Check our newest report - State of German SaaS Pricing 2023
By clicking "Accept All Cookies", you're unlocking a treasure trove of pricing and monetization knowledge!
These cookies help us analyze site traffic, improve navigation, and tailor our marketing efforts to your interests. By consenting to cookies, you're empowering us to fine-tune our content further, ensuring you get the most valuable insights possible. If you prefer to customize your cookie preferences, simply click "Preferences".

Penetration Pricing: What is It and When to Use It

by
in
Maciej Wilczyński
Managing Partner, Founder Valueships
March 9, 2024
pricing
consulting
strategy

With pricing, the main thing is not just about numbers; it's about strategy, understanding your market, and setting the stage for your product's journey. Penetration pricing stands out as a bold move in this journey, offering a way to grab attention and carve out market space amidst fierce competition.

What is Penetration Pricing?

Penetration pricing is a strategy where prices are set lower than competitors' to quickly gain market share and attract customers.

Rationale Behind Penetration Pricing

Unlocking Market Potential with Penetration Pricing

When entering a competitive market, standing out is key. A penetration pricing strategy does just that by offering new products or services at a low price. This approach isn't just about selling for less; it's a calculated move to build a customer base, foster loyalty, and disrupt the market dynamics.

  • Competitive Edge: By setting prices 6-10x lower than competitors, a brand can significantly undercut the competition, making it a go-to choice for cost-conscious consumers.
  • Rapid Market Share Gain: Lowering the entry barrier enables a company to gain market share 2-6x faster, laying the groundwork for long-term success.
  • Customer Loyalty: A low price point is an excellent way to attract new customers and, more importantly, keep them. Offering value for money fosters loyalty, encouraging repeat business.
  • Strategic Growth: Once a firm foothold is established, companies can leverage their customer base and economies of scale to improve their profit margin, even if prices increase later.
  • Awareness and Adoption: A lower price point makes trying a new product or service less risky for customers, speeding up market penetration and adoption rates.

However, it's crucial to balance the allure of low prices with the realities of sustaining a business. Penetration pricing is not without its disadvantages, such as potential price wars with competitors or the risk of customers perceiving the product as low quality due to its lower price. Moreover, once the market share is captured, raising prices to achieve a sustainable profit margin without driving customers away requires careful strategy.

In essence, using a penetration pricing strategy can be a powerful tool when entering a new market or launching a new product. It can help quickly build a customer base and disrupt existing market players. Still, it requires a careful approach to transition to a profitable business model in the long term.

When Would a Company Use Penetration Pricing?

Launching New Products

When introducing new products, companies often use penetration pricing to quickly attract attention and encourage trial. This strategy involves setting a low initial price to make the product accessible to a wide audience. It's especially effective for innovative items where early adoption can significantly influence market success. A perfect example of penetration pricing done right is Netflix's initial low subscription cost to gain viewership.

Entering Competitive Markets

In highly competitive markets, a penetration pricing policy can help a new entrant disrupt established players. By offering a lower price, a company can attract customers from competitors, quickly gaining market share. This approach requires careful planning to ensure it does not lead to unsustainable losses or trigger a price war, but when executed well, it can establish a strong market presence.

Building Market Share

A primary goal of penetration pricing is to build market share rapidly. This pricing model enables a company to become a significant player in the market by making its offerings more attractive than those of competitors. The strategy aims to create a large customer base that can be monetized through upselling or increased prices once loyalty is established.

Addressing Excess Capacity

Companies with excess production capacity may use penetration pricing to increase sales volume. This approach helps utilize idle capacity and achieve economies of scale, reducing per-unit costs. It's a practical marketing tactic for manufacturers looking to expand their market footprint without incurring significant additional costs.

Promoting Loss Leader Products

Loss leader pricing is a form of penetration pricing where a product is sold at a loss to attract customers. The aim is to increase traffic and promote the sale of more profitable goods or services. This strategy is commonly used in retail to draw customers into stores with the expectation that they will purchase additional items.

Responding to Market Saturation

In saturated markets, penetration pricing can rejuvenate sales by offering consumers a compelling reason to switch brands or try new products. This strategy involves careful analysis of the disadvantages of penetration pricing, such as potential impacts on brand perception and profitability. However, it can be an effective way to refresh interest in a product category.

Long-term Market Strategy

Penetration pricing is not just a short-term tactic; it can be part of a long-term strategy to dominate a market segment. After successfully attracting a customer base with low prices, companies can gradually raise prices as they introduce new features or products. This approach requires a balance to maintain customer loyalty while improving profit margins.

Countering Predatory Pricing

In some cases, penetration pricing may be used defensively to counter predatory pricing strategies by competitors. By matching or undercutting aggressive pricing, companies can protect their market share and prevent competitors from monopolizing the market. This requires a robust financial position to sustain lower profit margins temporarily and a clear understanding of the long-term benefits of maintaining market diversity.

What Types of Products Are Most Successful With Penetration Pricing?

Consumer Electronics

Consumer electronics often see successful penetration pricing, as technology enthusiasts eagerly await new releases. This strategy works well for items like smartphones, smartwatches, and laptops, where early market entry at a lower price can quickly build a customer base. Over time, prices may increase as the product becomes established and brand loyalty grows, demonstrating how penetration pricing enables a company to quickly gain market share.

Subscription Services

Subscription services, such as streaming platforms, software as a service (SaaS), or fitness apps, are prime candidates for penetration pricing. By offering introductory rates lower than competitors, these services can rapidly grow their user base. Netflix, for instance, is a great example of penetration pricing, initially offering low subscription costs to draw in viewers, later adjusting rates with an established subscriber base.

Fast-moving Consumer Goods (FMCG)

FMCGs, including groceries, toiletries, and over-the-counter drugs, can benefit from penetration pricing due to their high volume and frequent purchase rates. Lowering prices temporarily can attract customers and encourage them to switch brands, fostering loyalty and increasing market share. This strategy requires companies to closely monitor margins and ensure that low prices do not erode profitability.

Online Marketplaces

Online marketplaces can use penetration pricing to attract both buyers and sellers. By reducing fees or offering promotional rates, these platforms can quickly increase their listings and transactions, creating a vibrant community. The strategy aims to build a critical mass that sustains the platform long-term, transitioning to regular pricing as the marketplace becomes a preferred destination for online shopping.

Energy and Telecom Services

In sectors with high fixed costs like energy and telecom, penetration pricing can help new entrants challenge established providers. Offering lower rates for electricity, gas, or internet services can quickly attract customers. As the customer base grows, these companies can leverage economies of scale to maintain competitive pricing while improving service offerings, illustrating the benefits of penetration pricing in regulated industries.

Fashion and Apparel

Fast fashion and apparel brands can use penetration pricing to introduce new lines or enter new markets. By initially pricing items below market rates, brands can quickly attract fashion-forward consumers and establish a presence. This approach can be particularly effective in trend-driven markets, where brand visibility and volume can lead to long-term customer loyalty and brand recognition.

Educational and E-learning Platforms

E-learning platforms and educational services can implement penetration pricing to attract students and professionals looking to upgrade their skills. By offering courses at a lower price than traditional education institutions, these platforms can quickly expand their user base. As the value of the educational content is proven, prices can be adjusted, reflecting the high value of knowledge and skills gained.

Health and Fitness Products

Health and fitness products, including dietary supplements, fitness equipment, and wellness apps, can successfully employ penetration pricing to enter a crowded market. Lower introductory prices can encourage consumers to try new products in their health and fitness routines. Once customers experience the benefits, they are more likely to remain loyal, even if prices increase, leveraging the strategy to work effectively in the health and wellness sector.

Do you need more practical insights?
Do you need more practical insights?
Learn more about pricing

Pros of Penetration Pricing

Rapid Market Entry

Penetration pricing strategy aims to quickly establish a presence in a competitive market by setting low initial prices. This approach attracts customers away from established players, accelerating market entry and brand recognition. A prime example is Netflix, which initially offered lower subscription fees to quickly attract a vast customer base, disrupting traditional cable services. This strategy helps companies quickly scale their user base and establish a foothold in the market.

Building Customer Base

The goal of this pricing strategy is not only to enter the market but also to build a substantial customer base. By offering products or services at lower prices, companies can attract price-sensitive customers. Once these customers are onboard, businesses have opportunities to upsell or cross-sell, increasing revenue over time. This approach is particularly effective for businesses that rely on subscription models or recurring purchases.

Economies of Scale

A successful penetration pricing model can lead to economies of scale. As sales volume increases due to lower prices, companies can achieve cost savings in production, distribution, and marketing. These savings can then be passed on to the customer, maintaining low prices while improving profit margins. High sales volumes can also deter new entrants, solidifying the company’s position in the market.

Disrupting Competitors

Penetration pricing also serves as a competitive strategy to disrupt existing market players. By offering lower prices, new entrants can challenge established businesses, forcing them to reconsider their pricing strategies. This can lead to a shakeout of weaker competitors who cannot match the price or value, leaving a clearer field for the penetrating company to grow its market share.

Brand Loyalty and Market Share Growth

Lower initial prices can foster brand loyalty as customers perceive the brand as offering good value. As the company raises prices moderately after securing a market base, satisfied customers are less likely to switch to competitors. This long-term loyalty helps in maintaining and gradually increasing the market share, making penetration pricing a strategic foundation for sustainable growth.

Cons of Penetration Pricing

Perceived Value and Brand Image Risk

Penetration pricing can sometimes negatively impact the perceived value of a product or service. Customers might associate lower prices with lower quality, potentially damaging the brand image. This perception can be hard to reverse, even when prices are raised later, making it crucial for businesses to manage their value proposition carefully.

Lower Initial Profit Margins

By adopting a penetration pricing strategy, companies accept lower initial profit margins in exchange for potential market share gains. This approach requires significant upfront investment and may strain financial resources, particularly for startups or smaller businesses. The strategy may also extend the time required to achieve profitability, posing risks if the market does not respond as expected.

Dependence on Volume

The success of penetration pricing relies heavily on achieving high sales volumes. If the expected volume growth does not materialize, the company may find itself operating at a loss. This dependence makes penetration pricing risky, especially in markets with uncertain demand or strong competition.

Difficulty in Raising Prices

Once customers are accustomed to low prices, raising them can be challenging. The initial price sets expectations, and significant increases may lead to customer churn. Companies need to plan carefully how and when to adjust prices to avoid alienating their customer base, potentially eroding the initial gains made through penetration pricing.

Risk of Price Wars

When entering the market with a penetration pricing strategy, there's a risk of initiating a price war with competitors. Established companies may retalize by slashing their prices, leading to a downward spiral that hurts all players in the market. Price wars can diminish profit margins industry-wide, making recovery difficult even after prices stabilize.

Is Penetration Pricing Ethical?

Penetration pricing is a marketing strategy used to quickly enter the market and attract a large volume of customers. This approach, detailed in many a guide to penetration pricing, lowers the entry barrier for consumers, making it easier for them to try new products or services. But when we dive into the pros and cons of penetration pricing, ethical considerations come to the fore.

Key Considerations:

  • Fair Competition: Penetration pricing strategy may force competitors to slash their prices, potentially harming smaller businesses. Is it fair play, or does it exploit market dominance?
  • Consumer Benefit: On one hand, penetration pricing offers consumers more for less, at least initially. But, is this sustainable, or does it set unrealistic expectations?
  • Market Dynamics: Use market penetration wisely. It's crucial to balance aggressive pricing with the long-term health of the industry. Skimming strategy works well for innovative or luxury products where early adopters are willing to pay more. However, this might not always be the case with penetration pricing.

When considering penetration pricing vs. competitor pricing, the strategy's ethicality largely depends on its implementation and intent. If the goal is to genuinely offer value while fostering healthy competition, penetration pricing can be a boon to consumers and stimulate market growth. However, if used to undercut and eliminate competition, it could be viewed as predatory.

  • Transparency and Integrity: Always communicate pricing changes clearly to customers.
  • Monitor Impact: Regularly assess the impact of your pricing on the market and adjust if necessary to maintain fair competition.

Penetration Pricing Examples

Netflix: Revolutionizing Streaming Services

Netflix exemplifies price penetration strategy to quickly gain a vast subscriber base in the competitive streaming market. By initially offering low subscription fees, Netflix disrupted traditional cable services, attracting millions of users worldwide. As its content library expanded, Netflix gradually increased prices, retaining customers through high value. This case shows how penetration pricing can be the right strategy for digital platforms seeking rapid market growth.

Amazon Prime: Expanding E-commerce Reach

Amazon utilized price penetration when it introduced Prime, offering fast, free shipping for a low annual fee. This strategy not only increased sales on its e-commerce platform but also locked in customer loyalty. Over time, Amazon added more services to Prime, such as streaming video and music, justifying slight price increases while maintaining a strong subscriber base. Amazon Prime demonstrates how penetration pricing can enhance cross-selling opportunities.

Ikea: Entering New Markets

Ikea's strategy to enter the US market involved penetration pricing, offering quality furniture at lower prices than competitors. This approach helped Ikea quickly establish a presence and attract cost-conscious consumers. By streamlining production and supply chain processes, Ikea managed to maintain low prices, driving market share growth. This example highlights penetration pricing as an effective strategy for international expansion in retail.

Xiaomi: Gaining Footprint in the Smartphone Industry

Xiaomi utilized price penetration to disrupt the highly competitive smartphone market. By offering high-quality smartphones at significantly lower prices than established brands, Xiaomi rapidly gained market share, particularly in Asia. This strategy was supported by online-only sales and community engagement, reducing costs. Xiaomi’s approach shows how price penetration can challenge industry leaders and appeal to price-sensitive consumers.

Spotify: Streaming Music for Everyone

Spotify adopted penetration pricing by offering free, ad-supported access to its vast music library, alongside premium subscriptions at competitive rates. This model attracted a wide user base, converting many free users to paying customers over time. Spotify's approach highlights the benefits of using a freemium model as a form of penetration pricing to capture market share in digital services.

Razor-and-Blades Model: Printer Ink and Gaming Consoles

The razor-and-blades model, used by companies selling printers and gaming consoles, applies penetration pricing principles. Selling the primary product at a low margin or even a loss (printers or consoles) to boost sales of high-margin complementary goods (ink cartridges or games) exemplifies this strategy. This approach ensures long-term revenue streams and customer lock-in, showcasing the versatility of penetration pricing in various product categories.

Conclusion

Penetration pricing, when used responsibly, can be an effective pricing strategy. It's not just about the initial market splash but fostering long-term relationships with customers and contributing positively to the market ecosystem. Like any strategy, its ethical implications depend on how companies choose to use this strategy. As with Netflix, a great example of effective penetration pricing, success and ethics can go hand in hand – but with its advantages and disadvantages as well.

FAQ

What is a penetration strategy example?

Netflix is a great example, using low subscription fees to quickly grow its subscriber base.

What is a penetration pricing strategy?

Penetration pricing is a pricing strategy to quickly enter the market by setting low initial prices to attract customers.

What is a penetration approach?

A penetration approach involves setting low prices from the start to quickly capture market share.

Why use penetration strategy?

To quickly attract a large customer base and establish market presence by undercutting competitors.

What is price skimming?

Price skimming involves setting high initial prices for new, innovative products, gradually lowering them over time.

Do you need more than this? We have another option!

Subscribe to our newsletter and grab more pricing insights.

I want to know more!
Maciej Wilczyński
Managing Partner, Founder Valueships

Expert in B2B pricing, monetization and value-based selling strategies. Over the past year, he has completed over 40 consulting projects in Europe. Prior to founding Valueships, he worked at McKinsey & Company, mainly in the TelCo, software, and banking industries. He completed his doctorate in pricing in SaaS start-ups at the University of Economics in Wrocław, where he also lectures.

Schedlue a free consultation
Maciej Wilczyński
Managing Partner, Founder Valueships

Expert in B2B pricing, monetization and value-based selling strategies. Over the past year, he has completed over 40 consulting projects in Europe. Prior to founding Valueships, he worked at McKinsey & Company, mainly in the TelCo, software, and banking industries. He completed his doctorate in pricing in SaaS start-ups at the University of Economics in Wrocław, where he also lectures.