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Penetration Pricing Strategy: Definition, Advantages, And Examples

penetration-pricing-strategy:-definition,-advantages,-and-examples

One of the biggest factors in a customer's decision is price.

A successful launch of a new product depends on the right pricing strategy. Short-term, you want to build a following and earn market share. Long-term, you want to improve profitability and customer loyalty.

That's where penetration pricing comes in. The idea is to offer a low upfront price to pull potential customers away from the competition, giving up short-term profits for long-term growth.

There are a lot of brands that use penetration to drive early sales, like Netflix, Hyundai, and MeUndies. Increasing market share over time is the main goal.

Launching a new product in a competitive market? In this guide, you will learn how to use penetration pricing to maximize market share and maintain long-term profitability.

What is penetration pricing?

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.

Price penetration strategy vs. price skimming

Penetration pricing and price skimming are two common strategies used to launch new products. Both are temporary and offer different ways to maximize the results of a launch.

Knowing the difference between them can help you choose a strategy that maximizes profits and reduces competition.

  • 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.
  • Price skimming is more effective when you already have customers interested in your products. Brands charge a high price first to maximize short-term profits, then slowly bring it down to attract more customers.

A skimming strategy opens you up to competition undercutting your prices. If you use penetration pricing, you'll be the company selling similar products cheaper than your competitors.

Price skimming vs penetration pricing differences

Goals of penetration pricing

Let's take a closer look at some of the main goals of penetration pricing.

Capture market share

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.

Penetration pricing works well if consumers are price sensitive and products are similar, and price is the only differentiator.

According to the Law of Demand, lowering prices will increase demand. When you offer more value for less, consumers are more likely to buy what you have to offer.

Let's say you sell refrigerators. They all do the same thing: keep food cold. There are some with HD touchscreens and smartphone connectivity. Some have specialty ice dispensers. For the average consumer, those features don't matter much. They want a fridge that keeps their food cold and fresh.

A market penetration strategy would be a great way to introduce a new refrigerator to the market.


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Build brand loyalty

As noted, the goal of penetration pricing is to attract new, loyal customers by offering a competitive price. For a brand to build loyalty, it must continue to delight customers after the first purchase. One way to do this is to reward customers for continuous purchases with a loyalty program.

Sephora's Beauty Insider program is one of the best. Almost 80% of the company's sales come from the program, which has over 25 million members.

Sephora's Beauty Insider program

Members can redeem rewards points for gift cards and discounts, offsetting product prices without devaluing them. Members also save more when they spend more; everyone gets a free birthday gift, but big spenders get exclusive rewards.

These perks are great for members. If you're new to a brand with a good loyalty program, you'll probably spend more with them over time.

 

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Pull customers from competition

Businesses use penetration pricing to steal customers from their rivals. With low prices, the company hopes to capture customers' attention and provide the best deal, then impress and delight customers so they stick with the brand and spend more over time.

Pros and cons of penetration pricing

There are both advantages and disadvantages to the penetration pricing strategy. Let's walkthrough some of the pros and cons.

Pros:

1. Increased Customer Base: By setting a lower price for your product and effectively promoting it, you can attract customers away from your competitors. The allure of a quality product at a lower price can significantly expand your customer base.

2. Market Leadership: As you capture a larger market share through penetration pricing, you establish yourself as a market leader. This can yield benefits such as increased visibility, brand recognition, and influence over market trends.

3. Enhanced Brand Loyalty: Offering a product at a low initial price can help you build customer loyalty. If your product lives up to its quality promises, customers who were initially attracted by the low price may become loyal to your brand for the long term, even if the price subsequently increases.

4. Barrier to Entry: By setting a competitive and low price, you can deter potential competitors from entering the market. Competitors might find it challenging to match your low price while maintaining profitability, giving you a more secure position in the market.

5. Economies of Scale: Selling a larger volume of items due to lower prices can result in higher sales. This increased demand allows you to order supplies in larger quantities, which often leads to bulk discounts from suppliers and cost savings for your business.

Cons:

1. Upfront Costs: Implementing a penetration pricing strategy requires significant upfront investment in production, distribution, and marketing. Short-term profitability may be compromised as resources are allocated toward establishing a strong market position in the long term.

2. Negative Brand Perception: A penetration pricing strategy may impact your brand image, particularly if your intention is to position your products at a premium level in the market. Offering products at lower prices can create the perception that your brand is cheap or of lesser quality, potentially diminishing its value in the eyes of some consumers.

3. Potential Price Wars: In a competitive market, one of your rivals might respond to your penetration pricing by slashing their prices even further to gain a larger market share. This could trigger a price war, where each competitor tries to undercut the other, leading to diminishing profits and instability in the market.

It is important to carefully analyze and consider these pros and cons before implementing a penetration pricing strategy. Assessing the market conditions, understanding your target audience, and evaluating the long-term goals of your business can help you determine if penetration pricing is the appropriate pricing strategy for your product or service.

Keys to a successful penetration pricing strategy

Here are some keys to employing a successful penetration pricing strategy.

Build long-term loyalty

When you build a relationship with buyers after their first purchase, the penetration pricing model works. Once you've won them over with price, there are various ways to build brand loyalty:

  • Offer stellar customer service by addressing questions, fixing problems, and genuinely trying to help customers.
  • Cross-sell and upsell more profitable products based on purchase history.
  • Let customers leave feedback. Whether it’s positive or negative, they’ll feel heard, valued, and respected, which can build long-term customer loyalty.
  • Segment and personalize customer experiences.
  • Promote shared values so customers get an idea of what your brand stands for.
  • Build a community that allows customers to share their experiences, connect with like-minded people, and keeps your brand top of mind.

Avoid price wars

Price wars can happen if you match prices aggressively. It's a lose-lose situation when multiple competitors start discounting their products. If you find competitors are challenging you to a price war, there are a few ways to avoid it:

  • Compete on quality. Differentiate your products by adding new features or building awareness for lesser-known features. Emphasize the risks of choosing low-priced options.
  • Reveal your intentions. Offer to match competitors’ prices or reveal your cost advantage.
  • Deploy price actions. Offer bundled prices, price promotions, or loyalty programs for new products.

Competitive pricing is often talked about as a way to undercut competitors and offer lower prices, but that isn’t always the smartest strategy, so don’t fall into that trap and end up undercutting your own growth.

Ensure demand is high

Penetration pricing works when a lot of people are willing to switch brands because of price. Prices aren't cheap, but they're low compared to what the target market perceives as value. Make sure you're only using penetration strategies in price-sensitive markets.

To stay competitive, you'll have to sacrifice profitability. Costco, for example, can offer items at the lowest price because it has millions of customers. That's why you have to make sure there's a high demand for your products.

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Examples of penetration pricing

  • Netflix
  • Hyundai
  • TJ Maxx
  • MeUndies

Let's examine each of these high-profile penetration pricing strategies individually.

Netflix

Streaming service Netflix is a great example of penetration pricing done right. The late 90's was the heyday of rental services.

Netflix entered the market with a new promise: Waiting one or two days for a DVD to arrive will let you have access to a better movie library, without any fees. You could rent four movies at a time for $15.95 per month, and there was no return date.

That's a big difference from Blockbuster, its main competitor at the time. For a single, three-day rental, the rental service charged $4.99. The price point for a Netflix rental was around $1 per DVD.

It's history from there. By providing value to consumers, Netflix disrupted the rental market so much that Blockbuster went bankrupt.

Hyundai

When South Korean Hyundai entered the US market in 1986, they used penetration pricing to gain market share. The multinational automaker provided many things competitors were not at the time:

  • A reputation for reliability
  • 10-year warranties
  • Upscale interiors

Hyundai kept prices lower than its main overseas competitors, Toyota and Honda, while continuing to add value for consumers. As of May 2022, Hyundai is the third-largest automaker in the US, with 11.6% total market share.

TJ Maxx

TJ Maxx targets price-sensitive customers willing to search for bargains through limited and rapidly changing stock. Products at TJ Maxx are usually 20%-60% off full-price retailers' prices.

TJ Maxx storefront
By JJBers from Willimantic, Connecticut, USA – T.J. Maxx (Attleborough, Massachusetts) | Wikimedia Commons

It's not a special or discounted price. Targeting Every Day Low Price (EDLP) shoppers, TJ Maxx uses a permanent penetration strategy to grow its customer base and market share. TJ Maxx has 18.49% of the retail apparel market as of Q1, 2022.

MeUndies

MeUndies sells underwear, loungewear, and apparel direct to consumers. Competing in a multi-billion dollar market, they needed a way to appeal to consumers with a lower price.

MeUndies website

There are a few penetration strategies the brand uses that revolve around a low introductory price. Shoppers can save up to 45% on socks and underwear packs with “Build-a-Pack Sales.” The company also offers a free membership that lets shoppers save 30% off each order. A retailer can do both of these without ruining the brand's image or relying on massive economies of scale.

Is penetration pricing right for your store?

Penetration pricing is a highly effective strategy for businesses looking to gain traction with a new product. By setting initial prices lower than competitors, you can attract new customers and quickly capture a larger market share. However, it's important to remember that this approach is not a long-term solution.

To truly establish your brand and increase customer loyalty, you need to have a well-thought-out plan in place. As prices gradually increase, your goal should be to position yourself as a key player in the market. This means going beyond simply offering lower prices – you must also focus on delivering exceptional value and creating a positive customer experience.

Building long-term loyalty requires more than just a temporary pricing strategy. It necessitates a commitment to consistently delivering high-quality products and services that surpass customer expectations. By doing so, you can showcase the unique value proposition of your brand and demonstrate why customers should choose you over competitors.

It's important to understand that customers may be tempted to switch brands when the next enticing deal comes along. This is why it's crucial to continually prove your brand's worth. By consistently delivering on your promises and exceeding customer expectations, you can establish a reputation for reliability and trustworthiness.

In conclusion, penetration pricing can be a powerful tool for gaining market share and attracting new customers. However, to truly establish your brand and increase customer loyalty, you need to have a long-term plan in place. Focus on providing exceptional value, building trust, and consistently delivering on your promises. By doing so, you can position your brand as the preferred choice in the market and ensure that customers remain loyal even when faced with tempting offers from competitors.

 

This originally appeared on the Shopify Retail Blog and is made available here to cast a wider net of discovery.
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