Penetration Pricing: What are the Pros and Cons?

What is penetration pricing?

Penetration pricing does exactly what it says on the tin. It allows companies to penetrate a market by offering lower prices than their competitors for a specific period of time. A penetration pricing strategy aims to take market share from competitors, with the goal of retaining customers and increasing prices over time.

Businesses engaging in a penetration pricing strategy are prepared to take a hit on profit margins in return for increased sales volume and market share. This pricing model is similar to loss-leader pricing. This is where companies sell goods or services at a loss to attract more customers, with the intention of upselling them in the future. It is also closely linked to competitor pricing, where companies strategically set prices above, the same, or below competitors.

How does penetration pricing work?

Companies using a price penetration strategy will purposely undercut competitors to encourage customers to switch to their offering. For example, a meal subscription service might offer new customers 50% off their first month’s order. After customers are enticed by this better deal, the company works to retain those new customers by familiarising them with the product. They are then nurtured to become brand loyal. The company’s profit margins will reduce during this penetration period. However, they can recoup this through increased sales and by increasing prices over time.

When should companies use penetration pricing?

Like all pricing strategies, penetration pricing has specific use cases where it’s more effective. Here are some of them.

Product launch

Companies launching a new product or service into an existing market might consider a penetration pricing strategy to make a splash. This generates brand awareness and encourages product uptake.

To grow market share

If a company currently wants to increase its market share, e.g., from 10 percent to 20 percent, it could consider a penetration pricing strategy. By lowering its sales price for a fixed period of time and conducting marketing activities to generate awareness of its offer, it can motivate customers to switch from competing products to theirs.

In price-sensitive markets

Penetration pricing is especially effective in markets where customers are price-sensitive and not especially brand-loyal. Customers may be easier to lure away from competitors for a better price and a similar or better value proposition.

With high-demand, mass-market products

Because businesses must take a hit on profit margins while using penetration pricing, this model is usually only effective when there is high demand. High sales volumes will cushion the blow of reducing prices. Products must also be comparable for this strategy to work. If a company offers a lower price but the product quality is far inferior to competitors, it will struggle to convince customers to switch.

Penetration pricing example

Subscription streaming services like Netflix commonly use penetration pricing. They run campaigns offering new customers a special deal, like $10 per month for the first six months. Alongside this, they promote all their latest and most popular TV shows and movies. Customers find this offer enticing and sign up for the discounted price.

The streaming service nurtures the customer with notifications of new shows and must-see content that can only be found on their platform. After the introductory period, they raise prices to the normal level in the hope that the customer is sufficiently satisfied with the service and will stay with them.

This strategy has clearly worked for Netflix, whose market share clocked in at 39.4 percent in 2020. They claim the biggest share of the streaming market, at least 10 percent of its nearest competitor, Amazon Prime.

Pros and cons of penetration pricing

Penetration pricing can be a highly effective pricing tactic when used in the right situations. Let’s look at some of the advantages and disadvantages of this pricing strategy.

Advantages of penetration pricing

Rapidly growing market share, boosting product adoption, and generating economies of scale are some advantages of penetration pricing.

Increased market share and sales volume – Offering a lower price than competitors for a comparable product, accompanied by a strategic marketing campaign, will usually result in an increase in sales volume and market share. This is the primary reason why companies engage in penetration pricing.

Rapid uptake – Developing new products can be a costly process. A penetration pricing strategy is an effective way for companies to accelerate the uptake of a new product and recoup costs quickly. This fast adoption strategy is also linked to a sharp increase in market share.

Economies of scale – Penetration pricing leads to higher sales volume, creating economies of scale for companies. As volume increases, per-unit production costs decrease and other efficiencies can be realised.

Positive brand perceptions – When customers snap up a bargain, they love to tell their friends and family about it. Penetration pricing can create positive sentiment and word of mouth for a brand, which can last even after the promotional offer has ended.

Disadvantages of penetration pricing

Penetration pricing isn’t a one-size-fits-all pricing strategy for businesses that want to gain market share. Like with all pricing strategies, there are some downsides.

Reduced customer loyalty – Customers who switch products purely based on price are just as likely to switch to another provider when a better offer comes along. Companies must work hard to build customer loyalty and retain them with a superior product or service offering.

Diminished margins – Penetration pricing strategies require businesses to drop prices below their optimum level. While this is usually only for a set period of time, the company must be prepared to take a hit on its margins in the short term without leaving itself financially exposed. Smart businesses take a scientific approach to pricing using a software solution like Flintfox’s Margin Reporting tool, which provides complete visibility of margins in real time.

Disgruntled customers – The “high” of snapping up a great deal might turn to disappointment when customers notice the steady price increases over time. Most customers want to be rewarded, not penalised for staying loyal to a brand, so companies must consider how to keep customer satisfaction high, even when prices increase.

Price wars – What happens when competitors copy each other’s tactics and drop prices to attract customers away? Then you have a price war on your hands. Companies must be careful to avoid a “race to the bottom”, which can drag down customer value perceptions and slash the price customers are willing to pay, period.

Time-consuming – Managing price changes manually, including penetration pricing, creates extra legwork for teams and leaves room for errors.

Impaired brand image – Brands that are constantly “on-sale” risk damaging their brand reputation and may struggle to increase prices to more profitable levels.

How does penetration pricing relate to market penetration?

Market penetration refers to what percentage of the identifiable market is utilising a particular product or service. Companies use market penetration to understand the total size of the market and how much they can feasibly take compared to their competitors. Larger markets offer greater potential for entrants to operate profitably. Smaller markets may be less attractive if they are already saturated with other providers.

Penetration pricing is a strategy that’s often used to increase market penetration and grow a share of a particular market. In the streaming example we looked at earlier, we saw Netflix and Amazon Prime both jostling for the top spot, while several other competitors, including HBO, Disney+, and Hulu are also seeking to gain market penetration.

How is penetration pricing different from price skimming?

Companies using a price skimming strategy will charge the maximum possible price for a product or service based on what the market will tolerate. This pricing strategy is only usually effective with new or innovative products with less competition. Once other competitors enter the market with a similar offering, prices will naturally decrease over time. This allows those in the market first to maximise profits for a limited period of time.

On the other hand, penetration pricing aims to increase market penetration by undercutting existing players and luring customers away with a better offer.

Run penetration pricing the smart way

Your pricing strategy can make or break your business. Making decisions on-the-fly or manually wrangling vast swathes of pricing data can lead a business in the wrong direction. Flintfox’s intelligent margin reporting tool lets you view, track, and manage your margins in real-time. We make margin visibility simple so you can manage pricing exceptions, like penetration pricing campaigns, without the pain of manual work.

Find out more about how Flintfox can supercharge your business today.