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Price Penetration

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Price Penetration

The idea behind penetration pricing is to help a new product break into the market quickly and keep out competitors. This is a strategy used by many businesses, however, there are also various risks associated with price penetration. Let's take a look at this concept in more detail.

How does price penetration work?

Price penetration is a pricing strategy where a business offers a low price initially to attract a large portion of customers and gain market share.

If applied properly, price penetration can bring the company massive success. For example, lower prices can increase the rate of acceptance and allow the company to capture a substantial market share in a short period of time.

Higher sales lead to bulk purchases with discounts, which brings down production costs. As production costs decrease, the company can manufacture more goods and achieve economies of scale.

However, the drawback is if the price remains low, the business may not be able to make a sustainable profit. Also, there’s a risk of a price war with other competitors.

Pricing penetration works best when:

  • The product has an elastic demand curve (the change in the price affects the product demand significantly).

  • It is easy to achieve economies of scale.

  • The market is large enough with sufficient demand.

  • The skimming pricing strategy doesn't work — Competition remains high after the introduction stage.

  • The products are subjected to standardization (e.g. Microsoft computer software)

Price penetration examples

Now that we’ve covered the basic theory, let’s walk through a couple of examples:

Netflix

Netflix was founded by Reed Hastings and Marc Randolph in 1997. But before it became the world’s biggest streaming service, Netflix had taken over the DVD rental business.

Example of price penetration Netflix UnsplashPrice penetration example of Netflix, unsplash.com

The video rental industry was highly competitive at the time, though Netflix made several smart moves that allowed it to quickly attain the market-leading position. First, it announced that customers only have to wait one or two days to get their DVDs. Second, price penetration was adopted. Customers can rent out a DVD for as cheap as 50 cents.

This worked out nicely as the new business drove Blockbuster out of business and continued its path to world domination within the next twenty years.

In 1999, the company introduced a new subscription model priced from $15.95, which was later updated into a monthly subscription plan, at $19.95. In 2007, Netflix introduced its online streaming services with different pricing tiers according to the needs of the customers, starting from $8.99. Nowadays, the company has 209 million subscribers worldwide and earns roughly $25 billion per year.

Android

Another successful adoption of price penetration is by Android phone brands, most notably Samsung.

Price penetration example of Samsung UnsplashPrice penetration example of Samsung, unsplash.com

As opposed to Apple who adopts a price skimming strategy for the iPhones, Android companies market their products at a lower price end. They also throw out frequent discounts to attract price-sensitive individuals and later turn them into loyal customers.

The strategy proves highly effective as today Android holds more than 70% of the market share worldwide.

Penetration pricing vs price skimming

Comparison of price skimming and price penetration StudySmarterComparison of price skimming and price penetration, StudySmarter

Price penetration is the opposite of price skimming. Price penetration means to charge products at a lower end or with little margin whereas price skimming charges new products at a higher-end or with a large margin.

The two strategies are also suited for different kinds of products. Price skimming works well for innovative or luxury goods which tend to have a short life cycle or are made with supreme quality. They focus on attracting status-conscious customers who are willing to pay higher prices. By contrast, price penetration is often used for less exclusive goods such as cosmetics and groceries.

Types of penetration pricing

Penetration pricing strategy can range from subtle to extreme form. The subtle form is loss leader pricing where companies sell products at a loss to acquire customers. In this case, the product sold below the market price is called the loss leader. When customers purchase these products, they are "saving money". The hope is that they will use these savings for future goods and services to recoup the company’s previous loss.

At the other end is predatory pricing where the company drops the price significantly to keep out competition. The situation often leads to a monopolistic position, after which the company raises the price to make up for the losses. However, this strategy can prevent healthy competition and is thus banned in many countries.

Price penetration advantages

Price penetration comes with three major benefits:

  • Fast acceptance and adoption: Low prices allow the new product to penetrate the market quickly. The business will have a much easier time convincing people to accept and adopt the product. Once people are onboard, companies can work on building customer loyalty to keep them around when the price increases.

  • Free promotion from early adopters: Penetration pricing attracts many people to adopt the product in the beginning stage. If the early adopters love your product, they will provide word-of-mouth marketing campaigns for your business, a.k.a. free promotion.

  • Production cost reduction: High volumes of sales means the company can buy bulk materials at a discount, which reduces the production costs. As a result, you can manufacture more products and achieve economies of scale. It also releases the pressure early due to a lack of capital.

Price penetration disadvantages

That said, price penetration isn't without its advantages. Here are some limitations of this strategy:

  • Price expectation: Setting a low price upfront can create a price expectation for the product that lasts for a long time. Customers may attach your brand name to “cheap bargain ” or “discount”, which makes it hard for you to increase the price later on.

  • Negative brand image: Businesses that increase their price suddenly may incur a bad reputation. Customers may feel betrayed and turn their back against such brands. In other cases, pricing your product at a lower end can give an impression of poor quality and low value.

  • Brand loyalty: The biggest challenge is to make the customer stick around when the price increases. Though it may prove difficult since price penetration tends to attract many “bargain hunters'' who won't be shy to opt for lower-priced alternatives. Also, since products using penetration price are replaceable, it's also easy for people to make the switch.

  • Price war: Companies that adopt price penetration have their prices tied to the competitor. They may have to keep low all the time to stay in the market. So even though they make a lot of sales, the business is not sustainable in the long run. Moreover, companies may find themselves in a price war, a situation where they all offer low prices for very little profit

How to use penetration pricing successfully

Pricing penetration is not a long-term strategy since customer acquisition is mostly based on prices. However, it’s still helpful in the introduction stage, especially when your company is new and similar products have appeared in the market.

One popular price penetration practice is to offer your product at different pricing tiers. For example, you can introduce a free plan to attract many potential customers as well as a basic and premium plan to earn revenues from frequent users.

The key of this strategy is to keep your paid plan below the competitor’s benchmark to obtain customers quickly. As more people get on board, the focus should be shifted to building customer loyalty. Then, you can raise the prices to match that of the competitors and assert your position in the market.

Banking is well-known for using this:

N26, a digital bank in Europe, splits their plans into N26 Mastercard with 0 service fee, N26 You at 9.90 per month, and N26 Metal at 16.90 per month. While the free plan covers the basic features, the paid plan also includes an insurance package and exclusive discounts to provide customers with more benefits and convenience.

Pricing Decisions and Price Penetration - Key takeaways

  • Price penetration is a pricing strategy where a business offers a low price initially to attract a large portion of customers and gain market share.
  • Penetration pricing works well in the beginning but is not a long-term strategy because customer acquisition is mostly based on prices.
  • Price penetration is the opposite of price skimming. Price penetration charges products at a lower end or with little margin whereas price skimming charges new products at a higher end or with a large margin.
  • The advantages of price penetration are fast acceptance and adoption, free promotion from early adopters, and production cost reduction.
  • The disadvantages of price penetration include low price expectation, negative brand image, lower brand loyalty, and price wars.

Frequently Asked Questions about Price Penetration

Price penetration is a pricing strategy where a business offers a low price initially to attract a large portion of customers and gain market share whereas Price skimming is the strategy of setting a high price at the product’s launch, then lowering it when the demand declines and the market becomes saturated. 

As opposed to Apple which adopts a price skimming strategy for the iPhones, Android companies market their products at a lower price end. 

Price penetration means to charge products at a lower end or with little margin.

Price penetration is used in a competitive market for products which need to attract a large portion of customers and gain market share. Android phones, Netflix, and digital banks like N26 are examples of products that implemented price penetration.

The advantages of price penetration are:

  • Fast acceptance and adoption 
  • Free promotion from early adopters
  • Production cost reduction  

Final Price Penetration Quiz

Question

What is price penetration?

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Price penetration is a pricing strategy where a business offers a low price initially to attract a large portion of customers and gain market share.

Show question

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The opposite strategy of price penetration is...

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Price skimming

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Elastic demand means ...

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The change in the price affects the product demand significantly

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With price penetration, it is easy to achieve economies of scale. 

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True

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Products using price penetration methods are subjected to...

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standardisation

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Price penetration means charging products at a lower price end, then raising it over time as the demand increases. 

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True

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Name 2 types of penetration pricing

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Loss leader pricing

Predator pricing

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What is loss leader pricing?

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Loss leader pricing happens when companies sell products at a loss to acquire customers. 

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Why is predatory pricing banned in many countries?

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Predatory pricing is the strategy where companies drop their product's price significantly to keep out competitors. This prevents healthy competition and thus is banned in many countries. 

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Name 3 disadvantages of price penetration.

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  • Negative brand image
  • Price war
  • Hard to develop brand loyalty 

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Pricing penetration is not a long-term strategy. 

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True

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What is a price war?

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A price war is a situation where they all offer low prices for very little profit. 

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How price penetration can incur a negative brand image?

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Businesses that increase their price suddenly may incur a bad reputation. Customers may feel betrayed and turn their back against such brands. 

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What happens when a product is priced too low in the introduction stage?

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Customers may attach the brand to “cheap bargain ” or “discount”, which makes it hard to increase the price later on. 

Show question

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Name 3 benefits of price penetration.

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Answer

  • Fast acceptance and adoption
  • Free promotion from early adopters
  • Production cost reduction

Show question

Question

Products using the price penetration method have a high profit margin

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Answer

True

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Why does a company offer its product at different pricing tiers?

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The company can introduce the same product with basic or extended features. The basic plan may be free to attract as many customers as possible while the extended plan allows it to earn revenue from frequent users. 

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Price penetration works best when...

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The product has an elastic demand curve

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When price skimming doesn't work and competition remains high after the introduction stage, price penetration can be adopted. 

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True

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Define economies of scale

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The more output the company produces, the lower cost per unit. 

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What are the primary benefits of price penetration?

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Quicken the adoption rate

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What is not an advantage of price penetration?

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Free promotion from early adopters

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Penetration pricing works well in the beginning but is not a long-term strategy because ... are mostly acquired based on prices. 

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customers

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Price penetration is a pricing strategy where a business offers a ... price initially to attract a large portion of customers and gain market share.

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low

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Price penetration is most helpful in ... when the company is new and similar products have appeared in the market. 

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the introduction stage

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Companies that adopt price penetration have their prices tied to their...


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competitors

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