20 Sep
Have you ever wondered how some companies are able to gain so many customers and dominate the market in such a short period of time? The answer may lie in an obscure pricing strategy known as penetration pricing.
Penetration pricing involves setting a very low initial price for a product in order to rapidly gain market share. On the surface, it seems counterintuitive – why would a company purposefully cut its prices and reduce profits? As with many things, there is more than meets the eye with penetration pricing. Let’s discuss this in-depth and glance at a few market penetration examples.
What is Penetration Pricing?
You see when a new offering first enters the market, it faces a significant challenge – it needs to build awareness and make itself known to potential customers. However, getting that first wave of buyers is crucial because it allows the product to achieve a certain scale and momentum. Early adopters will talk up the item to friends and family, generating valuable word-of-mouth buzz. Social proof kicks in as more individuals see others using or discussing it.
Meanwhile, the losses incurred from low initial pricing are intended to be temporary. The hope is that by penetrating the market quickly through affordable entry costs, total revenue will surpass what might have been achieved through a conservative high-price launch. Volume can compensate for margins.
Once the product has spread widely, competitors have a difficult time breaking in and economies of scale reduce production costs over time. The company then raises prices as demand becomes more inelastic, locking in the customer base. Early losses are recouped through subsequent sales to now-addicted users.
The Advantages
It increases sales volumes
Setting prices below normal levels means more customers can afford the offerings. This is the main advantage of penetration pricing which leads to higher unit sales and revenue in the short term. More sales help brands reach economies of scale faster.
It boosts market share
Low prices act as a magnet for customers. Competitors find it hard to match the pricing without losing money. Over time, the early adopter brand gains a solid foothold in the market.
It spreads brand awareness
New products need publicity to succeed. Penetration pricing generates “buzz” as value-seeking customers share positive word-of-mouth. Broader awareness helps brands when prices inevitably rise later on.
The Disadvantages
It can erode profit margins
Aggressive discounts may not cover costs in the beginning and selling at a loss is unsustainable for companies to stay solvent. Brands must cross-sell high-margin add-ons to offset financial losses.
Competitors can match the prices
Once the temporary pricing tactic is revealed, competitors may match or even undercut the prices. This pricing war whittles away profits for all players involved and brands lose pricing power in the long run.
It trains customers to expect low prices forever
Customers who become used to bargain deals may resist future price increases. Raising prices can backfire with customers defecting to cheaper options- this makes it tough to optimize profits down the road.
Also Read: A Complete Guide to SKU Numbers
Types of Penetration Pricing Strategies
There are several interesting penetration pricing strategies that companies utilize in order to gain market share. Let’s take a look at a few of them.
Temporary Price Discount
Many companies will offer steep, but temporary discounts in order to attract new customers. The hope is that these customers will become loyal even after prices rise back to normal levels. For example, a cell phone provider may offer the latest smartphone for just $1 if customers agree to a 2-year contract. On the surface, this seems like a steal. But of course, the monthly bill makes up for it in the long run.
Versioning
Other businesses employ a tactic known as versioning. They release a basic no-frills version at an extremely low cost to gain market share. Then they offer successive versions with more features at higher price points. A good penetration pricing strategy example is software like Microsoft Office. You can get a simple Word processor for very little, but Microsoft hopes to sell you on pricier versions with PowerPoint, Excel, etc. that offer extra functionality.
Loss Leaders
Some merchants utilize certain best-selling items as “loss leaders” – products they’re willing to sell below cost to attract customers into their stores. The gamble is that customers will end up buying other full-priced goods as well to make up for the loss. A classic instance would be a grocery store pricing cornerstone brands of soup or cereal at a discount. It gets foot traffic in the door which leads to purchases of higher-margin products.
Also Read: What are the Most Profitable Retail Business Ideas?
How to Implement Penetration Pricing?
Know your goals
Market penetration pricing strategy is not about short-term gains, it’s about the long game. A business needs to be clear about why they want to rapidly expand their customer base. Is the goal to become the market leader? To educate consumers about a new product category? To block competition? Clearly defining the ultimate objective will help guide other decisions.
Evaluate your costs
It’s easy to get carried away and charge too little. A business needs to have an honest conversation about its own production and overhead expenses. How low can prices realistically go before losses pile up? Management should build models to understand break-even points. Being off by even a small margin could mean the difference between success and failure with this strategy.
Set a time limit
Penetration pricing is meant to be temporary. Without an end date, there’s a risk of getting stuck with permanently low prices. Companies should privately determine how long they can sustain discounts before needing to raise rates. Maybe it’s 3 months or 6 months. Whatever the self-imposed deadline, all other aspects of the plan should align with and support and transition past it.
Target the right customers
Don’t waste precious early-adoption subsidies on buyers who aren’t in the market yet. Penetration pricing works best when aimed at folks who are on the fence or value-conscious. Leverage market research and data on similar products to identify ideal first-wave customer profiles. Focus acquisition efforts like promotional messaging accordingly.
Have an elevation plan
Well before the penetration phase ends, businesses must figure out how they will gradually increase prices back to sustainable levels. This shouldn’t be a sudden shock that angers new clients. The ramp should be charted out step-by-step, testing how much hikes customers will tolerate locked-in benefits like network effects take hold. Effective communication can smooth such adjustments.
Conclusion
Now that you know the penetration pricing pros and cons, it can be an effective pricing strategy to jumpstart sales and market share for a new product or service. While it requires lowering prices initially which cuts into profits, it can have substantial upside if implemented properly.
To take advantage of this approach for your retail business, consider implementing a point-of-sale system like Hana Retail. An affordable cloud-based POS can help you offer competitive introductory prices, track sales performance, and smoothly transition to regular pricing. Sign up FREE today!
