Penetration Pricing

Unlock the secrets of a powerful pricing strategy with our comprehensive guide! Discover the penetration pricing definition, explore real-life price penetration examples, and unravel the key differences between penetration pricing vs. price skimming. As you navigate through the world of penetration pricing strategy, we'll unveil the advantages and disadvantages of this approach, highlighting market penetration pricing insights for students eager to grasp the essential dynamics of it. Get ready to become a pricing pro with our engaging and informative explanation.

Penetration Pricing Definition

Penetration pricing is a strategy where a company sets a low initial price for a new product to attract customers and gain market share quickly. Think of it as a special discount to get people to try something new and spread the word.

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

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.

Penetration Pricing: Netflix

Netflix was founded by Reed Hastings and Marc Randolph in 1997. But before it became one of the world's largest streaming services, Netflix had taken over the DVD rental business.

Fig. 1. Price Penetration Netflix Example

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

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 customers' needs, starting from $8.99. The company now has 209 million subscribers worldwide and earns roughly $25 billion annually.¹

Penetration Pricing: Android

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

Fig. 2 - Samsung's price penetration strategy has been very successful in the markets

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

The strategy proves highly effective today as Android holds more than 70% of the market share worldwide.²

Penetration Pricing vs. Price Skimming

Table 1. Price Skimming vs. Price Penetration

Price penetration is the opposite of price skimming. Price penetration means pricing products at a lower end or with little margin, whereas price skimming prices 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 of 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.

Penetration Pricing Strategy

Penetration pricing strategy can range from a more subtle to a more extreme form. The subtle form is loss leader pricing, where companies sell products at a loss.

In this case, the product sold below the market price is called the loss leader. When customers purchase these products, they are "saving money". They hope to 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 the competition.

The situation often leads to a monopolistic position, after which the company raises the price to compensate for losses. However, this strategy can prevent healthy competition and is thus banned in many countries.

Penetration Pricing Advantages and Disadvantages

Penetration pricing can be a powerful tool for businesses to quickly gain a foothold in the market and attract customers to their new products or services. By offering lower prices initially, companies can draw attention and encourage trial purchases. However, this strategy also comes with some drawbacks. In this analysis, we will explore the advantages and disadvantages of penetration pricing, along with examples that illustrate each point.

Penetration Pricing Advantages

Price penetration comes with three major benefits:

Rapid market share growth

Penetration pricing can help businesses quickly capture market share by attracting cost-conscious customers. For example, when Netflix entered the streaming market, it offered lower subscription prices compared to traditional cable TV, allowing them to amass a large customer base quickly.

Increased brand awareness

The lower prices offered through penetration pricing can create a buzz and draw attention to a new product or service, increasing brand awareness. For instance, when Xiaomi entered the smartphone market, their competitively priced phones generated significant interest and discussion, leading to increased brand recognition.

Economies of scale

Companies selling more products through penetration pricing can achieve economies of scale, reducing production costs per unit. For example, Amazon's low prices on e-books helped them sell more Kindle devices, which in turn allowed them to negotiate better deals with publishers and lower production costs.

Penetration Pricing Disadvantages

That said, price penetration isn't without any disadvantages. Here are some limitations to this strategy:

Lower profit margins

Penetration pricing often results in lower profit margins, as companies sacrifice profits to gain market share. For example, Uber initially offered low prices to attract riders, but this led to reduced profits and challenges in achieving long-term profitability.

Difficult to raise prices

Once customers become accustomed to low prices, raising them without alienating the customer base can be challenging. For instance, if a gym offers a low introductory membership fee, it may face resistance when trying to increase the price later on.

Potential negative perception

If the low prices are associated with poor quality, it can damage the brand's reputation. For example, a new restaurant offering low-priced dishes may struggle to shake off a reputation for subpar food, even if the quality improves over time.

Moreover, 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 a product at a lower end can give an impression of poor quality and low value.

May lead to price wars

Companies that adopt price penetration have their prices tied to their competitors. They may have to keep prices low at all times to stay competitive 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, where they all offer low prices for very little profit; this is unsustainable.

Market Penetration Pricing

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

One widespread 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 and a basic or a premium plan to earn revenue from frequent users.

The key to this strategy is to keep your paid plan below the competitor's benchmark to obtain customers quickly. As more people get on board, the business should shift the focus to building customer loyalty. Then, it can raise the prices to match competitors' prices and assert its position in the market.