Market Penetration Pricing: An Informative Guide (2021)

Introduction

As a business owner, you will need to make a critical decision about the introduction of a new product into the market or whilst entering a new market. Key decisions have to be made about how it needs to be priced to attract the customer and generate sales. Often used for a new product range or new product launch, a penetration pricing strategy is used to gather the customer base. It basically involves selling the product for a lower price to maximize sales volume and capture market share.  The initial promotional price gives the product recognition and is particularly useful when entering new markets. Read on to find out more about the meaning of penetration pricing.

1. What is Market Penetration Pricing?
2. Advantages
3. Disadvantages

1. What is Market Penetration Pricing?

What is penetration pricing, one may ask? Market penetration pricing strategy is a promotion technique used by firms to attract new customers to a new product or service. Experts define penetration pricing as a pricing tactic used quickly to gain market share by setting a low price for products initially, aimed at enticing customers. An extreme form of pricing for market penetration is called predatory pricing. The main aim is to penetrate into the market with the price of the product and then work towards retaining the customer base.

A lower price helps to quickly sell the product as it attracts new customers. This generates economies of scale and businesses can achieve break-even points quickly. Once the customer base is created and competition won over, businesses can slowly increase the price to cover production costs and gradually make profits.

The penetration pricing definition works on the premise that the lower the price of a new product or service, the higher the penetration and gain of customers from the competition. The reduced price helps a new product or service pierce the market and attract customers from competitors. Market penetration pricing depends on the premise of using low prices, in the beginning, to make customers conscious of a product and increase the customer base.

The goal of pricing for market penetration is enticing customers to experiment with a new product and build market segment. To learn what is price penetration, one has to know what is the rationale behind penetration pricing. Price is one of the key ways to distinguish from competitors. Penetration pricing helps to build brand loyalty, generate substantial demand, create economies of scale, switch customers from competitors, and kill competition too. Penetration price policy will work when:

•  Demand is price-elastic ( dependant on the price of the product).
• Too many similar products in the market and there is very little product distinction. For eg: different kinds of laundry detergents, and toothpaste available on market shelves.
• When the product is suited for the mass market. Mass markets let to have a wider customer base thereby creating economies of scale.

To understand penetrating pricing meaning, the following penetration pricing examples will be of good help. A few examples are an online grocery store offering a free delivery service for customers who sign up, banks offering a saving’s bank account at zero balance for six months. The below-market penetration pricing example will help to understand the concept of penetration pricing in a wider manner. 

If an FMCG company A is able to manufacture soaps at a lower cost because of excess production capacity. It decides to enter the market and sell soap at $5 where the cost of production is $5.50. If the average cost of soap in the market is $10, company A decides to sell at a lower cost by enticing customers, achieve economies of scale, and get customers to switch. It will then raise the price after gaining a monopoly over the market to gain a higher profit margin. 

Lower prices raise curiosity levels of customers and prompt them to buy the product. If the customer finds the product to their satisfaction, they will not think twice to pay a higher price for the product.

Penetration pricing will work effectively only if the quality of the product or service matches the customer expectations and demands.

2. Advantages

Penetration pricing can have a lot of advantages to businesses looking to enter a new market or trying to introduce a new product or service. A few advantages are listed below:

• Greater adoption and dispersion: Penetrating pricing helps a company to sell its product or service quickly and get it widely accepted and adopted by debutant customers.
• Dominance in the market place: Competitors are caught by surprise when a penetration pricing strategy is implemented and do not have enough time to counter. The company implementing the strategy gets the opportunity to gain new customers.
• Economies of Scale: Pricing strategy helps to increase sales which lets a firm or business to gain economies of scale and reduce its fringe cost.
• Better goodwill: Customers will pledge their loyalty to products or services that offer them a benefit or bargain in terms of price and quality. This also helps in creating a positive referral and publicity through shared experience.
• Increased inventory turnover: This pricing strategy helps in inventory turnover and improves the rate of sales in proportion to goods produced resulting in partners, for example, distributors, retailers, etc in the vertical supply chain happier. Those involved in the vertical supply chain also gain an increase in business.

3. Disadvantages

Whilst there are advantages, there are disadvantages to the penetration pricing strategy too. 

• Unrealistic expectations on pricing: When customers are offered low prices they expect it permanently. When it increases suddenly, customers become disgruntled and stop buying
• Low customer loyalty: Customers may be attracted to bargains and will switch if they find better deals. Price cuts helps in immediate sales but endangers customer loyalty.
• Loss of brand image: Low prices may be perceived as cheap products or poor quality products. This causes the brand image to be impacted.
• Price war: Price penetration triggers price wars. It reduces the overall profitability of the product in the market. New entrants companies are not robust enough to survive a price war even though they trigger it.
• Incompetent long-term strategy: Price penetration is an unviable pricing strategy in the long run. Companies must approach the market place with a valuing tactic or technique that they can manage with in the future. It may take a while to gain a market share but a patient and well-thought-out strategy are more resistant and resilient in terms of financial risks.

Conclusion:

Penetration pricing, as a marketing strategy can be successful when applied correctly. When devised well and implemented accurately with a well-devised plan, it can increase both market share and volume of sales. The higher amount of sales leads to reduce production costs, increase inventory turnover, and retain customer base. The key to improving sales is to retain newly-acquired customers.

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Also Read

5 of the Best Penetration Pricing Examples