What Is a Penetration Pricing Strategy?
Effectively pricing products or services is more nuanced than just looking at profit margins. Penetration pricing strategy involves having a solid understanding of what the market will tolerate. Moreover, the system provides an insight into competitor pricing, the overall value of a product or service, and a company’s financial stability.
Meg Prater, a managing editor of the HubSpot Blog, explains:
“Because this strategy requires companies to slash prices to almost below market value, it’s usually employed by new businesses in a high-growth phase that are prepared to absorb initial losses. These losses are viewed as a necessary sacrifice to gain market share and entice customers away from competitors.”
There are five key pricing strategies: price skimming, premium pricing, economy pricing, bundle pricing, and penetration pricing. Penetration pricing, in particular, is closely informed by competitor pricing. This pricing strategy offers a new product or service at a lower price. The strategy allows for an initial offering to attract new customers by luring them away from the competition. Introducing a new product or service priced enticingly low in an established market helps a company penetrate that market. They can quickly build awareness with potential customers. In turn, the strategy disrupts existing businesses in the space.
Penetration pricing strategies can initially entice new customers to purchase or subscribe to a service. However, the strategy can also result in churn or loss when the company increases the price. Product professionals realize that a penetration pricing strategy is not a sustainable long-term approach without ideal price points without customer support. Companies that don’t withstand up-front losses should steer clear of this pricing strategy.
Penetration Pricing Examples
Internet and cable providers use penetration pricing to entice new customers with a deal they can’t refuse. Still, when prices eventually increase, it’s not uncommon for customers to jump ship. Smartphone providers, such as Android, use a penetration pricing strategy to win new customers and create loyalty to the brand.
Other penetration pricing examples include Starbucks and Gillette. The former often introduces new or seasonal products at a lower price. In comparison, Gillette offers its core product at a lower cost price. However, the company sells its razor blades at premium prices.
A true standout in the penetration pricing approach is Netflix. The company has avoided significant price hikes while at the same time building steady growth of its customer base. Today Netflix holds 51% of streaming subscriptions in the U.S. and has a monthly churn of around 2%.
Here are a few excerpts of experts weighing in on how Netflix maintains strong customer loyalty and excels as a market leader.
“Netflix had a unique proposal,” explains financial services provider Brex. “If customers could wait a day or two for their DVDs to arrive, they could access a better movie library without any late fees. From the outset, Netflix emphasized ease and affordability to attract Blockbuster customers. 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.”
Intelligence Node notes: “Netflix is the perfect example of penetration pricing done right. We have often heard people complaining about their Netflix subscription prices going up or their one month of free subscription ending. Nevertheless, despite occasional grumbling, people are wonderful with paying the higher subscriptions for the eternal flow of good media content.”
The penetration pricing strategy of Netflix radically disrupted its target market, and the company’s unwavering commitment to providing value paved the way to gaining and maintaining a sizable market share–not to mention toppling a significant competitor.
What Is the Purpose of Penetration Pricing Strategy?
Penetration pricing attempts to disrupt an established market by introducing a new product or service at a lower price to entice new customers to purchase or subscribe to a service. This strategy helps a company capture the attention of buyers in the target space and build a customer base quickly.
Winning new customers is only half of the equation, however. To be effective long-term, cultivating customer loyalty from the get-go must be a priority. Without it, newly won customers will likely jump ship as soon as competitors introduce a cheaper offering for the same type of product or service.
This pricing strategy works most effectively when there is little product differentiation. And where the product or service is suitable for a mass market, such as in subscription pricing.
Advantages and Disadvantages of a Penetration Pricing Strategy
As we’ve discussed, penetration pricing enables a company to quickly earn market share, build its customer base, cultivate loyalty, and make a dent in the market share of competitors. Other advantages of using a penetration pricing strategy include:
- Fast-tracked adoption of a new product or service
- Weakened dominance of the competition
- Economies of scale due to higher sales quantity and a lower cost per unit
- Increased goodwill and positive word of mouth
- An improved inventory turnover rate
Of course, this strategy poses risks to companies as well. Disadvantages of a penetration pricing model include:
- Reduced customer loyalty if not intentionally cultivated (particularly among bargain hunters)
- Disappointed customers who expect low prices permanently
- Bruised brand image due to the perception that low prices equate to cheap or low quality
- Long-term angling for the lowest price among competitors in the market (i.e., a price war)
- Short-term gains at the expense of a long-term, sustainable strategy
According to Corporate Finance Institute:
“Price penetration is not a viable long-term pricing strategy. It is usually a better idea to approach the marketplace with a pricing strategy that your company can live with, long-term. While it may then take longer to acquire a sizable market share, such a patient, long-term strategy is more likely to serve your company better overall and less likely to expose you to severe financial risks.”
Penetration Pricing Strategy vs. Price Skimming
As previously discussed, Android uses penetration pricing to win new customers and create loyalty to the brand. One of its primary competitors, Apple, relies on a skimming pricing strategy.
Will Kenton, Investopedia blog contributor, writes:
“A skimming strategy works well for innovative or luxury products where early adopters have low price sensitivity and are willing to pay higher prices. Effectively, producers are skimming the market to maximize profits. Over time, prices will reduce to levels comparable to market prices in order to capture the rest of the market. Small businesses or those in niche markets can benefit from price skimming when their products or services are differentiated from competitors’ and when synonymous with quality and a positive brand image.”
While penetration pricing casts a wide net for an immediate appeal to as large a portion of a target market as possible, price skimming focuses all efforts on engaging a small, exclusive segment of a target market by offering high-cost products or services.
Market Penetration vs. Pricing Penetration Strategy
We’ve explored how penetration pricing enables a company to introduce a new product or service at a low cost to quickly generate awareness, build a customer base, and cultivate loyalty in an established market. Once the new product or service has entered the marketplace, it’s good to develop a solid understanding of how it compares to the total market.
That’s where market penetration strategy and developing a sound product strategy comes in. Market penetration measures the utilization of a company’s product or service in a particular market compared to the total market for that product or service. Often this data is expressed as a percentage (e.g., a company’s product or service represents X% of the total market for that particular industry).
This information helps companies understand the overall size of the market, the number of potential customers within the market, and the potential for gaining a market share within the industry. A firm grasp of a target market enables companies to create the right strategy for increasing market share or advancing market penetration.
Why Is Pricing Strategy Important to Product Management?
Selecting the right pricing strategy plays a significant role in a product’s success. According to the U.S. Chamber of Commerce, “pricing your inventory properly is essential for continued business success. You may have the best product in the world, an excellent team, and a beautiful storefront, but if you can’t price your products effectively, your sales will ultimately struggle.” The cost of a product or service can also reflect a company’s identity. For example, to successfully price SaaS products, an organization needs to stay aware of the market.
Pricing also impacts conversation rates and profitability. That’s why product managers need to consider pricing strategy early in the product development process.