Penetration Pricing Definition, Examples, and How to Use It

What Is Penetration Pricing?

Penetration pricing is a marketing strategy used by businesses to attract customers to a new product or service by offering a lower price during its initial offering. The lower price helps a new product or service penetrate the market and attract customers away from competitors. Market penetration pricing relies on the strategy of using low prices initially to make a wide number of customers aware of a new product.

The goal of a price penetration strategy is to entice customers to try a new product and build market share with the hope of keeping the new customers once prices rise back to normal levels. Penetration pricing examples include an online news website offering one month free for a subscription-based service or a bank offering a free checking account for six months.

Understanding Penetration Pricing

Penetration pricing, similar to loss leader pricing, can be a successful marketing strategy when applied correctly. It can often increase both market share and sales volume. Additionally, a higher amount of sales can lead to lower production costs and quick inventory turnover. However, the key to a successful campaign is keeping the newly-acquired customers.

For example, a company might advertise a buy-one-get-one-free (BOGO) campaign to attract customers to a store or website. Once a purchase has been made; ideally, an email or contact list is created to follow-up and offer additional products or services to the new customers at a later date.

New entrants often use penetration pricing strategy to quickly steal a portion of the market share. Because its brand is not yet known, it must rely on favorable pricing to differentiate itself from other, more established market participants. Once a company has attracted customers via penetration pricing, it often changes strategy to create brand loyalty, convert customers into long-term consumers, and drive competitors out of the market.

Tips on Successful Penetration Pricing

Penetration pricing is just the first step to a long-term plan to attract, convert, and establish relationships with new customers. In order for a penetration pricing strategy to work, it must often meet the following criteria or adhere to the following guidelines.

High Product Demand

Penetration pricing is most effective when there are goods in high demand. If there is not a large market for a product, it often is less important the price of the good because there are less consumers to capitalize and attempt to retain. Therefore, the most successful penetration pricing strategies rely on broader markets with more exposure where a single penetration pricing strategy can have the greatest effect.

Avoid Price Wars

Though easier said than done, the goal of a pricing strategy is not to get into a spiraling competition with another company. The purpose of penetration pricing is not to simply offer a very low price; it is to most effectively take market share. Price wars can be expensive, ineffective, and may publicly damage the reputation of a company should the battle ineffectively evolve.

Pursue Economies of Scale

As the company attracts new customers, it is imperative that the company seeks out economies of scale. With more customers, the company should be able to more efficiently use resources, obtain pricing, and scale operations. For example, consider a company ordering raw materials for inventory. With more customers and more orders, the company should be able to purchase larger quantities and reduce its cost per unit produced.

Gradually Make Changes

One of the worst strategies to employ with penetration pricing is to raise the price back to normal too quickly. Not only does this open the door for a competitor to swoop in an employ their own penetration pricing strategy, but quickly making changes breaks customer trust. With the customer on board with the new company, the new company must slowly make changes and gradually raise prices to more profitable levels, else it will face the risk of losing the long-term value.

Build Long-Term Loyalty

Though penetration pricing is a short-term strategy, the ultimate goal is to foster long-term loyalty. That means honoring existing pricing where applicable, understanding limitations on what can be offered, and still emphasizing value in product quality and customer service. As many telecom companies offer sign-up bonuses or one-time incentives to switch providers, it is then their responsibility to foster the business relationship.

Penetration Pricing Participants

There are three primary users of penetration pricing, each of which are discussed below.

New Companies

Most often, penetration pricing is used by new competitors entering a market for the very first time. These companies do not have an existing presence in the market and are often not known or may be young. These companies may have limited resources, so they may not be able to deploy capital for aggressive marketing campaigns. The ultimate goal of these new companies is to steal market share from market leaders.

Established Brands Offering New Products

In other cases, more established companies may introduce new products to the market. Although the brand name may be recognized and known, the company may not be known for some specific products. Because the company may have a large stockpile of resources, it often is able to sacrifice short-term profits in favor of establishing itself in a new market.

Price-Elastic Brands

Last, some companies may use penetration pricing for items that have high price elasticity. Price elasticity is the relationship between demand and price for a good; if a small change in price creates a large change in demand, the price is said to highly elastic. In these cases, a company may very slightly reduce its price to achieve the benefits of the price elasticity.

Advantages and Disadvantages of Penetration Pricing

Pros of Penetration Pricing

The primary advantage of penetration pricing is that is may be one of the quickest ways to convert a customer. Many customers may not be loyal to a specific brand. In these cases, it may be easiest to simply offer a lower price to attract their business. Whether a company is a service company, retailer, or manufacturer, all types of companies can offer penetration pricing strategies.

Companies can successfully use this short-term strategy and leverage new customers into long-term success. Companies can capitalize on goodwill earned when their pricing discounts were available, and this may foster brand recognition for being one of the low-price providers in an industry. As long as consumers associate the penetration pricing company as the low-cost provider, there will always be long-term brand equity created via penetration pricing.

Penetration pricing also fosters loyalty because consumers directly benefit from the lower price. Though some of this loyal is jeopardized as a company begins to raise its prices in the long-term, consumers may not directly benefit from conversion tactics quite like they can when companies battle over lower prices.

Penetration pricing may also help naturally foster economies of scale. If pricing is aggressive enough, a massive amount of customers may be converted. As a company has larger order quantities and is able to build greater infrastructure, it often experiences less cost per unit due to manufacturing or operational efficiencies.

Cons of Penetration Pricing

Though customers are attracted by a very low price, it may not be feasible to offer that price forever. The new company is trying to eventually make a profit, and some penetration pricing strategies result in short-term losses. A company must be able to temporarily cover its expenses if it is not earning enough from customers during the penetration pricing period.

Once customers are lured, there is a significant risk of consumers leaving once prices are increased. Consider the fact that a consumer lured by penetration pricing may leave because of another penetration pricing strategy. A company must be incredibly sensitive to raising prices, changing contract agreements, and making changes in the long term.

Some consumers may view penetration pricing as an unfavorable marketing tactic. A company may get the reputation of having lower-quality goods should consumers inappropriately associate low prices with product quality. Consumers may also see through the strategy and not appreciate the attempt to be bailed by short-term marketing tactics.

As other companies take wind of what is happening, they may decide to price match or further reduce their own price. In addition, many companies now offer price matching and may have a greater warranty or customer service process. Companies must move delicately as creating an expensive price war often leaves the new company in a less favorable position than before.

Last, penetration pricing strategies are not useful as long-term strategies. They take effort to create, then a company needs to change direction again and deploy more resources to create long-term value. These changing strategies may be burdensome to finance and must be aligned in order to effectively streamline a short-term customer into a lifetime purchaser.

Penetration Pricing vs. Skimming

With pricing penetration, companies advertise new products at low prices, with modest or nonexistent margins. Conversely, a skimming strategy involves companies marketing products at high prices with relatively high margins. A skimming strategy works well for innovative or luxury products where early adopters have low price sensitivity and are willing to pay higher prices. Effectively, producers are skimming the market to maximize profits. Over time, prices will reduce to levels comparable to market prices in order to capture the rest of the market. 

Small businesses or those in niche markets can benefit from price skimming when their products or services are differentiated from competitors' and when synonymous with quality and a positive brand image.

Real-World Examples

Costco and Kroger, two major grocery store chains, use market penetration pricing for the organic foods they sell. Traditionally, the margin on groceries is minimal. However, the margin on organic foods tends to be higher. Kroger and Costco use a penetration pricing strategy when they sell organic foods at lower prices. The lower costs allow Kroger and Costco to maintain their profit margins even while undercutting the pricing of their competition.

Cell phone carriers also implement penetration pricing by offering the latest cell phones when a new consumer agrees to a long-term service contract. For example, T-Mobile (and other carriers) now offer a free phone when a customer switches to a T-Mobile plan from a plan with another company. The company can't simply survive forever by giving away these phones for free.

The Bottom Line

Penetration pricing is the short-term strategy to lure customers from competitors by offering lower prices. Though these prices may not be profitable in the long-term, a company's hope is they can convert the customer into a long-term relationship that ultimately yields a profit per consumer.