penetration pricing is a type of pricing strategy used when launching a new product in the market and you’re hoping to create a market share.
The idea is once you sell your products and services at lower prices, you will create enough customer loyalty and satisfaction that they will continue to stay with you once the prices go back to their normal levels.
For example, a company launching a new product may offer prices much lower than the competition to have as many customers as possible try it out.
The company hopes that once the customer tries its products and services, they will continue to purchase from them at normal price points instead of going to the competition.
The penetration pricing strategy can be effective in markets where competitors have very similar products, the demand is price-elastic, and the product can be produced in bulk.
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Why Use Penetration Pricing
The main reason why a company will use a penetration pricing strategy is to entice customers to try its products and services.
The more it is able to attract customers, the more it is able to tap into the market share for the product.
In many industries and markets, consumers tend to make purchasing decisions mainly based on price.
For example, if you are looking to buy whole wheat bread and have two similar options, you will likely choose the cheaper alternative.
In such markets, a penetration pricing strategy can be used to either “penetrate” the market if you’re launching something new or increase your market share if you are already a market player.
Here are other reasons why penetration pricing can be used:
- To drive competitors out of the market
- To increase market share
- To benefit from economies of scale
- To create customer loyalty
Penetration Pricing Advantages
There are several advantages to adopting a penetration pricing strategy.
A company successfully executing a penetration pricing strategy is able to beat its competitors on price and take their market share.
The reduced prices will typically translate into higher sales.
Then, the higher sales can translate into possible economies of scale allowing the company to produce more at a lower cost per unit.
Ultimately, the company’s overall profitability can go up with more sales and a lower cost per unit.
What’s crucial when adopting a penetration pricing strategy is to win new customers and then keep those customers when prices go back up to their normal levels.
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Penetration Pricing Disadvantages
Although penetration pricing can have advantages in increasing sales and market share, companies should also be mindful of possible disadvantages.
The main disadvantage of penetration pricing is lowering prices to win new customers.
However, when the prices return to their initial levels, the newly acquired customers abandon the company and return to the competitors.
In this context, the penetration pricing strategy could not successfully translate into a sustainable increase in sales and market share.
Another important disadvantage is that when a company competes on price, the competitors may also choose to lower their prices.
If that happens, your penetration pricing impact will be lost, but the competitors will fight one another on lower prices.
As a result, the companies involved in such a pricing strategy can potentially lose significant profits for an extended period of time.
Another united result of using the penetration pricing strategy is that customers expect prices to remain at the new lower levels.
In that case, the return of prices to their normal levels will result in a further loss of market share.
In this context, the penetration pricing strategy results in an effective loss of market share and possible brand damage.
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Penetration Pricing vs Price Skimming
What is the difference between penetration pricing and price skimming?
Penetration pricing is a type of pricing strategy where a company’s objective is to lower the prices of its goods and services for a period of time to gain new customers.
The company hopes that the lower prices will translate into higher sales and an increase in market share.
The main focus of the penetration pricing strategy is to increase market share and not profits.
On the other hand, price skimming is a type of strategy where a company offers its products and services at high prices.
Price skimming can be an effective pricing strategy when a company sells premium products, luxury goods, or something innovative that can be highly differentiated in the market.
Companies that can differentiate their products on quality, brand, or innovation can charge higher prices and skim the market.
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Penetration Pricing Example
Let’s look at an example of penetration pricing to see how it works.
Example 1
Let’s say a new company has developed a soda drink and wants to enter the market.
To take some of Coca-Cola and Pepsi’s market share, the new market player will offer its soda drink at a 50% discount on the competitor’s prices.
The objective here is for Coca-Cola and Pepsi customers to try the new soda drink based on the attractive price.
If they buy the new soda drink and continue buying the same drink in the future, the penetration pricing is successful.
Example 2
Let’s say a new airline company is looking to penetrate a new travel destination market.
To do that, the new airline will offer airline ticks at a 60% discount over the competitor’s rates.
The price is so attractive that customers will choose this airline over the others as airline consumers generally highly price sensitive.
If the new airline company can provide a good service and customer experience, many of its new customers may continue using this airline when prices go back up.
Example 3
Let’s assume a new Internet provider wants to start offering Internet services in particular area.
The best way to enter the market and entice customers using other Internet providers to switch is to offer highly competitive prices.
As a result, a new Internet provider will offer Internet services significantly lower than the price offered by the competitors.
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Takeaways
So there you have it folks!
What is penetration pricing?
In a nutshell, penetration pricing is a pricing strategy where a company sets low prices on its goods and services to attract customers to make a purchase.
Very often, penetration pricing is use by new market players looking to start competing in a market segment.
Adopting a penetration pricing strategy is to prioritize market share over profits for a specific period of time.
When a company successfully executives its pricing strategy, it is able to gain the required market share on the basis of low prices, and keep the new customers as prices rise to the original levels.
This type of strategy is used when a company knows that it could sell a large volume by lowering its prices as the additional sales can compensate for the lower profits.
Now that you know what penetration pricing is and how it works, good luck with your research!
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