Penetration pricing is a marketing strategy involving the initial offering of a product or service at reduced prices to attract customers.
Using this strategy, regardless of industry, can be a powerful method for building a customer base.
New businesses rely on clear and strong differentiators to stand out from the competition. For many consumers, nothing makes their buying decision easier than price. A penetration pricing strategy is based on this idea.
By entering the market with a low price, businesses aim to attract customers quickly and then gradually raise their prices. Many well-known startups have used this strategy to disrupt industries and become today’s market leaders.
This article delves into the concept of penetration pricing, advantages, drawbacks, and includes examples of its application.
Penetration Pricing Strategy
A penetration pricing strategy is a marketing strategy used by businesses when launching a new product or entering a new market. It involves offering the product at initially lower prices than needed for profitability, aiming to attract a large number of customers to try it.
The specific pricing is influenced by factors such as market competition, product similarity, and competitors’ pricing strategies.
The goal is to showcase the product’s value at a reduced price, with the intention of retaining customers even after subsequent price increases.
This strategy helps in expanding the customer base and increasing profits over time.
Penetration pricing, similar to loss leader pricing, can be a strong marketing tactic if executed effectively. It has the potential to boost market share and sales volume, leading to reduced production costs and faster inventory turnover.
However, the crucial aspect lies in retaining the customers gained through this strategy.
Example: Penetration Pricing Strategy
For instance, a company might run a buy-one-get-one-free (BOGO) campaign to attract customers to visit their store or website.
After a purchase, establishing a contact list allows for follow-up offers of additional products or services to these new customers in the future.
New market entrants often use penetration pricing to quickly capture a segment of the market.
Since their brand is not yet established, competitive pricing becomes vital to stand out from established market participants.
Once customers are attracted through penetration pricing, the focus shifts towards building brand loyalty, turning one-time buyers into long-term patrons, and eventually, edging out competitors from the market.
Purpose of penetration pricing strategy
The purpose of penetration pricing strategy is multifaceted:
- Disrupting Established Markets: By offering a new product or service at a lower price, penetration pricing aims to shake up established markets and attract attention from potential customers.
- Attracting New Customers: The lower price attracts new customers to try the product or service, expanding the customer base rapidly.
- Building Customer Loyalty: While attracting new customers is important, building loyalty ensures their long-term retention. Loyalty is crucial for sustaining customer relationships even when competitors introduce lower-priced alternatives.
- Effective in Undifferentiated Markets: Penetration pricing is most effective when there is little differentiation among products or services, making price a significant factor in consumer choice.
- Mass Market Suitability: This strategy works well for products or services targeted at a broad audience, especially in subscription-based models where economies of scale can be leveraged to offer competitive prices.
- Market Entry: Penetration pricing facilitates rapid market entry by attracting customers with low initial prices.
- Market Share: It helps gain significant market share quickly, especially in competitive industries.
- Economies of Scale: High sales volumes from penetration pricing can lead to lower production costs per unit.
- Brand Awareness: It increases brand visibility and can generate positive word-of-mouth due to initial low prices.
- Competitive Advantage: Competitors may find it challenging to respond quickly, giving the company a competitive edge.
Penetration pricing aims to establish a strong market presence, acquire customers quickly, and create a foundation for long-term success by fostering customer loyalty.
Objectives of Penetration Pricing
The rationale behind penetration pricing is often adopted by new entrants aiming to quikly gain a notable market share.
Price serves as a straightforward method to distinguish new players from established competitors.
The primary objectives of this pricing strategy are:
- Capture Market Share: By offering lower prices, companies can attract customers from competitors and secure a portion of the market.
- Create Brand Loyalty: Providing value through competitive pricing can foster loyalty among customers, encouraging repeat purchases.
- Switch Customers from Competitors: Lower prices incentivize customers to switch from existing brands to the new entrant’s offerings.
- Generate Significant Demand: Aggressive pricing can stimulate demand, leading to increased sales volumes and potential economies of scale benefits.
- Drive Competitors Out of the Market: Intense pricing strategies can create challenges for competitors, potentially leading to their exit from the market.
- Profit Margins: Initial low prices may lead to lower profit margins, especially if costs are not efficiently managed.
- Brand Perception: Constant low prices might create a perception of lower quality or devalue the brand image.
- Customer Expectations: Customers may expect continued low prices, making it difficult to increase prices later.
- Price Wars: Penetration pricing can trigger price wars, reducing profitability for all competitors in the market.
- Sustainability: It may not be a sustainable long-term strategy as profitability can be affected once prices need to be increased.
Where is Penetration pricing effective ?
Penetration pricing is particularly effective in scenarios where:
- Product Differentiation is Limited: When products are relatively similar across brands, price becomes a critical factor influencing purchasing decisions.
- Demand is Price-Elastic: Products with price-sensitive demand are more responsive to changes in pricing, making penetration pricing strategies impactful.
- Mass Market Suitability: Products targeted at a broad consumer base can benefit from economies of scale, making lower prices feasible and attractive to a larger audience.
Marketing experts across various industries commonly use penetration pricing strategies in their work. They use these strategies not only to market their own products effectively but also to assess if competitors are employing similar tactics.
This understanding enables them to adjust their marketing approaches accordingly, taking into consideration competitive pricing dynamics.
Advantages of Penetration pricing
Penetration pricing strategies indeed offer several benefits that can be advantageous for businesses. Here’s a summary based on your points:
- Introducing New Products: Penetration pricing helps in quickly establishing a new product in the market by attracting early adopters and gaining initial market share.
- Positive Branding: Lower prices can create a positive perception of the brand, especially if the quality matches or exceeds expectations. Customers may associate the brand with value for money.
- Increased Market Share: By offering competitive pricing, businesses can attract customers from competitors, leading to a larger market share over time.
- Attracting Loyal Customers: Customers who initially purchase due to lower prices may become loyal if they are satisfied with the product quality and overall experience, leading to repeat purchases.
- Improved Cost Control: Penetration pricing requires a close look at costs to ensure profitability despite lower prices, leading to better cost management practices.
- Increased Profits from Other Products: Customers drawn in by lower-priced products may explore and purchase other offerings from the brand, leading to additional revenue and potentially higher overall profits.
These benefits highlight the strategic value of penetration pricing in both short-term market penetration and long-term customer retention and profitability.
Disadvantages of Penetration Pricing
- Customer Switching: Customers may switch to competitors once prices increase, especially if they don’t perceive significant differences in product value. Highlighting unique product features can help retain customers.
- Challenging for Small Businesses: Penetration pricing can reduce short-term profits, which may be difficult for smaller businesses to sustain. Limiting the duration or scope of the strategy can help manage this challenge.
- Potential Quality Misrepresentation: Lower prices may lead some customers to perceive lower product quality. Clearly communicating that the lower price is temporary can address this perception.
- Pricing Competition: Reduced prices may trigger price wars with competitors, leading to ongoing price reductions. Anticipating and planning strategies to avoid excessive price competition is essential before implementing penetration pricing.
Examples of Penetration Pricing Strategies
Here are some examples of penetration pricing strategies:
Example 1: Cosmetics Company
A cosmetics brand introduces a new line of hair care products in a new market, initiating a sale where these products are priced at half of their regular rates.
This strategy attracts customers from other brands, some of whom continue purchasing even after the sale ends due to product preference. Additionally, the company offers free product bundles with purchases to encourage repeat buying.
Example 2: Streaming Company
A movie streaming firm enters the market with a penetration strategy, offering a one-month free trial and then slashing prices by half compared to competitors for the next three months.
This competitive pricing encourages customers to switch and may encourage them to stay due to the service quality offered by the new company.
Example 3: Phone Provider
A mobile services provider aims to attract customers from rivals by launching a holiday special including a free smartphone and a 20% discount on monthly bills for three months post-registration.
Although this initially reduces profits, the company anticipates long-term gains from retaining a significant portion of these new customers.
Why is Pricing Strategy Essential in Product Management?
Choosing the appropriate pricing strategy is crucial for the success of a product. As stated by the U.S. Chamber of Commerce, “accurate pricing of your inventory is vital for sustained business growth.
Even if you have top-notch products, a skilled team, and an appealing storefront, inadequate pricing can hinder sales performance.”
Additionally, the pricing of a product or service can reflect a company’s image. For instance, effectively pricing SaaS products requires continuous market awareness.
Moreover, pricing directly impacts conversion rates and profitability, underscoring the importance for product managers to address pricing strategy early in the product development phase.
