What is Penetration Pricing?
Penetration pricing refers to a pricing policy generally used by a new entrant in the market. The product’s price is set at lower levels to gain the market share and therefore penetrate the market by attracting customers from its competitors. This pricing strategy is usually scrapped after the company gains a satisfactory share in the market.
Based on the type of the product and the level of competition, one may decide whether it will be beneficial to opt for penetration pricing or other pricing strategies such as skimming pricing strategy. The penetration pricing policy acts as a factor that disrupts the flow of markets and competitors are forced to alter their prices as well to retain their market share.
Table of contents
- Penetration pricing is a pricing policy a new entrant in the market utilizes. In this policy, the product’s price is fixed at lower levels to obtain market share.
- Generally, this strategy is used by new sellers in the developed economy. If a seller comes to the current product’s existing market, he must attract customers as a newcomer.
- This concept is for a specific product’s particular set. It sells the other products at regular prices to manage a reasonable profitability margin and is helpful for the products whose demand is elastic to its price.
Penetration Pricing Explained
Penetration pricing is generally used by sellers who are new to the already developed economy Developed EconomyA developed economy is the one that has a high per capita income or per capita GDP, a high degree of industrialization, developed infrastructure, technical advances, and a relatively high rank in human development, health, and education.. When a seller enters an existing market of a current product, he may find it difficult to attract customers being a newcomer. Such a seller can introduce penetration pricing and reduce its product prices for an initial period to attract customers to leave the competitors and connect with the seller. Sellers usually adopt this strategy for a particular set of products and simultaneously continue to sell the other products at their normal prices to maintain a reasonable profitability margin. The plan is useful for those products where the demand is elastic to its price.
It is also important to know that even existing players in the market adopt this strategy while launching or introducing a new product in the market. This helps them gather a considerable number of customers hooked to the product at a lower price and would not mind paying a little extra in the future as the product or service has become a part of their purchasing list.
Rest of the players in the market with similar products or product lines are also forced to make alterations to their plans to remain in competition and customers can still find value in purchasing their products despite the penetration pricing method adopted by their competitors.
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Let us understand the concept of adopting the penetration pricing policy with the help of a couple of examples.
A new telecommunication company in the market has offered to provide one-month free internet services to its subscribers. Such is an example of penetration pricing since the telecommunication company, to enter the market, has provided its internet services for free for an initial period of one month.
The news spread like wild fire and people purchased the SIM card to access free internet for their work and entertainment. After one month though, they began charging $10 per month for customers while the market average price was around $45 per month.
As a result, millions of users shifted from their existing network providers and moved to the new company. Subsequently, all other players reduced their pricing to around $15-$20 per month to retain what was left of their customer base.
In March 2023, the Reliance Group of Companies, one of the largest conglomerates in India acquire Campa and relaunched their products at prices literally half its competitors.
The carbonated drinks market worth $18 billion in India was dominated by PepsiCo and Coca-Cola.
The price for a 200 ml can, the price was $0.24 (INR 20) set by both multi-national companies. However, to penetrate the market with brutal force, the prices of Campa were literally half its competitors’ prices.
Their 200 ml can was priced at $0.12 (INR 10). Both Coca-Cola and PepsiCo face stiff competition and a good chance of losing their loyal customer base for decade because of a local brand re-emerging and far more affordable prices than the market standard.
The diagram below gives us a clear understanding of the penetration pricing policy. This will help us understand the concept in depth.
Here, the price and the quantity expected to be sold are represented on the vertical and horizontal axes. Thus, against price “P1”, a quantity expected to be sold is “Q1”. The price is kept at a relatively higher side. As a result, less quantity of goods is expected to be sold. If the price is further reduced to P2, more quantities, i.e., Q2, could have been sold. Thus, the graph represents that a lower price attracts the sale of a higher quantity, which is the subject matter in the case of penetration pricing.
Advantages and Disadvantages
Despite having multiple factors that help a company grow a fresh customer base, it has its share of risks and hassles as well. Let us understand the advantages and disadvantages of the penetration pricing method to understand the concept in detail.
- It helps a company establish its market share quickly and leaves the competitors with a lesser response time.
- It creates goodwillGoodwillIn accounting, goodwill is an intangible asset that is generated when one company purchases another company for a price that is greater than the sum of the company's net identifiable assets at the time of acquisition. It is determined by subtracting the fair value of the company's net identifiable assets from the total purchase price. for a company since customers promote the products automatically by word of mouth.
- Since prices are set at the lower end, it encourages the company to maintain cost controlsMaintain Cost ControlsCost control is a tool used by an organization in regulating and controlling the functioning of a manufacturing concern by limiting the costs within a planned level. It begins with preparing a budget, evaluating the actual performance, and implementing the necessary actions required to rectify any discrepancies., leading to resource efficiency.
- Such a pricing strategy discourages new competitors from entering the market.
- As the prices are low, it may not result in sufficient profitability for the company even if a substantial quantity of the product is sold.
- If the prices are initially kept lower, it becomes difficult to justify the increase in the costs later.
- The pricing strategy will not be useful for products with a shorter life cycle as the loss suffered by the company due to penetrative pricing in such a shorter life cycle may be substantial.
- If the sales do not rise quickly, it may be difficult for a company since the working capital will get blocked, leading to a shortage of funds.
Penetration Pricing vs Price Skimming
Both penetration pricing policy and price skimming are policies most often resorted by companies introducing themselves or their new products for the first time in the market. Let us understand the differences of both these strategies through the comparison below.
Penetration pricing is a pricing strategy wherein a seller introduces its products at a low price for a particular time to attract a larger market share. The school of thought behind the plan is that lower prices will attract more customers and help a company develop a good market share by shifting the customers’ focus from competitors. Afterward, the company increases the product’s price to its normal price.
On the other hand, price skimmingPrice SkimmingPrice skimming refers to a pricing strategy where the producers sell new, innovative, or improvised products or services at a high price for a short period targeting high-end customers and subsequently, reduces the price to tap remaining market segments. is a pricing strategy wherein a company aims to maximize its profits by charging high prices for its newly introduced product. After that, the costs are reduced to a normal price. This type of pricing strategy is adopted in case of unique products for which the customers may be willing to pay higher costs. A classic example of the price skimming policy is high technology-driven mobile phones, wherein customers are willing to pay higher prices owing to the phone’s features.
Frequently Asked Questions (FAQs)
The product’s seller uses the penetration pricing strategy if demand for a new product or service is expected to rise and also expects that the sales volume may offset the product’s cost, which is below the average price.
Many companies use this strategy to introduce a new product, enter a new market, or compete with established competitors. For instance, Netflix has adopted a market penetration pricing strategy to eliminate a significant competitor. Other companies like Starbucks have used this idea, bringing new or seasonal products at a lower price.
This pricing strategy is not illegal; however, if pushed too far, it results in predatory pricing, which is considered an unlawful business practice of setting low prices to discard competition. In addition, it breaches Antitrust laws that make a monopoly. Still, the process can be challenging to attempt.
Penetration pricing is the same as loss leader pricing. Therefore, it can be a suitable marketing method if used appropriately. Moreover, it may escalate market share and sales volume.
This article is a guide to what is Penetration Pricing. Here we explain its strategy, examples, advantages, and disadvantage and compared it to price skimming. You may learn more about financing from the following articles: –