There are countless ways to price your products.
You may have seen companies with a product that’s priced lower than anyone else. The only catch is that the price is temporary. It’s usually referred to as an introductory offer.
This is known as penetration pricing.
Depending on your goals and the product you’re selling, you may want to implement penetration pricing to grow your business.
In this article, I’ll look at what penetration pricing is, when you’d want to use it, and advantages/disadvantages.
What is penetration pricing?
Penetration pricing is a strategy used to gain market share by temporarily reducing the price of your goods or services. The lower price entices new customers to try your products or switch from their current vendors.
It’s a common tactic used by new market entrants.
Once the product has gained enough market share, the business increases the price so it’s in line with other players in the market.
In the short term, profits are lower than if it was priced higher. Even though you may be losing money or making less, the long term benefits of increased market share outweigh the short term losses you may incur.
Why you’d want to use penetration pricing
Penetration pricing isn’t the best choice in all situations. If you’re creating a new product category then people have no reference point for the price so they may be willing to pay a lot more.
If you go in with a lower price point then you may anchor the entire category there while leaving a lot of profits on the table. It may be best to use a value-based pricing strategy there.
Conversely, if you’re entering a crowded space where consumers are well aware of the price points of products and services then it may be a worthwhile strategy.
For example, it would be tough to bring out a new brand of detergent because there are entrenched players. To compete, you may slash your prices for a limited time.
People may try it for no other reason than to save a few dollars. It’s important to note that penetration pricing is ideal for products that have massive markets and can take advantage of economies of scale.
It wouldn’t make sense to use it when going after a relatively small niche market. Like the example of detergent, consumer products are well suited for penetration pricing. To a lesser extent, B2B products can also take advantage of penetration pricing.
When used properly and in the right situation, it can help you:
- Capture unaffiliated market share (people who don’t use a competitor)
- Take customers away from competitors
- Create loyalty to your brand
- Drive competition out of the market (this is often the case when businesses use predatory pricing)
This pricing strategy comes with a lot of advantages. I’ve mentioned some of them already. Other ones to consider are:
- Quick adoption. Because of the relatively low price point, there’s a lower barrier for people to try the product. If, after trying it, the product is good then they’re likely to continue using it or keep it as a regular alternative to another brand.
- Catching competitors off guard: Pricing is an area many companies don’t spend much time or energy on. They set prices and review them every few years if at all. When you appear with a lower price, competitors are often caught off guard and by the time they react you’ve taken a large portion of market share.
- Goodwill: Yes, this is a thing. Goodwill makes people come back and spread the word about you. As long as the product is sound, your first customers are likely to come back and inform others about the deal they found.
Even though there are some powerful advantages associated with penetration pricing, there are still disadvantages.
- Temporary market share gains: The reality is that consumers aren’t loyal to you beyond the utility or advantages you provide. When you’re pricing your products below what’s attainable elsewhere, there are distinct advantages. When those prices climb you’re evaluated in a different way. If the product isn’t clearly better than the incumbent products then a lot of the market share gains may be lost.
- Price expectations: Once a cheaper brand always a cheaper brand – right? Consumers may get used to the lower price you set to gain market share and expect you to continue to charge that amount. When the price eventually increases, the built-up goodwill is lost. It’s always harder to increase prices.
- Negative brand associations: Years ago, Pepsi was in the cola wars with Coke. Coke had achieved market saturation and Pepsi was just coming up. In order to gain market share, Pepsi implemented a type of price penetration strategy and it worked. More people bought it but it was considered the bargain brand that you’d pretend was Coke when guests came over.
- Price wars: Though uncommon, it has been known to happen. It’s especially possible when the established competitors have the resources to sustain prolonged price reductions. It may result in lower profitability for the entire market.
- Losses that can’t be recovered: Not all penetration pricing strategy plays are successful. If a price war ensues, you may be forced to reduce prices to the point where you’re losing money and may eventually be pushed out of the market. The losses incurred won’t be recovered by that product line.
Penetration pricing is a viable strategy to enter new markets because it makes it easy for consumers to try your products and services.
When done right, it’s a temporary fix that allows you to grab market share while the competition isn’t looking. Even though it can be effective, it’s not meant for every situation and has real disadvantages.
Analyze the pros and cons deeply before you take the plunge. For example, will your competitors react and lower their prices to compete? Will people expect prices to stay low? Is there a large enough market to make it worthwhile?
If it checks out for you then by all means use penetration pricing and reap the rewards.
Daniel Ndukwu is a regular contributor to the PayKickstart blog. He has extensive experience with online businesses, conversion optimization, and subscription revenue models. When he’s not writing insightful content, he works with other entrepreneurs to help them grow their bottom line.