Penetration pricing entails setting a reduced price at the beginning, to increase market share. It’s used in a number of circumstances, but the commonality is the goal of gaining a bigger market share. The price is used as a stimulus for people to purchase a product or service.
Penetration Pricing Definition
Penetration pricing is a type of pricing strategy often used by retailers to captivate new customers to a new retailer, product or category. According to this strategy, the initial price of a product is low to persuade customers to choose the new brand.
Market share growth or creating market for a brand new product is the major goal of penetration pricing. After this objective is achieved, retailers usually increase prices. Moreover, a higher market share and long-term profit preferences as a result justify applying the penetration pricing in your market strategy.
The penetration strategy usually works best for a new product on a market. Especially if it’s a market with tiny differentiation of products (e.g. hi-tech electronics), and high price elasticity of customer’s demand.
Penetration Pricing Explanation
In contrast to price skimming strategy, where the price starts high but then is slowly reduced to graze different segments of the market to maintain profitability over a period, penetration pricing begins at a low cost. Instead of the basic idea of the law of demand and supply, where the smaller the price, the bigger the demand of goods, price penetration begins at a low price, and then it rises with the hopes that the demand increases too. The idea is to expand market share and gradually increase prices over time.
Take, for example, discount stores (e.g. Walmart), wholesalers (like, SaleHoo) and hook-and-bait manufacturers (e.g. printers or razors). They use penetration pricing in a couple of ways. First, they use it to sell new products in their stores by advertising how low their prices are compared to other stores. They do this in hopes that the customers will purchase few items upon entering the store. Although they would be losing funds on the new product, they would be getting more customers into the store. Additionally, they use penetration pricing to undersell their established competition. Once they’ve secured and expanded their customer base, they gradually start raising prices. The explanation is that often the initial prices introduced via penetration pricing don’t give a great deal of profitability since the margins are generally very slim. As a result, the business needs to rise prices over time in order to be able to offer their products and services more profitably.
When coming into a new market, the penetration pricing approach is crucial since it’s useful when determining whether the product can capture a secure market rate. Despite not making any change to the company’s marketing strategy, it has an unimaginable potential for both profit and revenue growth. However, it is important to understand all advantages and all disadvantages of penetration pricing as well as the risks that it carries.
Advantages of Penetration Pricing
- If penetration pricing is put into place, the adoption percentage, as well as diffusion, are elevated. Adoption is like diffusion, but it concentrates more on the emotional acknowledgment whereas diffusion depends on the acceptance from consumers of the recent product or service.
- Consumers, having found great deals on your product or service before, will most likely come back again in order to catch those profitable deals again.
- Initially, there is hardly any competition since the competitors are taken aback by the action and don’t have enough time to react and to implement price intelligence. If they do decide to enter, they risk having smaller profits. They would also be entering a new market share which is full of uncertainty.
- Low prices encourage the word-of-mouth advertising for a product, therefore any promo activity becomes more efficient.
Disadvantages of Penetration Pricing
- Brand damage. Consumers often assume that the prices will stay as low as they are now. They are often taken aback by abrupt rises in prices and as a result, they may be prone to try switch to a competitor. Therefore there is a loss of market share that had been gained.
- False loyalty. Penetration pricing may attract a particular type of customers who only keep their eyes out for profitable deals and nothing else.
- Pricing wars. Competitors will try to hold their market share by setting low prices, too. It may cause price wars and profitability losses.
To conclude, penetration pricing is putting a product or service onto the market for a lower price than what is considered to be the norm. This scares away the competition, leaving the company to be on its own. Then they raise their prices and ultimately achieve a monopoly over that market. The price could have a one time, but significant increase or it could have a gradual one. However, neither of those methods are certain for success.
A pricing strategy for fast market penetration gives a better chance of attracting first-time customers, yet be aware, that implemented inaccurately it may cause money loss and pricing wars instead of profit/market share growth.