Penetration pricing - AbsoluteAstronomy.com

For other pricing strategies and policies please see here: Pricing strategies
Pricing strategies
Pricing strategies for products or services include the following:-Competition-based pricing:Setting the price based upon prices of the similar competitor products.Competitive pricing is based on three types of competitive product:...

Penetration pricing is the pricing

Pricing

Pricing is the process of determining what a company will receive in exchange for its products. Pricing factors are manufacturing cost, market place, competition, market condition, and quality of product. Pricing is also a key variable in microeconomic price allocation theory. Pricing is a...

technique of setting a relatively low initial entry price, often lower than the eventual market price, to attract new customers. The strategy works on the expectation that customers will switch to the new brand

Brand

The American Marketing Association defines a brand as a "Name, term, design, symbol, or any other feature that identifies one seller's good or service as distinct from those of other sellers."...

because of the lower price. Penetration pricing is most commonly associated with a marketing

Marketing

Marketing is the process used to determine what products or services may be of interest to customers, and the strategy to use in sales, communications and business development. It generates the strategy that underlies sales techniques, business communication, and business developments...

objective of increasing market share or sales volume, rather than to make profit in the short term.

The advantages of penetration pricing to the firm are:

It can result in fast diffusion
Diffusion (business)
Diffusion is the process by which a new idea or new product is accepted by the market. The rate of diffusion is the speed that the new idea spreads from one consumer to the next. Adoption is similar to diffusion except that it deals with the psychological processes an individual goes through,...

and adoption. This can achieve high market penetration
Market penetration
Market penetration is8th growth strategies of the Product-Market Growth Matrix defined by Ansoff. Market penetration occurs when a company enters/penetrates a market with current products. The best way to achieve this is by gaining competitors' customers...

rates quickly. This can take the competition by surprise, not giving them time to react.
It can create goodwill among the early adopters segment
Market segment
Market segmentation is a concept in economics and marketing. A market segment is a sub-set of a market made up of people or organizations with one or more characteristics that cause them to demand similar product and/or services based on qualities of those products such as price or function...

. This can create more trade through word of mouth
Word of mouth
Word of mouth, or viva voce, is the passing of information from person to person by oral communication. Storytelling is the oldest form of word-of-mouth communication where one person tells others of something, whether a real event or something made up. Oral tradition is cultural material and...

.
It creates cost control and cost reduction pressures from the start, leading to greater efficiency.
It discourages the entry of competitors. Low prices act as a barrier to entry (see: porter 5 forces analysis
Porter 5 forces analysis
Porter's five forces analysis is a framework for industry analysis and business strategy development formed by Michael E. Porter of Harvard Business School in 1979. It draws upon industrial organization economics to derive five forces that determine the competitive intensity and therefore...

).
It can create high stock turnover throughout the distribution channel
Distribution (business)
Product distribution is one of the four elements of the marketing mix. An organization or set of organizations involved in the process of making a product or service available for use or consumption by a consumer or business user.The other three parts of the marketing mix are product, pricing,...

. This can create critically important enthusiasm and support in the channel.
It can be based on marginal cost pricing
Profit maximization
In economics, profit maximization is the process by which a firm determines the price and output level that returns the greatest profit. There are several approaches to this problem...

, which is economically efficient.

The main disadvantage with penetration pricing is that it establishes long term price expectations for the product

Product (business)

In general, the product is defined as a "thing produced by labor or effort" or the "result of an act or a process", and stems from the verb produce, from the Latin prōdūce ' lead or bring forth'. Since 1575, the word "product" has referred to anything produced...

, and image preconceptions for the brand

Brand

The American Marketing Association defines a brand as a "Name, term, design, symbol, or any other feature that identifies one seller's good or service as distinct from those of other sellers."...

and company. This makes it difficult to eventually raise prices. Some commentators claim that penetration pricing attracts only the switchers (bargain hunters), and that they will switch away as soon as the price rises. There is much controversy over whether it is better to raise prices gradually over a period of years (so that consumers don’t notice), or employ a single large price increase. A common solution to this problem is to set the initial price at the long term market price, but include an initial discount coupon (see sales promotion

Sales promotion

Sales promotion is one of the four aspects of promotional mix. Media and non-media marketing communication are employed for a pre-determined, limited time to increase consumer demand, stimulate market demand or improve product availability...

). In this way, the perceived price points remain high even though the actual selling price is low.

Another potential disadvantage is that the low profit margins may not be sustainable long enough for the strategy to be effective.

Price Penetration is most appropriate where:

Product demand is highly price elastic
Price elasticity of demand
Price elasticity of demand is a measure used in economics to show the responsiveness, or elasticity, of the quantity demanded of a good or service to a change in its price. More precisely, it gives the percentage change in quantity demanded in response to a one percent change in price...

.
Substantial economies of scale
Economies of scale
Economies of scale, in microeconomics, refers to the cost advantages that an enterprise obtains due to expansion. There are factors that cause a producer’s average cost per unit to fall as the scale of output is increased. "Economies of scale" is a long run concept and refers to reductions in unit...

are available.
The product is suitable for a mass market (i.e. enough demand).
The product will face stiff competition soon after introduction.
There is not enough demand amongst consumers to make price skimming
Price skimming
Price skimming is a pricing strategy in which a marketer sets a relatively high price for a product or service at first, then lowers the price over time. It is a temporal version of price discrimination/yield management...

work.
In industries where standardization is important. The product that achieves high market penetration often becomes the industry standard (e.g. Microsoft Windows) and other products, whatever their merits, become marginalized. Standards carry heavy momentum.

A variant of the price penetration strategy is the bait and hook model (also called the razor and blades business model), where a starter product is sold at a very low price but requires more expensive replacements (such as refills) which are sold at a higher price. This is an almost universal tactic in the desktop printer business, with printers selling in the US for as little as $100 including two ink cartridges (often half-full), which themselves cost around $30 each to replace. Thus the company makes more money from the cartridges than it does for the printer itself.

Taken to the extreme, penetration pricing becomes predatory pricing

Predatory pricing

In business and economics, predatory pricing is the practice of selling a product or service at a very low price, intending to drive competitors out of the market, or create barriers to entry for potential new competitors. If competitors or potential competitors cannot sustain equal or lower prices...

, when a firm initially sells a product or service at unsustainably low prices to eliminate competition and establish a monopoly

Monopoly

A monopoly exists when a specific person or enterprise is the only supplier of a particular commodity...

. In most countries, predatory pricing is illegal

Antitrust

The United States antitrust law is a body of laws that prohibits anti-competitive behavior and unfair business practices. Antitrust laws are intended to encourage competition in the marketplace. These competition laws make illegal certain practices deemed to hurt businesses or consumers or both,...

, although it can be difficult to differentiate illegal predatory pricing from legal penetration pricing.

See also