What is penetration pricing?
If you’ve just started a business and you’re entering a new market for the first time, settling on a pricing strategy is one of the most important decisions that you’ll be faced with. From free trials to skimming, prestige pricing to captive pricing, there is a broad range of strategies that you may be able to implement. One of the most effective pricing strategies is referred to as penetration pricing. Find out more about how to use a penetration pricing strategy, starting with our penetration pricing definition.
Penetration pricing definition
Penetration pricing is a pricing strategy (often used in the SaaS space) that can help businesses gain a foothold in the market by setting a low initial price-point for their product/service. Most of the time, penetration pricing is used by new entrants to the market, rather than established businesses. There are many penetration pricing examples that you’re likely to be familiar with, but some of the most common include internet providers and smartphones.
A penetration pricing strategy aims to capture a share of the market, win customers from competitors, push competitors out of the market, generate brand loyalty, and boost demand. Then, when prices begin to rise back to normal levels, businesses using a penetration pricing strategy will hope that their newly-acquired customers will remain with the brand. Although penetration pricing may lead to a short-term loss, it’s essentially an investment in long-term profit.
Penetration pricing examples
To give you a better sense of how a penetration pricing strategy works in practice, let’s look at an example of penetration pricing. Imagine that keyboards retail for around £15-20. If Company A – a larger company with a high production capacity – leverages their additional production power, they can afford to sell keyboards for a significantly lower amount.
Using a penetration pricing strategy, Company A decides to start selling keyboards for £5 (at a production cost of £4.90). Although the business is making nominal profits per sale, Company A is achieving a larger market share. After a certain period, their competitors may decide to exit the market. At this point, – having established a monopoly – Company A can begin to increase their prices and increase their profit margin.
What are the best penetration pricing advantages?
There are lots of potential advantages associated with penetration pricing. Firstly, and perhaps most importantly, penetration pricing can help you achieve a high adoption rate among your customer base. Because your competitors are likely to be caught off guard by your strategy, penetration pricing gives you an excellent opportunity to siphon as many customers as possible. It’s also worth noting that you’re likely to gain goodwill from customers with your bargain prices. Even as your prices return to a more stable level, the brand loyalty you’ll generate with a market-leading product/service should be enough to encourage them to stick around.
Disadvantages of penetration pricing
While there is a broad range of penetration pricing advantages, it’s also essential to pay attention to the drawbacks associated with this pricing strategy. It’s certainly not for everyone. Firstly, you’ll need to be careful about the way that you position your brand. Low prices might cause customers to perceive your business as low quality. At the same time, it’s also worth remembering that a penetration pricing strategy is more likely to attract bargain hunters or customers with limited brand loyalty who’ll move on from your business once your prices return to normal. Most significantly, penetration pricing isn’t a workable long-term solution, and in some cases, a more patient strategy will serve your company better.
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