Definition
Penetration pricing is a marketing strategy in which a company sets a low initial price for its product or service to attract customers and gain market share. This approach aims to establish a customer base, create brand loyalty, and eventually lead to increased sales and profits. Businesses often employ penetration pricing when launching a new product, entering a new market, or competing against established rivals.
Phonetic
Penetration Pricing Definition: /ˌpɛnɪˈtreɪʃən ˈpraɪsɪŋ dɛfɪˈnɪʃən/Examples: /ˈɛgzəmplz/And: /ænd/How: /haʊ/To: /tu:/Use: /juz/It: /ɪt/
Key Takeaways
- Penetration Pricing Definition: Penetration pricing is a marketing strategy wherein a company offers a new product or service at a significantly lower price than its competitors, with the aim of attracting customers and gaining a large market share quickly. The low pricing is often temporary and may be increased once the product gains a significant share of the market or is well-established in the market.
- Examples of Penetration Pricing: Examples of penetration pricing strategies include a new smartphone company offering lower-priced models to compete with established brands, a new video streaming service offering an initial low-priced subscription to attract users, or a newly-launched fast-food chain providing combo meals at a discounted price compared to rival brands.
- How to Use Penetration Pricing: To make the most of penetration pricing, a company should follow these steps:
- Analyze the target market and the competition to determine the appropriate pricing strategy.
- Set a low, yet sustainable price that can still generate profits but is low enough to encourage customers to try the new product or service.
- Promote the product by highlighting the value proposition and emphasizing the competitive pricing in marketing campaigns.
- Monitor the progress of the product’s market share and customer base, making adjustments to the pricing strategy as needed. Once the desired market share is achieved, gradually increase the price to a level that maintains a balance between customer satisfaction and profitability.
Importance
Penetration pricing is an important business and finance term, as it refers to a strategic approach that introduces new products or services at a lower price to enter a competitive market and attract customers. It plays a crucial role in gaining market share, building brand awareness, and fostering customer loyalty by enticing them with an affordable and attractive pricing point. Through penetration pricing, companies create opportunities to navigate market barriers and draw consumers away from competitor offerings, ultimately leading to increased sales and revenue. Additionally, once a significant market share has been achieved, companies can gradually raise their prices without losing customer loyalty, thus maximizing profitability. By understanding and utilizing penetration pricing, businesses can effectively establish themselves within competitive markets, drive their growth, and achieve long-term success.
Explanation
Penetration pricing is a strategic approach used by businesses to gain market share by initially setting low prices for their products or services. The purpose of this pricing strategy is to attract new customers and stimulate market demand by taking advantage of their price sensitivity. By offering a lower cost for their product, companies are able to quickly garner consumer interest and establish their presence in the market. This tactic is particularly effective in highly competitive industries, where the difference in prices can significantly influence consumers’ purchasing decisions. Moreover, penetration pricing aims to encourage existing customers to increase their usage of a company’s product while also enticing potential customers to switch from competitors’ products.
In order to effectively employ the penetration pricing strategy, businesses must be prepared to invest heavily in marketing efforts to communicate the value of their product and its competitive price. Examples of companies that have successfully used penetration pricing include Netflix, Amazon, and Spotify. These companies offered their services at an attractive introductory price, positioning themselves as a budget-friendly option, and, in turn, attracted a large user base. Once substantial market penetration is achieved, the company may choose to gradually increase its prices or shift to a different pricing model while still offering added value to maintain customer loyalty. The increased market share allows businesses to economies of scale, lower production costs, and eventually, enhance their profitability.
Examples
Penetration pricing is a marketing strategy used by businesses to gain a foothold in a market by initially offering products or services at a lower price to attract customers. The goal is to quickly gain market share, acquire a large customer base, and establish brand loyalty before gradually raising prices. Here are three real-world examples of penetration pricing in action:
1. Netflix: When Netflix entered the online streaming market, they employed penetration pricing to attract a large number of subscribers by offering lower-priced plans than the competition. In the early 2010s, Netflix offered unlimited streaming plans for as low as $7.99 per month, significantly lower than competitors like HBO, who charged around $15 per month. As a result, Netflix quickly built a massive subscriber base and gained substantial market share. Over time, as the company expanded its content library and improved its platform, it gradually increased subscription prices without significantly impacting its market dominance.
2. Amazon: Amazon has effectively used penetration pricing to enter new markets and expand its product offerings over the years. An example is Amazon’s Kindle e-reader, which was initially sold at a lower price than competitors such as Barnes & Noble’s Nook e-reader. This strategy helped Amazon draw in customers and establish an early lead in the e-reader market. As the company gained market share and customer loyalty, it introduced new and more advanced versions of the Kindle at higher price points while also offering services like Kindle Unlimited, a monthly e-book subscription service, at an additional cost.
3. Uber: When Uber entered the ride-sharing market, it employed penetration pricing by offering lower fares compared to traditional taxis and even providing promotions such as free first rides to attract new customers. As the company gained a large user base and established itself as the go-to ride-sharing platform in many cities worldwide, Uber gradually raised prices, introduced premium services like UberXL and UberBLACK, and implemented surge pricing during peak times. This allowed the company to capitalize on its dominant market share, generate revenues, and continue to expand its services.
Frequently Asked Questions(FAQ)
What is penetration pricing?
Penetration pricing is a marketing strategy used by businesses to attract customers by setting a low initial price for a new product or service. The primary objective of this approach is to quickly gain market share and foster customer loyalty before competitors have a chance to react.
How does penetration pricing work?
With penetration pricing, a business initially sells its product or service at a lower-than-market price to increase brand awareness, stimulate trial, and ultimately gain a significant market share. Once the initial objectives are achieved, the business can gradually increase the prices to match the market rate or maintain prices at a level compatible with its strategy.
What are some examples of penetration pricing?
Some examples of penetration pricing include:1. A new mobile phone company launching a low-priced yet feature-rich smartphone to compete against established brands.2. A streaming service offering discounted membership during its initial phase to gain users and compete with existing platforms.3. A software company offering a new program at a significantly lower price compared to similar tools in the market to attract customers and build word-of-mouth marketing.
When should a business use penetration pricing?
A business can consider using a penetration pricing strategy in the following situations:1. When entering a highly competitive market with established brands.2. When launching a new product or service and seeking to create brand awareness quickly.3. If the business aims to grab market share, fostering customer loyalty, and making it difficult for competitors to enter the market.
What are the advantages of using penetration pricing?
The advantages of penetration pricing include:1. It quickly expands market share and customer base.2. Encourages customer loyalty and brand preference in the long run.3. Creates barriers for competitors and makes it challenging for them to enter the market at a higher price point.4. Stimulates mass adoption of the product or service, leading to economies of scale and potentially reducing production costs.
What are the disadvantages of penetration pricing?
The disadvantages of penetration pricing include:1. It may lead to reduced profit margins in the short term due to low prices.2. Customers may perceive the low price as an indication of lower quality or value.3. If the market perceives the price increase negatively, it may lead to loss of customers.4. It is not a viable strategy for businesses with limited resources, as it may require sustained marketing efforts alongside low prices to gain significant market share.
How do businesses transition from the initial low price to a sustainable, long-term price?
Transitioning from the initial penetration price to a higher, sustainable price should be done gradually to avoid shocking the customer base. Businesses can introduce price increases in small increments, giving customers time to adjust to the new pricing model. Additionally, companies can enhance the value proposition by continually improving the product or service quality and offering additional features or benefits that justify the increased price.
Related Finance Terms
- Penetration Pricing Definition: Penetration pricing is a marketing strategy where a company initially sets a low price for a product or service to attract customers, gain market share, and later increase the price as the product or service becomes more established and popular.
- Examples:
- Introductory offers for subscription-based services (e.g., Netflix, Spotify, Amazon Prime)
- Pricing for a new smartphone to compete with established brands
- Discounted prices for initial product launches in the software industry
- How to Use Penetration Pricing: Companies can use penetration pricing by carefully researching their target market, setting an intentionally low initial price, increasing brand awareness through marketing, and strategically raising prices over time as the product or service gains popularity.
- Advantages: Penetration pricing can help businesses attract customers, increase market share, and create buzz about their products or services in the early stages of their introduction to the market.
- Disadvantages: Some potential drawbacks of penetration pricing include lower initial profits, potential difficulty in raising prices later on, and the possibility of alienating customers when increasing prices.
