The Basics of Penetration Pricing: How Does it Work?

With the majority of e-commerce niches being highly competitive, it is hard to outperform other retailers when you want to launch a new product – everyone has their market share. A penetration strategy is one of the best ways to kickstart sales even if your brand is not a well-known one. This guide explains how the penetration pricing strategy works, its pros and cons for businesses, and when it should be applied.

Penetration pricing is a pricing strategy used by companies in an attempt to ‘penetrate’ the market by offering lower prices than competitors. This approach entices customers to make a purchase and allows a seller to quickly gain product awareness before other vendors come with better deals.

A penetration pricing strategy can be useful in a situation when a company launches a new product on the market with moderate competition. The seller can win a large market share by neutralizing potential competitors who are unable to achieve similar cost reductions after offering substitutes for the product.

In the case of durable goods, penetration pricing is also used in response to the threat of new competitors. A penetration price allows the seller to capture a significant portion of a potential market before it faces competition from competitors. If a product is bought frequently, penetration pricing allows the company to attract an additional market segment by giving it a chance to try the product before a price race begins. If it is hard to compare the quality of similar products, a company may enjoy low price sensitivity, and it will be easier to compete with late-entry brands.

As mentioned previously, penetration pricing is used when a seller wants to quickly capture a large share of the market. It is based on the assumption that a lower price is perceived as providing a better deal.

For a penetration pricing strategy to work, a company needs to conduct thorough market research and see how much competitors are charging for a product with similar features/functionality. The new product is then sold at a significantly lower price, even if the profit falls below an acceptable level.

The goal of penetration pricing is to attract as many consumers as possible before competitors can react by cutting prices even further. Typically, this is a short-term pricing strategy because sooner or later, the seller has to return prices back to a competitive level. As a result, it might repel customers and force them to switch to competitors’ offers. Therefore, when the penetration strategy is no longer effective, companies need to promote other aspects of their products (such as quality or service).

Penetration pricing strategies are used by both offline and online businesses. They can effectively drive sales in different markets. Let’s observe a few examples.

Many streaming services use pricing strategies to expand their subscriber base by giving a trial period to potential customers. This provides customers with both a preview of paid content and a reflection of how the company interacts with its customers. This strategy also serves as promotional content that can help the customer choose one service over another.

Netflix is a great example of an effective penetration strategy. In 2000, their customers could rent four movies at a time for $15.95 with no return date – an average moviegoer could rent a DVD for $1 or less, while a 3-day rental from Blockbuster cost $4.99. As a result, Netflix started making profit in 2003 and greatly expanded its customer base. In 2010, Blockbuster filed for bankruptcy, while Netflix became one of the most popular services in the world.

Grocery store chains can use a penetration pricing strategy to promote a brand by offering products at discounted prices. This strategy also serves to promote new products, which can help build positive relationships with customers and marketing partners.

Brodington's Market grocery store offers a membership service that gives shoppers access to certain discounts on new or popular products. To promote the service, Brodington offers organic fruit options at a discounted $2.99 for buyers who sign up as new members when making a purchase. This helped the retailer increase its customer base and develop strong relationships with organic fruit distributors.

Unlike Apple, which exploits a price skimming strategy, Android manufacturers, with Samsung at the forefront, offer steep discounts in an attempt to make users loyal to the brand. Indeed, such an approach to price formation ensures a steady flow of buyers on the Android market.

Unfortunately, very low smartphone prices may turn out to be a bad deal for customers. Providers can sell cheap phones in return for long-term contracts with telecom providers.

There are several advantages of using a penetration pricing strategy that make it highly effective for brands that launch new products and want to win a market share.

Since many customers are interested in low-price offers, sales volume can greatly increase. A seller can quickly spread the word about their product, and it will be tried by as many people as possible before competitors react and step in.

Using penetration pricing means that no other sellers are ready to offer the same competitive prices, at least as long as the low price lasts. However, by the time the price finally increases, a successfully implemented penetration strategy will lay the path to success in the market.

By offering affordable products of a decent quality, a seller can win many loyal customers right from the start. Low prices bring in more consumers, and if you offer good value, you stand a better chance that customers will continue buying after you increase the prices.

By using one or another penetration pricing strategy, companies can increase their inventory turnover rates and order more supplies, making other supply chain partners (manufacturers and retailers) satisfied.

With a large number of sales, a company can reduce its marginal cost and scale the business by adjusting prices.

At the same time, penetration pricing is not always applicable for all market segments and businesses. Here are the major drawbacks of this strategy.

Sooner or later, the seller has to increase prices as part of its penetration strategy. Customers who expect permanently cheap goods might become frustrated by the higher price and will stop purchasing the product or service.

Many customers may associate cheap prices with poor product quality. This impression can be applied to the whole brand, making it less reliable and valuable in consumers’ eyes.

If other sellers decide to enter the competition, it will trigger a price war. In an attempt to offer a lower price, every participant in this race to the bottom will lose profit. As a result, severe price cutting will eliminate weaker market players – only strong companies can survive through such periods (and usually they are not new players).

A price penetration strategy is not suitable for the long run because sooner or later a seller will have to increase the price to cover expenses and start getting profit to fuel further development. Sometimes it takes more time than projected to obtain the desired market share, but keeping prices too low exposes a company to serious financial risks.

Both penetration pricing and skimming are short-term strategies that are typically applied at the beginning of a product’s life cycle to attract customers. However, in the case of skimming, a seller charges the highest price to reap maximum profit when they release a product. Hence, sellers ‘skim’ profit from upper market segments and then gradually lower prices to target more price-sensitive buyers.

Businesses can benefit from price skimming if their products or services can be differentiated (by quality or additional features) from competitors and when their brand has a positive image.

By using a penetration strategy, a company can achieve a large sales volume by underpricing its product relative to competitors’ substitutes. This pricing strategy works best in industries where consumers are sensitive to the price of the product, and therefore can switch to the brand that offers a better deal.

Penetration pricing will be efficient only if a significant number of consumers are willing to try a new product or service, or abandon products they used to purchase. At the same time, this strategy can undermine the value of the brand if cheap prices are associated with poor quality.

To implement penetration pricing safely and effectively, you need to keep your finger on the pulse of the market and adjust your prices accordingly. Instead of wasting hours on manual analysis, consider using automated tools by Priceva: price monitoring and price optimization software. It will crawl marketplaces and online stores to provide relevant competitor pricing data and suggest price corrections for your items.

Price penetration is usually applied when a seller releases a new product and wants new customers to try it. If it is impossible to differentiate the new product from competitors’ goods, a low price can be the only way to attract consumers. In the case of innovative or luxury products, price skimming might be a better option than penetration.

In the case of value pricing, the seller charges as much as they believe the product is worth. With penetration pricing, the goal is to charge less than competitors, even if the product’s value exceeds the price.

A penetration pricing strategy is used by both offline and online sellers when they are 1) a startup that is entering the market; 2) launching a new product. In both cases, the ultimate goal is to attract customers and get them acquainted with their goods or services.

This pricing strategy helps sellers promote certain products and their entire brand when they cannot compete with other market players in terms of outstanding quality and/or service.