Penetration Pricing
A marketing strategy firms use to encourage customers to try a new product or service by initially setting low prices for their product.
What Is Penetration Pricing?
Penetration pricing is a well-known marketing strategy firms use to encourage customers to try a new product or service by initially setting low prices for their product.
It should be noted that penetration pricing is not specifically about encouraging customers to try a new product or service.
Penetration pricing is a pricing strategy used when introducing a new product or entering a new market, but it doesn't necessarily involve offering the product for customers to try. This approach intends to enter the market and attract customers away from competitors.
The main aim of this strategy is to encourage customers to give the new product a chance and capture a portion of the market share, with the expectation of retaining them even after prices change to their regular levels.
Examples of this strategy include a news website providing a one-month free subscription or a bank offering a free checking account for six months.
The effectiveness of this strategy is highest when applied to elastic goods, as small price changes can lead to significant demand fluctuations.
However, there is a risk that new customers may choose the brand initially but switch to a competitor once prices increase. Companies often use unprofitable strategies to eliminate this, such as offering a new cell phone in exchange for a long-term service agreement.
When executed correctly, this strategy can be a successful marketing strategy.
It has the potential to increase market share, boost sales volume, reduce production costs through higher sales, and facilitate quick inventory turnover. However, it is crucial to retain newly acquired customers to ensure the campaign's overall success.
Key Takeaways
- Penetration pricing is a pricing strategy used when introducing a new product or entering a new market.
- It involves setting an initial low price to attract customers and gain market share quickly.
- The advantages of penetration pricing include creating market awareness, driving initial sales, and establishing a strong customer base.
- Penetration pricing can lead to economies of scale and cost efficiencies, contributing to long-term success.
- It can serve as a defensive strategy against new entrants or competitors by creating barriers to entry.
Advantages of Penetration Pricing
By initially setting a low price, companies can stimulate demand, attract customers, and gain a competitive edge.
1. Market Share
One major advantage of this strategy is its ability to capture market share quickly. By offering a lower price than competitors, businesses can attract a larger customer base and encourage customers to switch from existing brands or products.
By gaining a significant market share early on, businesses can establish themselves as key players in the industry.
Additionally, this strategy can help businesses achieve economies of scale. By offering a lower price and attracting a larger customer base, companies can increase their sales volume significantly.
This increased demand allows for higher production levels, leading to manufacturing, distribution, and procurement cost efficiencies. As a result, per-unit production costs can decrease, ultimately improving the company's profitability and competitiveness.
3. Barrier For Competitors
Using this strategy can also act as a barrier to entry for potential competitors. Competitors may find it challenging to match or undercut the low price without suffering financial losses.
Another advantage of this strategy is its potential to create customer loyalty. Businesses can generate repeat purchases and foster long-term customer relationships by building a loyal customer base from the beginning.
4. Market Insights
Additionally, penetration pricing allows businesses to gain insights into market dynamics and customer behavior. Companies can gather valuable customer preferences, demand patterns, and price elasticity data by monitoring customer responses to low prices.
Implementing this strategy offers several advantages for businesses. It enables rapid market share acquisition, generates market awareness, and creates buzz around the product or brand.
5. Expansion of Customer Base
By attracting a larger customer base, businesses can achieve economies of scale and improve profitability. Penetration pricing can act as a barrier to entry, foster customer loyalty, and provide valuable market insights.
However, businesses should carefully plan their pricing strategy, considering long-term profitability and customer relationships.
Disadvantages Of Penetration Pricing
Although penetration pricing has numerous advantages, it also comes with certain drawbacks and risks that businesses must consider before implementing this strategy.
1. Low Profitability
One of the main drawbacks of this strategy is its potential negative impact on profitability.
By setting an initial low price, businesses may need help covering costs and generating profits, especially if they fail to account for production, marketing, and distribution expenses.
2. Price Wars
Furthermore, penetration pricing can trigger price wars among competitors. When a business firm enters the market with a low price, it forces existing competitors to respond by lowering their prices as well.
This can result in a cycle of continuous price reductions, eroding profit margins for all companies involved.
3. Price-Sensitive Customer Base
Another disadvantage of this strategy is that it may attract price-sensitive customers who are less loyal and more likely to switch to a competitor offering a better deal.
Customers driven primarily by price may not develop a strong affinity for the brand. They may switch to a different product or brand as soon as a better price option becomes available.
This can make it challenging for businesses to build long-term customer relationships and generate repeat purchases.
4. Lower Quality Perception Of Product
Additionally, penetration pricing may give the perception of lower quality or value compared to competitors. Overcoming this perception can be difficult, even if the product offers comparable or superior features.
This strategy also carries the risk of cannibalizing sales of existing products or brands within the company's portfolio.
Note
Businesses considering penetration pricing should carefully assess these potential drawbacks and develop a comprehensive pricing strategy that aligns with their long-term goals and profitability objectives.
How Penetration Pricing Works
The primary objective of penetration pricing is to penetrate the market and capture a significant customer base quickly.
By offering a lower price compared to competitors, businesses aim to encourage trial purchases, attract price-sensitive customers, and establish a foothold in the market. Here's how penetration pricing works:
1. Market Analysis
Before implementing penetration pricing, businesses must thoroughly analyze the target market, including customer preferences, competitor pricing strategies, and market conditions.
This analysis helps determine the optimal initial price to attract customers while allowing the company to achieve its objectives.
2. Setting the Initial Price
Based on the market analysis, the company sets an initial price that is lower than the competitors' prices. This price should be attractive enough to entice customers to switch from existing products or choose the new product over alternatives.
3. Cost Considerations
While setting a low price, businesses must carefully consider their costs to ensure that the price covers production, marketing, and distribution expenses.
4. Marketing and Promotion
Penetration pricing relies heavily on effective marketing and promotion to generate awareness and stimulate demand.
Companies often invest in advertising, public relations, and promotional campaigns to highlight the product's value proposition and communicate the limited-time offer.
5. Market Share and Volume
With penetration pricing, the focus is on capturing a significant market share rather than immediate profitability.
6. Gradual Price Increases
While the initial price is set low, penetration pricing is not intended to be a permanent pricing strategy. The key is to balance customer expectations with the need for sustainable profitability over time.
7. Differentiation and Value-Added Features
To sustain the competitive advantage gained through penetration pricing, businesses often focus on product differentiation and adding value. This can involve enhancing product features, improving quality, or introducing additional services to justify higher prices in the future.
8. Competitive Response
It's important to anticipate competitors' responses when implementing penetration pricing. Competitors may lower their prices to maintain their market share or engage in price wars.
Businesses should be prepared to adjust their pricing strategy and respond strategically to competitive pressures.
Note
It is important to note that while implementing such a strategy offers advantages in specific situations, it may not be suitable for all businesses or products.
Summary
With competitive pressure from existing competitors or new entrants, companies may choose to use penetration pricing as a defensive strategy. The company can deter competitors from capturing market share or entering the market by offering a lower price.
This strategy creates barriers to entry and makes it more challenging for competitors to match or undercut the low price without incurring financial losses.
Penetration pricing is particularly effective in price-sensitive markets where customers constantly seek better deals. Penetration pricing helps attract price-sensitive customers, gain market share, and establish the company as a cost leader in the market.
Note
As explained above, offering services at lower prices than other players in the market gives consumers a reason to switch brands, but if the other side is satisfied with the services of a brand, they will not switch to other brands irrespective of price change.
Although the primary motive is to capture market share, its counter effect would be some players losing market share in the same industry as mentioned above. In the above case, Jio still dominates in the telecom sector and has created a high barrier to entry.
When a company introduces upgraded or advanced versions of existing products or expands its product line, penetration pricing can be used to encourage customers to try the new offerings.
The company can entice existing customers to upgrade and experience the improved features by setting an initially low price.
In some cases, companies may use penetration pricing to clear excess inventory or outdated products. By offering a lower price, the company can quickly sell off the inventory and make room for new products or fresh stock.
This strategy helps minimize losses and allows the company to recover some value from the inventory.
Companies use penetration pricing in situations where they aim to quickly gain market share, overcome competitive pressure, target price-sensitive markets, introduce new products, or enter new markets.
By strategically implementing penetration pricing, companies can achieve their business objectives and establish a strong position in the market.
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