Penetration Pricing

Published Mar 22, 2024

Definition of Penetration Pricing

Penetration pricing is a marketing strategy used by businesses to attract customers to a new product or service by offering a lower price during its initial offering. The aim is to gain market share quickly and draw customers away from competitors. Once the business has successfully gained a foothold in the market and built a steady customer base, it may gradually increase the price to more sustainable levels. This strategy is often used in highly competitive markets.

Example

Imagine a new streaming service, StreamFast, entering a market dominated by established names like Netflix and Amazon Prime. To differentiate itself and attract subscribers, StreamFast decides to introduce a penetration pricing strategy by offering its services at $4.99 per month — significantly lower than its competitors. This attractive pricing draws in a large number of subscribers who are looking for a more affordable option for their streaming needs.

As StreamFast grows in popularity and its content library expands, the company slowly increases its subscription fee to $7.99, which is still competitive but allows for better margins. This gradual price increase is accepted by the now loyal subscriber base who value the content provided.

Why Penetration Pricing Matters

Penetration pricing is a powerful tool for entering a new market or launching a new product. It helps a business establish its presence in a competitive environment by incentivizing trial and brand switching. If successful, it can lead to rapid market share gain, economies of scale, and strong customer loyalty. The initial loss in profit margin can be offset by the volume of new customers attracted by the low pricing strategy.

However, businesses must carefully manage this strategy to ensure that the value of the product or service is not perceived as low quality. Additionally, a clear path to profitability should be defined, considering the cost of acquiring customers and the feasibility of increasing prices without significant churn.

Frequently Asked Questions (FAQ)

Is penetration pricing suitable for all types of products?

No, penetration pricing may not be suitable for all products, especially those that are positioned as luxury or high-end. For these, a premium pricing strategy might be more appropriate. Penetration pricing works best for products or services in highly competitive markets where the primary goal is to gain market share quickly.

How long should a business keep its prices low before increasing them?

The duration of maintaining low prices varies depending on the market dynamics, customer acquisition goals, and the financial health of the company. It’s critical to monitor market response, customer growth, and financial performance closely during the introductory phase. Typically, once the set targets for market penetration are achieved, the company can start increasing prices gradually.

What are the risks associated with penetration pricing?

Risks include the potential for creating a price-sensitive customer base that may leave for competitors if prices increase. Additionally, if the low price is sustained for too long, it could erode the perceived value of the product or service. Financial risk is also a factor, as the initial lower margins may not cover the costs, leading to losses if the strategy does not result in the anticipated scale of customer uptake.

Can penetration pricing be used in combination with other strategies?

Yes, businesses often combine penetration pricing with other marketing strategies such as heavy promotion, bundling (offering products or services together at a discount), or freemium models (where the basic service is free, and customers pay for premium features). The combination of strategies can create a more compelling offer to encourage trial and adoption.

How do competitors typically respond to a penetration pricing strategy?

Competitors may respond with their own price reductions, special offers, or by highlighting the unique benefits of their products or services. In some cases, a price war could ensue, which might lead to reduced industry profits. Therefore, companies need to be prepared for potential backlash and have a clear, sustainable long-term strategy in place.