New businesses rely on clear and powerful differentiators to stand out from the competition. For many consumers, nothing makes their buying decision easier than price. A penetration pricing strategy is built on this concept.
New businesses rely on clear and powerful differentiators to stand out from the competition. A penetration pricing strategy is built on this concept. By entering the market with a low price, businesses aim to attract customers quickly—then gradually raise their price. Many high-profile startups have used this strategy to disrupt industries and become today’s market leaders.
Penetration Pricing Strategy
As we've mentioned before, the penetration pricing strategy involves offering a new product or service at a low initial price to gain customers' attention. The goal is to aggressively get customers in the door with low prices and gain market share. With penetration pricing, new products are sold at low prices to build a customer base. In the short term, profit margins are lower, but heavy sales volumes compensate for the small margins. You can raise the price as demand increases.
The theory behind market penetration pricing is that a low initial price secures market acceptance and forms customer habits. The method is effective for entering new markets with little difference between products, like kitchen appliances or internet service providers.
Pros and Cons of Penetration Pricing
- More customers. If your product is high-quality and launched efficiently, you'll attract customers away from your competitors.
- Market leadership. The more market share you own, the more of a market leader you become.
- Increased brand loyalty. You can build a loyal customer base through penetration. The low price gets them in, and if your product is good, they'll keep buying even if the price goes up.
- Less competition. By selling products at a low price, you prevent competitors from entering the market, since they can't afford to sell at that price.
- Lower costs. Low prices can lead to high sales. When you sell more items, you order more supplies, which you can get bulk discounts on from suppliers.
- Upfront costs. Penetration strategies require resources for production, distribution, and marketing strategy. Short-term profits are sacrificed for long-term benefits, such as a strong market position.
- Poor brand perception. A penetration strategy can hurt your brand image. If you want to be known as a premium brand, launching products at a low price can make consumers think you're cheap.
- Possible price wars. A fierce competitor might cut their prices to get more market share. If your competitor lowers their price, you might want to do the same. If you do, they might lower theirs again—and the cycle continues.
Examples of Penetration Pricing
- Netflix: It is a powerful example of using market penetration pricing to edge out a major competitor. In the late 1990s and 2000s, DVD rentals were becoming mainstream. Although Blockbuster dominated the home entertainment market, it was also associated with late fees and limited selections.
In 2000, Netflix users could rent four movies at a time with no return-by dates for the $15.95 subscription plan. That put rentals at or below $1 per DVD for regular movie-watchers, where Blockbuster charged about $4.99 for a single, three-day rental.
Penetration pricing allowed Netflix to build its subscriber base and reach profitability in 2003, five years after opening. The low initial price point let customers test their new service and make the switch. In 2007, the company’s convenient online streaming service propelled it into the future. Heavy competition from Netflix and Redbox, another new rental company, contributed to Blockbuster’s bankruptcy filing in 2010.
- Internet and cable providers: It’s common to see cable companies offer free streaming services or extra channels to draw in new subscribers. Although there’s usually a time limit attached, perks like these are still effective. These incentives and bonuses help companies stand out in a saturated market.
- Food and beverage companies: Snack and drink manufacturers sometimes introduce new products and flavors at low prices so customers will give them a try.
- Cell phone carriers and smartphones: Some carriers offer customers inexpensive or free smartphones in return for a long-term contract. Technology companies creating the phones employ this strategy too. Android phones are often priced low so customers build brand loyalty and Android achieves greater market penetration. Apple, on the other hand, practices price skimming. They charge as high a price as customers will pay and slowly lower it. The initial high cost builds their luxury brand reputation, and they “skim” price-sensitive customers from competitors over time as the price of the product slowly drops.
Market penetration is a challenge for any business, especially entrepreneurs attempting to change the face of an industry. A penetration pricing strategy aims to achieve adoption by growing a customer base with low initial prices. It can be an effective way to amass buyers, build goodwill, and stand apart from other market competitors. But it can also lead to noncommittal customers and thin margins as a business is starting out.
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