One vital decision you have to make as a business owner is deciding the price of your products. Think about it — the business world is overcrowded, competition is stiff, and many consumers are price sensitive. Therefore, setting the cost of your new product too high or too low can be counterproductive to your profitability.
The reason is that by setting a high price, you can lose sales opportunities and revenue. In reverse, by setting a low price, you attract more customers but may not realize your long-term profit motives. Profit maximization is at the core of every business. Your first step toward getting your pricing right is choosing the appropriate pricing strategy.
Several pricing strategies exist, suitable under different economic and marketing conditions. This article will focus on the price penetration strategy, its pros and cons, and how you can implement it in your own business.
What Is a Penetration Pricing Strategy?
A penetration pricing strategy is when business owners lower the entry price of their new product or service to attract new customers. As a marketing strategy, price penetration aims to stimulate market growth, capture market shares, and maximize sales volume.
The idea is that by offering a low initial price, rapid demand for the new product is induced, enabling the company to build a customer base within a short time frame while maximizing brand loyalty. Usually, after a growth period during which the company has sliced through a large chunk of its competitors' customer base and gained new customers, the company gradually raises its price to reflect its value and maximize profit.
High price limitation is removed and the new product is offered to consumers to try out at a below-average market price. This undercuts competitors, leaving them with little or no time to respond. After gaining a large chunk of the market share, a price point that matches the perceived product value is set to maximize profit. Market penetration pricing is adopted when there's a projected high demand for a new product or service. Businesses expect that the large sales volume will make up for the low price in such instances.
Pros and Cons of Penetration Pricing Strategies
One of the key advantages of penetration pricing strategies is high sales volume. Other pros and cons include:
- Low introductory prices may encourage fast adoption of products or services by customers.
- It encourages economies of scale since the emphasis is on maximizing sales volume through lower prices. Maximizing sales volume necessitates mass production and mass market.
- It enables new businesses to cultivate goodwill among customers. Customers consider a low price a good deal. Price-sensitive customers may switch, with the possibility of promoting the product by word of mouth.
- There is less competition. Low price entry may undercut competitors with little or no time to react.
- Diligent budgeting, planning, and forecasting that precedes the strategy may enable the business to discover ways to lower marginal costs, improve cost efficiency, and control overall business expenses.
- The strategy leads to a customer base of "switchers" who may revert to competitors once the price rises. Customer loyalty isn't guaranteed.
- A low price may negatively impact the brand image and reputation, as most customers may consider the product inferior.
- Additionally, a lower cost may hurt brand recognition, making it difficult to build brand loyalty (especially for people that equate higher price with authenticity).
- It may spark up competition when competitors react by lowering their prices, starting up a price war (which is unhealthy for a new company).
- There's an emphasis on sales volume, which means there's a possibility of incurring loss through oversupplying or excessive stocking.
- A longer wait time to implement the price increase and maximize profits may expose the business to losses.
How to Apply a Penetration Pricing Strategy
Penetration pricing works well under a specific set of conditions. Consider the following before choosing market penetration:
- Type of product or innovation: Are you offering a breakthrough or undifferentiated product? Usually, you just need to fix the price and penetrate the market for a breakthrough product without reference price or competition. However, for undifferentiated products in a very competitive market, you need to offer differentiation in terms of low initial price to survive since many people are already selling similar products.
- Goal: Is your short-term goal market shares, maximum revenue per unit, high total profit, or profit margins? You must be willing to trade off some goals in place of others. Suppose your business has high capital expenditure requirements. In that case, penetrative pricing might be the best bet since there's an increased need to meet cash-flow needs.
- Price sensitivity: Is it high or low? Penetration pricing strategy is ideal for high price elasticity. Low prices can lead to higher volumes or many customers buying more. However, you should ensure sufficient market sensitivity to account for the lower margin.
- Customer segmentation: Are there many segments or just one? When willingness to pay doesn't differ among consumers or there's little or no customer segmentation, penetrative strategy prevails.
Consider a hypothetical restaurant hoping to add pizza to its menu. Let's call the restaurant NativeKitchen. NativeKitchen has some great ideas that'll enable their pizza to stand out. For instance, they hope to organize a high-tech pizza hunt for kids or collaborate with a local Greek restaurant and make special pizza using their ingredients.
However, that's for the future. For now, the restaurant wants to put NativePizza out on the market. Since there won't be much difference in taste or flavor compared to their competitors, the restaurant can use price differentiation to attract customers.
Suppose the average price of a large pizza is $12. In that case, NativePizza can start at $9.99 with the intention of increasing the price later (after NativeKitchen has cut through the competition). The $9.99 is also a psychological pricing strategy. It gives buyers a sense of paying in a single decimal unit ($9 instead of $10). Some steps NativeKitchen needs to take to ensure the success of the penetration pricing strategy include:
- Analyzing production costs to see if there's a chance of earning profit through a large sales volume
- Deciding a perfect entry price at which a large sales volume is poised to boost the profit margin
- Deciding the ideal time or percentage of market share required to implement the original price gradually (a long period may result in losses)
- Monitoring customer behavior while gradually raising the price (usually after implementing the strategy)
Penetration Pricing Strategy Example
There are so many cases of companies that have successfully executed the penetration strategy and eased out competitors. Let's take Netflix, for instance. Between 1990 and 2000, when video rentals were mainstream, people could head to the local video store to rent a video.
Among the local entertainment stores at the time, Blockbuster was dominant. Blockbuster charged between $4 and $5 per day for new movies. However, with Blockbuster, there was the problem of a limited library and late fees.
When Netflix stepped onto the scene, it came with a unique proposal. The proposal gave consumers access to more movies without incurring late fees only if they waited a day or two longer before receiving their DVDs. The coolest part was that movie-lovers didn't have to leave their homes, as Netflix mailed the DVDs. By emphasizing affordability and ease of use, Netflix was able to woo customers over to their brand.
For $15.95, customers could rent up to four movies at a time. It was a great deal when compared with Blockbuster's pricing and late fees. Through this revolutionary and innovative approach, Netflix built a loyal customer base and reached profitability in 2003 using price penetration.
The low initial price encouraged testing and fast adoption. By 2007, Netflix became an entertainment giant propelled by its online streaming services.
Stay on Top of Your Business Finances With Skynova
Once you've gotten your pricing strategy right and the money starts coming in, you'll be faced with an essential obligation of adequately managing your finances. Unfortunately, financial mismanagement can ruin your business faster than anything else.
The great news is that there's accounting software that can make handling your business finances easier. With Skynova's accounting software, you can track and manage your income and expenditures, send invoices, and do other cool accounting stuff with ease.
Notice to the Reader
This article is about the penetrating pricing strategy and shouldn't be considered expert advice. Although the penetrating pricing strategy can work, there's no guarantee that it'll work for your specific situation or business. You should seek an expert opinion on the right strategy that'll work for you.