Penetration PricingExplained with Advantages & Disadvantages

Lisa Borga

Date Published: September 22, 2022

Penetration pricing is a pricing strategy through which businesses attempt to quickly increase their market share by setting an initially low price for their product or service.

This strategy is often used by new entrants to a market in order to attract customers away from established competitors.

The strategy works by attracting customers away from competitors with lower prices in order to gain market share.

Once established, a company performing penetration pricing hopes to retain the customers once prices rise to a normal level.

Penetration pricing is widely used in a number of industries though it remains a controversial strategy.

When taken to an extreme, penetration pricing is referred to as predatory pricing.

Penetration Pricing Explained

penetration pricing

Penetration pricing is a common strategy for a company to make substantial gains in market share in a short period of time.

This is done by providing a product or service for a lower price than established competitors, generally just slightly higher than its market value.

By doing this, a company, most often a new entrant to a marketplace, can attract customers away from more established competitors.

This is particularly effective when products possess low differentiation, which means consumers will see little difference between choosing one provider or another.

When applied correctly, this can increase market share and volume of sales and drive competition out of a market.

In some cases, the greater amount of sales may also allow a company to reduce its production costs and achieve greater economies of scale.

However, in order to achieve successful results, a company must be able to retain its newly gained customers once prices rise to a normal level.

As an example of this, an online news provider may provide a starting subscription price of only one dollar for six months.

However, after six months pass, the prices may rise to $15 for six months.

At this point, many customers could choose to leave looking for other bargains or their previous provider instead of paying the higher subscription fee.

When customers do not remain with a company using penetration pricing, this can result in one of the major drawbacks of this approach.

If the low prices are necessary to retain customers and the increased volume of sales, then greater sales may not lead to greater profits.

Also, if competitors in the market respond to a company applying a penetration pricing strategy by reducing their own prices, then a price war may result.

This can lead to lower profits for all participants in a market for a period of time.

Differences Between Penetration Pricing and Skimming

Penetration pricing involves marketing a product at low prices intended to generate demand while earning little to no profit margin off of sales.

In contrast, skimming is a pricing strategy in which a company markets a product at a very high price with very high-profit margins.

Skimming is often highly effective in a new market where consumers possess low price sensitivity and thus are more willing to accept higher prices.

This allows producers to earn high profits until prices fall to a typical market level.

This strategy is also particularly effective when a provider’s products or services can be differentiated from other providers, as well as when they possess a positive reputation for quality.

Benefits of Penetration Pricing

  • Encourages Diffusion: Penetration pricing can offer one of the fastest and most effective ways for a company to introduce a new product or service, increase its sales, and gain new customers.
  • Creates Rapid Gains in Market Share: Penetration pricing is often able to take competitors by surprise and give them little time to adjust their own strategies to compete. This will often lead customers to search for the greatest bargain and switch providers.
  • Creates Goodwill: Particularly among early adopters, a low price creates a positive association for a brand, often spreading through word of mouth and encouraging customer loyalty.
  • Increases Inventory Turnover: A penetration pricing strategy will generally create rapid inventory turnover, which in turn is typically highly welcomed by partners in a vertical supply chain.
  • Creates Economies of Scale: The increased sales offered by penetration pricing can enable a company to create the high sales volume necessary for reducing marginal costs and realizing economies of scale.
  • Drives Competitors Out: A successful penetration pricing strategy can force some market participants that are unable to compete out of the market entirely. This can make it easier to raise prices without losing customers to a competitor.
  • Creates Barriers to Entry: Potential market entrants may be unable to create the economies of scale necessary or sustain low-profit margins long enough, establishing a high barrier to entry.

Drawbacks of Penetration Pricing

  • May Create Long-Term Pricing Expectations: One of the most significant drawbacks of a penetration pricing strategy is that it can create low price expectations for a product as well as a preconception that a company will provide it at that price. As a result, a company may struggle to raise prices without losing customers.
  • Low Brand Loyalty: Penetration pricing is most likely to attract bargain hunters and other customers with low brand loyalty. These customers can offer a significant increase in sales rapidly; however, if a company needs to raise prices, they are less likely to remain.
  • Can Cause a Price War: When a company employs a penetration pricing strategy, competitors in a market may respond by lowering their own prices. This will lead to low or non-existent profits for all participants, and many companies may not be able to survive a protracted price war.
  • Poor Strategy for Long-Term Pricing: Penetration pricing can work in the short-term however it is generally not viable as a long-term pricing strategy. Often it is more beneficial to pursue a viable long-term pricing strategy that poses fewer financial risks.

Predatory Pricing

Predatory pricing is an extreme form of penetration pricing in which a company sets its prices extremely low with the goal of driving competitors out of the market.

After driving competitors out, the company will be left with a dominant market share and will be capable of setting prices higher in order to recoup its losses.

This practice violates antitrust laws and thus is illegal.

However, it has often proven difficult to enforce as low pricing is a routine practice with ordinary market competition.

Penetration Pricing Examples

Some of the most common users of penetration pricing are telecommunications providers.

These companies will often offer extremely low-priced deals on services in order to attract customers from other providers.

Often, however, these customers will leave as soon as prices rise.

Other common examples include streaming subscription services and grocery stores, which often apply a penetration pricing strategy.

Key Takeaways

  • Penetration pricing is a method used by companies to quickly increase market share by offering a low initial price.
  • Penetration pricing is most often used by new entrants to a market in order to gain customers from established participants.
  • Penetration pricing often attracts bargain hunters searching for the best deal, but it comes with the risk that these customers may leave once the price rises to a normal level.

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  1. Monash "Market Penetration Pricing" Page 1 . September 22, 2022

  2. University of Hawaii "Introductory Pricing Strategies" Page 1 . September 22, 2022