Penetration pricing is the strategy of initially setting a low price for a product or service to quickly attract customers and gain market share. The new offering’s lower, competitive price can generate a large sales volume and build a customer base. Once the product establishes a foothold in the market and secures customer loyalty, the company can gradually increase its price. This tactic is particularly effective in highly competitive markets with price-sensitive customers.

In this article, we’ll cover how penetration pricing works, its benefits, and best practices.

What’s in this article?

• How does penetration pricing work?
  
• Penetration pricing examples
  
• Penetration pricing challenges
  
• How to refine penetration pricing
  

How does penetration pricing work?

Penetration pricing uses a low initial price to achieve these objectives:

• Attract customers: The low initial price can quickly attract customers, even if they haven’t considered the brand before.

• Gain market share: With a lower-priced product, the company can entice customers away from competitors and establish itself as a key player in the industry, especially in highly competitive or price-sensitive industries.

• Build brand awareness: Customers might talk to one another about the low price, increasing awareness of the brand and its new offering.

• Boost sales: A lower price point can increase sales volumes, leading to increased revenue despite the lower profit margin per unit. High sales volumes can also improve the brand’s visibility and market reputation.

• Create loyalty: Customers who have a positive experience with the product or service during the introductory period might develop brand loyalty, even if prices increase later.

• Build economies of scale: As the customer base grows, production and operational costs can decrease due to economies of scale. Higher production volumes can lower per-unit costs, increasing long-term profit.

• Discourage competition: Competitors might struggle to match the low price, which can deter them from entering the market or force them to lower their prices.

Once the product or service gains traction and establishes a customer base, the company can gradually increase prices to a more sustainable level. This strategy’s success depends on several factors, including demand elasticity, production costs, and competition.

Penetration pricing examples

Many modern companies across all industries have used penetration pricing successfully. Here are just a few examples:

• Netflix: Netflix initially offered much lower prices than traditional video rental stores such as Blockbuster did, quickly gaining a massive subscriber base.

• Android: The lower prices of Android devices, compared to those of Apple iPhones, attracted a wider range of customers and increased the brand’s market share.

• Internet service providers (ISPs): Many ISPs have introductory rates that are cheaper than their regular rates to attract new customers.

• Gillette: Gillette often introduces new razor models at lower prices to encourage customers to try them, then it sells replacement blades at a premium.

• Food and beverage companies: Many new food and beverage products launch with lower prices to encourage use and build brand awareness.

Penetration pricing challenges

Here are some penetration pricing challenges and their solutions.

Low profit margins

Companies using penetration pricing often operate at slim or even negative profit margins. This can strain a business’s finances, especially during the early stages when sales volumes might not be high enough to offset the reduced revenue per unit.

Solutions

• Cost optimization: Rigorously analyze and minimize production, marketing, and operational costs to ensure the lowest possible break-even point.

• Volume projections: Accurately forecast sales volumes to estimate how quickly the company can reach profitability.

• Phased pricing increases: Plan gradual price increases as the product gains traction to improve profitability without alienating customers.

Perceived low quality

Customers often associate low prices with inferior quality. This perception can damage a brand’s reputation, particularly if the brand aims to be high-end.

Solutions

• Strong value proposition: Communicate the unique features and benefits of the product or service, emphasizing quality, innovation, or other differentiators.

• Limited-time offers: Frame the low price as an introductory offer or promotion, signaling that it’s not the regular price.

• Premium bundles: Offer higher-priced bundles or versions of the product to reinforce the perception of high quality.

Price wars

Competitors might retaliate by lowering their own prices, sparking a price war. This can cause a race to the bottom, eroding profits for all involved and potentially harming the whole industry.

Solutions

• Competitive analysis: Thoroughly assess competitors’ cost structures and pricing tactics to anticipate their reactions.

• Differentiation: Focus on differentiating the product or service based on quality, features, or customer service—rather than on price alone.

• Value-added services: Offer additional services or benefits that competitors cannot easily replicate.

Difficulty raising prices

Customers become accustomed to the low initial price and might resist price increases. This can lead to customer churn and lost market share.

Solutions

• Gradual increases: Gradually increase prices over time to prevent sudden shocks to customers.

• Transparency: Communicate reasons for price increases such as rising costs and improved features.

• Loyalty programs: Reward loyal customers with discounts or exclusive benefits to incentivize them to stay.

Attracting price-sensitive customers

Penetration pricing often attracts customers who are primarily motivated by price rather than by brand loyalty. These customers might be more likely to switch to competitors if they find a better deal.

Solutions

• Customer segmentation: Target specific customer segments who are likely to appreciate the value proposition beyond the price.

• Relationship building: Build relationships with customers through excellent customer service and personalized experiences.

Financial strain

The initial investment in production, marketing, and distribution can be substantial. Combined with low profit margins, this can strain a company’s finances, especially for smaller businesses with limited resources.

Solutions

• Financial planning: Develop a comprehensive financial plan that accounts for the initial investment, projected sales, and expected profitability timeline.

• External funding: Secure adequate funding from investors or lenders to cover the initial costs and provide a buffer for unexpected expenses.

Production capacity

If demand exceeds expectations due to the low price, the company might struggle to meet the increased production needs. This can delay restocking and dissatisfy customers.

Solutions

• Scalable production: Ensure that production processes can adjust quickly to meet increased demand.

• Contingencies: Prepare backup plans for sourcing additional production capacity or managing customer expectations in case of delays.

• Preorders or waitlists: Consider accepting preorders or creating waitlists to gauge demand and manage production accordingly.

How to refine penetration pricing

Here are some best practices for penetration pricing.

• Targeted segmentation: Instead of aiming for the entire market, identify price-sensitive customer segments that are likely to respond positively to the low price. You can then allocate resources more strategically, increasing the likelihood of attracting loyal customers.

• Phased pricing: Increase prices in phases. Start with a very low price to capture attention, then gradually raise prices in small increments as the product gains popularity. This helps prevent sudden shocks to customers and reduces the risk of losing them.

• Clear communication: Clearly communicate the value proposition beyond the price. Demonstrate the unique features, benefits, and quality of the product or service to avoid the perception of low quality. Use marketing and advertising to emphasize the value customers receive from the brand, even at a lower price point.

• Bundling and upselling: Offer higher-priced bundles that combine the core product with complementary products or services to attract customers who are willing to pay more for a complete solution. You can also upsell premium versions or add-ons to attract customers seeking more features or functionality.

• Limited-time offers: Frame the low price as a limited-time introductory offer or promotion. This creates a sense of urgency and encourages customers to act quickly, while signaling that the price will eventually increase.

• Loyalty programs: Implement loyalty programs that reward repeat customers with benefits such as discounts and exclusive access. These can help your brand retain customers in the long term and mitigate the risk of losing price-sensitive customers to competitors.

• Data-driven decision-making: Track sales data, customer feedback, and market trends to monitor the effectiveness of your penetration pricing. Use this information to make informed decisions about pricing adjustments, marketing efforts, and product improvements.

• Exit strategy: Prepare an exit strategy for when and how to raise prices. This could involve gradually increasing prices, introducing premium versions, or offering tiered pricing options. You should communicate the exit strategy to customers to manage expectations.