The Advantages and Disadvantages of Penetration Pricing
Penetration pricing is a pricing approach that entails setting a reduced price at the beginning, in order to increase market share and then over some time, gradually raise the prices to make the product or service profitable.
It’s used in a number of circumstances, but the commonality is the goal of gaining market share where the price is used as a stimulus for people to adopt and purchase the product or service.
Unlike price skimming, where the price starts high but then is slowly reduced to skim different segments of the market to maintain profitability over a period, penetration pricing begins at a low cost. Instead of the basic idea of the law of supply and demand, where the smaller the price, the bigger the demand of goods, price penetration begins at a low price, and then it rises with the hopes that the demand increases too. The idea is to try to expand market share and then gradually increase prices over time.
Take, for example, discount stores (e.g. Walmart), wholesalers (like, SaleHoo) and hook-and-bait manufacturers (e.g. printers or razors). They use penetration pricing in a couple of ways. First, they use it to sell new products in their stores by advertising how low their prices are compared to other stores. They do this in hopes that the customers will purchase several items upon entering the store. Although they would be losing funds on the new product, they would be getting more customers into the store. Additionally, they use penetration pricing to undersell their established competition. Once they’ve secured and expanded their customer base, they gradually start raising prices. The explanation for this is that often times the initial prices introduced via penetration pricing don’t allow for a great deal of profitability since the margins are generally very slim. As a result, the business needs to increase prices over time in order to be able to offer their products and services more profitably.
When coming into a new market, using the penetration pricing approach is crucial since it’s useful when determining whether the product can capture a secure market rate. Despite not making any change to the company’s marketing strategy, it has an unimaginable potential for both profit and revenue growth. However, it is important to understand the advantages and disadvantages of penetration pricing as well as the risks that it carries.
- When penetration pricing is put into place, the adoption and diffusion percentages are elevated. Adoption is like diffusion, but it concentrates more on the emotional acknowledgment whereas diffusion depends on the acceptance from consumers of the recent product or service.
- Consumers, having found great deals on your product or service before, will most likely come back again in order to catch those profitable deals again. This also drives promotion by word of mouth.
- Initially, there is hardly any competition since the competitors are taken aback by the action and don’t have enough time to react. If they do decide to enter, they risk having smaller profits. They would also be entering a new market share which is full of uncertainty.
- Consumers often assume that the prices will stay as low as they are now. They are often taken aback by abrupt rises in prices and as a result, they may be prone to try switch to a competitor. Therefore there is a loss of market share that had been gained.
- There is a common belief that a good customer relationship cannot be created. As a result, customers only keep their eyes out for profitable deals and nothing else.
To conclude, penetration pricing is when a product or service is first put onto the market for a lower price than what is considered to be the norm. This scares away the competition, ultimately leaving the company to be on its own. Then they raise their prices and eventually achieve a monopoly over that market. The price could have a one time, but significant increase in pricing or it could have a gradual one. However, neither of those methods are certain for success.