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Penetration Pricing

Penetration Pricing

The idea behind penetration pricing is to help a new product break into the market quickly and keep out competitors. This is a strategy used by many businesses; however, there are also various risks associated with price penetration. Let's take a look at this concept in more detail.

Penetration Pricing Definition

Before we dive deep into the effects of a penetration pricing strategy, let's consider its definition.

Penetration pricing is a pricing strategy where a business offers a low price initially to attract a large portion of customers and gain market share.

If appropriately applied, price penetration can bring the company massive success. For example, lower prices can increase the acceptance rate and allow the company to capture a substantial market share in a short period.

Higher sales lead to bulk purchases with discounts, which brings down production costs. As production costs decrease, the company can manufacture more goods and achieve economies of scale.

However, the drawback is if the price remains low, the business may not be able to make a sustainable profit. Also, there's a risk of a price war with other competitors.

Pricing penetration works best when:

  • The product has an elastic demand curve (the change in the price affects the product demand significantly).

  • It is easy to achieve economies of scale.

  • The market is large enough with sufficient demand.

  • The skimming pricing strategy doesn't work — Competition remains high after the introduction stage.

  • The products are subjected to standardization (e.g., Microsoft computer software)

Price penetration Examples

Now that we've covered the basic theory, let's walk through a couple of examples.

Penetration Pricing: Netflix

Netflix was founded by Reed Hastings and Marc Randolph in 1997. But before it became one of the world's largest streaming services, Netflix had taken over the DVD rental business.

Penetration Pricing POV image of a person holding a remote while there is netflix openin on the tv in the background StudySmarterFig. 1. Price Penetration Netflix Example

The video rental industry was highly competitive at the time, though Netflix made several intelligent moves that allowed it to attain the market-leading position quickly. First, it announced that customers only have to wait one or two days to get their DVDs. Second, the company adopted price penetration. Customers could rent out a DVD for as cheap as 50 cents.

This strategy worked out nicely as the new business model drove competitors like Blockbuster out of business, and Netflix continued its path to world domination within the next twenty years.

In 1999, the company introduced a new subscription model priced from $15.95, which was later updated into a monthly subscription plan at $19.95. In 2007, Netflix introduced its online streaming services with different pricing tiers according to the customers' needs, starting from $8.99. The company now has 209 million subscribers worldwide and earns roughly $25 billion annually.1

Penetration Pricing: Android

Another successful adoption of price penetration is by Android phone brands, most notably Samsung.

Penetration pricing Samsung example StudySmarterFig. 2 - Samsung's price penetration strategy has been very successful in the markets

As opposed to Apple, which adopts a price skimming strategy for the iPhone, Android companies market their products at a lower price. They also throw out frequent discounts to attract price-sensitive individuals and turn them into loyal customers.

The strategy proves highly effective today as Android holds more than 70% of the market share worldwide.2

Penetration Pricing vs. Price Skimming

Price Skimming
Price Penetration
Price
High
Low
Profit Margin
High
Low
Type of Product
Innovative or luxury goods
Generic consumer goods
Examples
iPhone, Gucci bags, etc.
Milk, eggs, bread, etc.

Table 1. Price Skimming vs. Price Penetration

Price penetration is the opposite of price skimming. Price penetration means pricing products at a lower end or with little margin, whereas price skimming prices new products at a higher end or with a large margin.

The two strategies are also suited for different kinds of products. Price skimming works well for innovative or luxury goods which tend to have a short life cycle or are made of supreme quality. They focus on attracting status-conscious customers who are willing to pay higher prices. By contrast, price penetration is often used for less exclusive goods such as cosmetics and groceries.

Penetration Pricing Strategy

Penetration pricing strategy can range from a more subtle to a more extreme form. The subtle form is loss leader pricing, where companies sell products at a loss.

Loss leader pricing is when companies sell products at a loss to acquire more customers.

In this case, the product sold below the market price is called the loss leader. When customers purchase these products, they are "saving money". They hope to use these savings for future goods and services to recoup the company's previous loss.

At the other end is predatory pricing, where the company drops the price significantly to keep out the competition.

Predatory pricing involves setting prices below the market price to force competitors out of the market.

The situation often leads to a monopolistic position, after which the company raises the price to compensate for losses. However, this strategy can prevent healthy competition and is thus banned in many countries.

Penetration Pricing Advantages

Price penetration comes with three major benefits:

  • Fast acceptance and adoption: Low prices allow the new product to penetrate the market quickly. The business will have a much easier time convincing people to accept and adopt the product when its price is low. Once people are onboard, companies can work on building customer loyalty to keep them around when the price increases.

  • Free promotion from early adopters: Penetration pricing attracts many people to adopt the product in the beginning stage. If the early adopters love your product, they will provide word-of-mouth marketing campaigns for your business, a.k.a. free promotion.

  • Production cost reduction: High sales volumes mean the company can buy bulk materials at a discount, reducing production costs. As a result, you can manufacture more products and achieve economies of scale. It also releases the pressure early due to a lack of capital.

Penetration Pricing Disadvantages

That said, price penetration isn't without any disadvantages. Here are some limitations to this strategy:

  • Price expectation: Setting a low price upfront can create a price expectation for the product that lasts for a long time. Customers may attach the brand name to "cheap bargain" or "discount", making it hard for the business to increase the price later.

  • Negative brand image: Businesses that increase their price suddenly may incur a bad reputation. Customers may feel betrayed and turn their back against such brands. In other cases, pricing a product at a lower end can give an impression of poor quality and low value.

  • Brand loyalty: The biggest challenge is to make the customer stick around when the price increases. However, it may prove difficult since price penetration tends to attract many "bargain hunters" who won't be shy to opt for lower-priced alternatives. Also, since products using penetration pricing are replaceable, it makes it easier for people to switch.

  • Price war: Companies that adopt price penetration have their prices tied to their competitors. They may have to keep prices low at all times to stay competitive in the market. So even though they make a lot of sales, the business is not sustainable in the long run. Moreover, companies may find themselves in a price war, where they all offer low prices for very little profit; this is unsustainable.

Market Penetration Pricing

Pricing penetration is not a long-term strategy since customer acquisition is mainly based on prices. However, it's still helpful in the introduction stage, especially when a company is new and similar products have appeared in the market.

One widespread price penetration practice is to offer your product at different pricing tiers. For example, you can introduce a free plan to attract many potential customers and a basic or a premium plan to earn revenue from frequent users.

The key to this strategy is to keep your paid plan below the competitor's benchmark to obtain customers quickly. As more people get on board, the business should shift the focus to building customer loyalty. Then, it can raise the prices to match competitors' prices and assert its position in the market.

For example, N26, a European digital bank, splits their plans into N26 Mastercard with 0 service fee, N26 You at 9.90 EUR per month, and N26 Metal at 16.90 EUR per month. While the free plan covers the basic features, the paid plan also includes an insurance package and exclusive discounts to provide customers with more benefits and convenience.

Penetration Pricing - Key takeaways

  • Price penetration is a pricing strategy where a business offers a low price initially to attract a large portion of customers and gain market share.
  • Penetration pricing works well initially but is not a long-term strategy because customer acquisition is mainly based on prices.
  • Price penetration is the opposite of price skimming. Price penetration prices products at the lower end or with a small margin, whereas price skimming prices new products at a higher end or with a large margin.
  • The advantages of price penetration are fast acceptance and adoption, free promotion from early adopters, and production cost reduction.
  • Price penetration's disadvantages include low expectations, negative brand image, lower brand loyalty, and price wars.

References

  1. Macrotrends. Netflix Revenue 2010-2022 | NFLX. 2022. https://www.macrotrends.net/stocks/charts/NFLX/netflix/revenue#:~:text=Netflix%20revenue%20for%20the%20twelve,a%2024.01%25%20increase%20from%202019.
  2. Statcounter. Mobile Operating System Market Share Worldwide. Aug 2021 - Aug 2022. https://gs.statcounter.com/os-market-share/mobile/worldwide

Frequently Asked Questions about Penetration Pricing

Penetration pricing is a pricing strategy where a business offers a low price initially to attract a large portion of customers and gain market share.

The purpose of a market penetration pricing strategy is to attract a large group of customers, gain market share, and benefit from fast acceptance and adoption. 

The advantages of penetration pricing include fast market penetration and acceptance of the product, lower production costs due to bulk buying, and free word-of-mouth campaigns.

An example of penetration pricing can be observed through Android phones. 

As opposed to Apple, which adopts a price skimming strategy for the iPhone, Android companies market their products at a lower price. They also throw out frequent discounts to attract price-sensitive individuals and turn them into loyal customers. 

Penetration pricing is used when introducing new products to the market. When using a penetration pricing strategy, the company hopes that it will attract many customers to the new product development and increase its market share. 

Final Penetration Pricing Quiz

Question

What is price penetration?

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Answer

Price penetration is a pricing strategy where a business offers a low price initially to attract a large portion of customers and gain market share.

Show question

Question

The opposite strategy of price penetration is...

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Answer

Price skimming

Show question

Question

Elastic demand means ...

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Answer

The change in the price affects the product demand significantly

Show question

Question

With price penetration, it is easy to achieve economies of scale. 

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Answer

True

Show question

Question

Products using price penetration methods are subjected to...

Show answer

Answer

standardisation

Show question

Question

Price penetration means charging products at a lower price end, then raising it over time as the demand increases. 

Show answer

Answer

True

Show question

Question

Name 2 types of penetration pricing

Show answer

Answer

Loss leader pricing

Predator pricing

Show question

Question

What is loss leader pricing?

Show answer

Answer

Loss leader pricing happens when companies sell products at a loss to acquire customers. 

Show question

Question

Why is predatory pricing banned in many countries?

Show answer

Answer

Predatory pricing is the strategy where companies drop their product's price significantly to keep out competitors. This prevents healthy competition and thus is banned in many countries. 

Show question

Question

Name 3 disadvantages of price penetration.

Show answer

Answer

  • Negative brand image
  • Price war
  • Hard to develop brand loyalty 

Show question

Question

Pricing penetration is not a long-term strategy. 

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Answer

True

Show question

Question

What is a price war?

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Answer

A price war is a situation where they all offer low prices for very little profit. 

Show question

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How price penetration can incur a negative brand image?

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Answer

Businesses that increase their price suddenly may incur a bad reputation. Customers may feel betrayed and turn their back against such brands. 

Show question

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What happens when a product is priced too low in the introduction stage?

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Answer

Customers may attach the brand to “cheap bargain ” or “discount”, which makes it hard to increase the price later on. 

Show question

Question

Name 3 benefits of price penetration.

Show answer

Answer

  • Fast acceptance and adoption
  • Free promotion from early adopters
  • Production cost reduction

Show question

Question

Products using the price penetration method have a high profit margin

Show answer

Answer

True

Show question

Question

Why does a company offer its product at different pricing tiers?

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Answer

The company can introduce the same product with basic or extended features. The basic plan may be free to attract as many customers as possible while the extended plan allows it to earn revenue from frequent users. 

Show question

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Price penetration works best when...

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Answer

The product has an elastic demand curve

Show question

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When price skimming doesn't work and competition remains high after the introduction stage, price penetration can be adopted. 

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Answer

True

Show question

Question

Define economies of scale

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Answer

The more output the company produces, the lower cost per unit. 

Show question

Question

What are the primary benefits of price penetration?

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Answer

Quicken the adoption rate

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What is not an advantage of price penetration?

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Answer

Free promotion from early adopters

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Question

Penetration pricing works well in the beginning but is not a long-term strategy because ... are mostly acquired based on prices. 

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Answer

customers

Show question

Question

Price penetration is a pricing strategy where a business offers a ... price initially to attract a large portion of customers and gain market share.

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Answer

low

Show question

Question

Price penetration is most helpful in ... when the company is new and similar products have appeared in the market. 

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Answer

the introduction stage

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Question

Companies that adopt price penetration have their prices tied to their...


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Answer

competitors

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