Penetration Pricing Definition, Examples, and How to Use It

Penetration pricing is a marketing strategy employed by businesses to attract customers to a new product or service by offering a significantly lower price during its initial offering stage. This approach aims to capture market share quickly, attract customers away from competitors, and achieve economies of scale early. Over time, once the customer base is established and the product or service gains popularity, the prices are gradually increased.

Definition

Penetration pricing involves setting a low initial price for a new product or service with the intent to attract a large number of customers and gain market share rapidly. This pricing strategy is particularly effective in price-sensitive markets where consumers are drawn to lower prices, and it is often used when entering competitive markets. Its temporary nature differentiates it from other pricing strategies such as cost-plus pricing or value-based pricing.

Penetration pricing serves several purposes, including:

Achieving Market Penetration: Quickly gaining a significant share of the market.
Building Customer Base: Establishing a foundation of loyal customers who will continue to purchase as prices rise.
Erecting Barriers to Entry: Making it difficult for competitors to attract the same level of customer interest due to the lower initial price.
Economies of Scale: Increasing production volume to lower long-term unit costs.

Examples of Penetration Pricing

1. Netflix

When Netflix initially launched its streaming service, it offered a very low subscription fee to undercut established competition like cable television providers and other streaming services. This low pricing strategy helped Netflix build a substantial subscriber base rapidly. Over time, as the service gained popularity and customer loyalty, Netflix gradually increased their subscription costs.

2. Amazon

Amazon frequently uses penetration pricing, especially in new markets like groceries or hardware (such as the Kindle Fire). When Amazon Fresh was first introduced, it offered significant discounts and offers to build a customer base. The Kindle Fire tablet was initially priced much lower than comparable products to quickly gain market share and build an ecosystem around Amazon’s digital services.

3. Xiaomi

Xiaomi, a leading smartphone manufacturer, employs penetration pricing, particularly in emerging markets like India. By launching high-quality smartphones at lower prices than competitors, Xiaomi quickly garnered a large customer base. Once they cemented their position, they began to incrementally raise prices while introducing higher-end models.

How to Use Penetration Pricing

Step-by-Step Implementation

Market Research: Conduct thorough market research to understand customer preferences, price sensitivity, and evaluate the competitive landscape. Identify similar products or services and analyze their pricing strategies.
Set Objectives: Define clear business objectives for the penetration pricing strategy—be it capturing market share, generating word-of-mouth, or deterring potential competitors.
Pricing Decision: Determine the initial low price point. This should be significantly lower than competitor prices but should still consider cost-covering and potential losses initially.
Promotion Plan: Develop an extensive marketing and promotional plan to create awareness around the low pricing. Utilize digital marketing, social media campaigns, discounts, and introductory offers.
Monitor Sales and Market Response: After launch, closely monitor sales volume, market penetration rate, and customer feedback. Be prepared to make adjustments based on market reception.
Gradual Price Increase: Once a significant market share and loyal customer base are achieved, begin to incrementally raise prices. Ensure that the price increase is justified with improved services, added features, or product updates to maintain customer satisfaction.

Best Practices

Quality Assurance: Ensure that the product or service quality remains high despite the low pricing. A positive customer experience is crucial in converting penetrative pricing efforts to long-term success.
Communication: Transparently communicate the reasons for any subsequent price increases. Customers are more accepting of price hikes if they understand the added value or reason behind the increase.
Value Additions: Offer additional value or improved services during the transition to higher prices. This can include better customer support, enhanced features, or exclusive offers to retain the customer base.
Scalability: Assess whether your production capabilities can scale sustainably with increased demand. Failing to meet market demand can turn initial success into long-term struggles.
Cost Management: Closely manage costs to avoid substantial losses during the penetration phase. Balance between offering competitive prices and maintaining a sustainable revenue model.

Conclusion

Penetration pricing can be a potent strategy for new market entries or launching new products, provided it is executed thoughtfully. By offering a lower price initially, businesses can rapidly build a customer base, establish market share, and achieve economies of scale. However, the transition from initial low pricing to higher prices requires careful planning, clear communication, and continuous evaluation to ensure long-term success.

Resources

By strategically using penetration pricing, firms can create a strong presence in competitive markets, encouraging brand loyalty and long-term profitability.