When the price is right, your product will sell. But how do you determine that sweet spot? There are many different pricing strategies that a small business can use, but when the goal is to attract customers for a new offering, the strategy known as “penetration pricing” is often a wise approach.
What Is Penetration Pricing?
Penetration pricing is a pricing strategy used to attract customers to a new product or service during its initial offering. The idea is to lure consumers away from the competition by tempting them to try a new product with a lower introductory price. This market penetration pricing strategy builds awareness and facilitates the company's entry into the market, maximizing its impact and reach.
Common examples of penetration pricing are the first-time buyer discounts offered by many retail web sites and the free trial periods offered by many streaming services. But while this approach can help a company find acceptance for a new product, it also reduces – and possibly eliminates – its profit margin, as the introductory price may not cover the cost of all the raw materials, labor inputs, and development resources than were needed to bring the new offering to market. The product can only become viable if the company can recover its costs, so the hope is that once the product is established, customers can accept a price increase based on the value that they’re receiving.
The Goals and Advantages of Penetration Pricing
Penetration pricing is simple to implement and a relatively easy way to differentiate a new offering from other products already on the market. The goal behind a penetration pricing strategy is to launch a new product or service effectively into an already crowded market, fostering a successful market entry. Offering it for a limited time at a low, introductory rate can help set the new product apart from the rest of the field and attract customers who may already be using other, similar products from competitors.
Among its many advantages, penetration pricing can help companies:
- Gain a foothold in the market by quickly attracting a customer base. If the new product or service meets their needs, customers are likely to keep buying it, even once they lose the initial discount and have to pay more. This is especially true if the product is of better quality or provides more features than competitors’ offerings.
- Create brand loyalty by familiarizing customers with the company’s product line. If consumers are impressed with the quality and utility of the new item they’ve been purchasing, they may be more inclined to try the company’s other products and favor its brand going forward.
- Achieve high inventory turnover by increasing demand. This can be a big competitive advantage, since selling in high volumes greatly enhances the market’s perception of a company’s brand. It also allows the business to take advantage of economies of scale.
The Disadvantages and Risks of Penetration Pricing
Despite its advantages, there are also downsides to consider. Disadvantages of penetration pricing can include:
- Cost and budgetary pressures due to increased demand. Penetration pricing amounts to a grab for market share, but it also entails a short-term hit to the company’s margins. This can put pressure on the corporate budget, as greater product demand increases production and marketing costs without a commensurate rise in revenue.
- Diminished brand perception due to heavy discounting. Sometimes price-cutting can backfire, as customers tend to equate higher prices with better quality. When a brand that’s associated with high-end service or merchandise suddenly offers a new product at cut-rate prices, consumers may take this as a sign that the company has cut corners and is no longer offering a premium product.
- Unhealthy price competition as competitors counter a company’s penetration pricing strategy with aggressive price cuts of their own. This can trigger a price war and condition consumers to expecting unrealistically low prices. Such a scenario makes it much more difficult to raise prices moving forward and damages everyone’s bottom line.
There is also the risk that once a penetration pricing campaign ends and the company raises its prices, its newfound customers can prove fickle, choosing to switch back to their old and familiar provider.
If the new product or service meets their needs, customers are likely to keep buying it, even once they lose the initial discount and have to pay more.
The Yin and Yang of Devising a Pricing Strategy
Product pricing is a balancing act between maximizing customer acceptance and optimizing profitability. Put another way, what a business would prefer to charge its customers is not always what its customers are willing to pay. And in a crowded market, the business should also take the competition into account: If an item is priced too high, the business can lose market share to its competitors; too low, and the business can gain customers but lose money on every sale.
In other words, choosing the right pricing strategy for your business takes time and careful consideration, from deciding what your pricing objectives are and appreciating your customers’ needs, to evaluating profit margins and understanding market trends.
Penetration Pricing vs. Price Skimming
Price penetration and price skimming are both strategies to introduce a new product offering and build market share. However, price skimming involves charging a high price at launch to make short-term profits at the onset. This is applicable especially when there is a clear need for the product and competition is limited. Once comparable competitors start to enter the market, prices are gradually lowered.
The usual target market for price skimming strategies is early adopters for whom price is not a barrier to the product's perceived benefits, while the target market in the case of penetration pricing is customers who are very price sensitive and want the same benefits, but at a lower price.
Market Penetration Strategy vs. Penetration Pricing Strategy
A market penetration strategy is employed by a company that already exists in the market to grow its footprint or market share. They use the current market share or the total number of products or services sold to target and reach the estimated market size.
The Bottom Line
Penetration pricing can help a new product offering gain traction by luring customers away from competitors in a crowded field. But the tradeoff is the hit the company takes to its bottom line. If well executed as a short-term strategy, penetration pricing can help a company gain market share and build customer loyalty. Mishandled, however, or used inappropriately, this approach to pricing can damage a business’s profitability and the appeal of its brand.
Photo: Getty Images
