In a competitive market where there is little product differentiation, a new entrant can stand out by selling at a low price. Even if the substitute products are slightly better, brands that compete on price tempt the mass market. The aim of this comprehensive article is to bring clarity to penetration pricing strategy and draw a distinction between pricing strategies that are often interchangeably used.
What is Penetration Pricing?
‘Penetration Pricing’ is a short-term marketing strategy, that brands try in the initial phase to increase market share. By offering the lowest price in its category, the product intents to sell maximum volume. After capturing a sizeable market share, the price is then steadily increased. The ultimate goal of such brands is to develop long-term loyalty among customers.
Penetration pricing suits products that are price-elastic. Such products are sensitive to price variation and have high mass appeal and aspiration value. If your business goal aims to achieve any of the following or a combination, then a penetration pricing strategy may work for you.
Price Skimming vs. Penetration Pricing
In one of our earlier articles, we explored prestige pricing, a strategy in which a premium price is set for a product to give an impression of high quality and desirability. The price skimming strategy is similar to prestige pricing. In both strategies, products are launched with a high price tag. Unlike prestige pricing, in skimming, the price is reduced a few months after its launch. Car brands and tech-related products are highly competitive sectors. As soon as a product launches, competitors introduce products with similar features. Therefore, skimming is a commonly used pricing strategy. This line graph is a classic example of price skimming. It shows the price reduction of 9 different models of Samsung phones over 41 months since their launch.
The penetration pricing strategy is exactly the opposite. When a product is launched, it is priced much below its competitors, and over time the price is increased.
Penetration Pricing vs. Loss Leader Pricing
The intention of loss leader pricing and penetration pricing is the same – to expand the market share. Loss leader pricing is used at any phase in a product’s lifecycle but only brands that have two complementary products can use this pricing. In this strategy, they sell one of the items at a loss and entice customers to buy their highly-priced complementary product. This strategy of killing two birds with one stone was very cleverly implemented by Gillette. The brand sold its mechanical razor below cost price to stimulate customers to buy higher profit-generating replacement blades.
Introductory Pricing vs. Penetration Pricing
There is a very subtle difference between introductory pricing and penetration pricing. In both these strategies, low prices act as a stimulus to attract customers to buy a newly launched product. The introductory trial price runs from one month to a year, thereafter it goes full price. Whereas, brands using penetration pricing intend to gain a large market share by selling more volume of products at low prices. To fulfill this goal, there are instances when companies extend the strategy for more than a year.
In the above example, when the Slurpee lemon lychee drink was introduced in February ’22 at 7Eleven stores, in Malaysia, the introductory price offer of RM1.50 was offered for a month. After March 2022, the price was increased to RM2.30. Introductory pricing is a strategy to encourage consumers to try a new item. Once a sizeable number of customers try the product, they take off the discounted price. If customers like the product, they might continue to buy the product at full price.
Industry Examples of Penetration Pricing Strategy
Most brands use penetration pricing in the first phase of the product cycle. Thereafter, when the product gains enough market share it shifts its pricing strategy to a favorable circumstance.
Uber Wins Market Share with Penetration Pricing
Uber is an online marketplace that uses a dynamic pricing model. But to capture market share in a new city, it offers penetration pricing. For instance, in New York, yellow cabs do not give an estimate of the ride fare. Often when the trip ends, customers have to pay exorbitant fares. In this scenario, when Uber introduced its service in 2014, it gave an estimated fare through its app. The company received a cold shoulder from the customers. Not many passengers shifted their loyalty as the rides on UberX (seats up to 4 passengers) were costlier than the yellow cabs. That’s when Uber used penetration pricing to gain a major market share. The fare was reduced by 20% for a limited time. The graph below is a comparison of the fare of the yellow cab and UberX before and after penetration pricing. Presently, Uber has 71% of the ride-sharing market in the US.
Generally, Uber shifts to dynamic pricing after winning a major market share in a city. The company decides on an optimal price based on advanced big data analytics and rich customer insights. When the demand for a ride is greater than the number of cabs available, the price per trip goes as high as 8 times the normal price. And when there are more cabs around the requested location but not much demand for rides, the price drops.
Netflix Localizes Penetration Pricing
Blockbuster was a popular video-rental company in the US that charged $4.99 as rent for three days, and a fine was levied for each extra day. In 1997, Netflix disrupted the rental market with a new promise. They introduced a penetration pricing scheme wherein customers could rent four movies at a time for $15.95 per month without any penalty for late returns. By offering a value addition of not charging a late fee, customers instantly joined Netflix.
Besides Netflix, all streaming services such as Amazon, HBO, Hulu, and Disney Plus have implemented penetration pricing successfully by offering discounts or free trial periods to customers when they enter a new market. In 2019, when Disney+ launched with an attractive price of $6.99/month, a big chunk of family subscribers did shift their loyalties, yet Netflix continued its top position with better content. Their thorough understanding of the client’s needs, the localized country-wise pricing, and the features that people from each region are willing to pay is Netflix’s strengths.
Penetration Pricing on Organic Food – a Bait for Shoppers
For grocery items where there is little differentiation between brands, buyers may not mind switching loyalties if they receive value for their money. The Organic industry survey conducted between 2020-21 by Organic Trade Association shows, in the organic category, food comprises over 90 percent of the sales. It rose to $57.5 billion, i.e. roughly 2 percent growth, and non-food sales saw 7 percent growth reaching $6 billion in sales. The reason for this tremendous growth is that Americans are gravitating towards healthier choices.
Owing to huge demand, organic products cost 63% more than their non-organic counterparts in all grocery stores. As a value addition to their loyal customers, Costco and Kroger apply penetration pricing to their organic segment. Costco along with supermarket chain Kroger both enjoy a sizeable market share in this segment as the volume of sales they are doing has gone up. The smaller grocery chains are applying the same strategy. Brodington’s Market’s grocery store offers organic fruits at a special price of $2.99 as a feel-good factor to new members who sign up with them.
In consumer packaged goods, as a result of recent inflation, shoppers have shifted their loyalties to private labels that offer quality products at lower prices. Besides, big players like Kroger, Walmart, Costco, Sam’s Club, and Aldi; retail chains like Sprouts, Publix, Whole Foods, and Wegman have implemented penetration pricing in their premium line of private labels. These retailers are reaping the benefits because of economies of scale.
IKEA Enters New Markets With Penetration Pricing
IKEA largely sells contemporary-styled furniture, as it appeals to consumers of different regions. The company uses penetration pricing to establish a strong presence in a new geographical area. Once the brand establishes, it uses multiple pricing strategies like competitive pricing to have a competitive edge over other brands; and promotional pricing as a tactic to drive sales, clear inventory, and make room for new products.
The unique strategies this Swedish furniture brand comes up with are just amazing! Usually, all furniture brands price their items post-production depending on the cost incurred. The company follows a reverse design process, where the company decides the price range before designing its furniture. IKEA practices a cost leadership strategy to bring efficiency to production and thereby reduce operational costs. Another marketing strategy that this brand beautifully executes is ‘the decoy effect’, wherein the brand offers 3 options in a product category- budget, the product features that do not justify its price, and thirdly, an option with premium features that is slightly more priced than the 2nd option. It is more likely for customers to choose the third option in this scenario. This marketing strategy where the existence of an unattractive option is there just to make a higher-priced product look fascinating is the decoy effect.
Pros and Cons of Price Penetration
The demand for a product increases manifold in penetration pricing, as the price is low. The challenge is to prevent this demand from dwindling with the price increase.
- It is a great method to increase the customer base.
- Limited-time discount encourages customers to act quickly.
- Higher sales volume leads to lower production costs.
- If the volume is consistently high, brands see an increase in revenue.
- Fast inventory turnover opens the way for new collections.
- Selling at a lower price prevents competitors from entering the market.
- Offering a significantly lower price helps to attract customers but if the prices remain low for very long, smaller business groups may not be able to sustain themselves.
- When an unestablished brand introduces products with cheaper price tags, customers might perceive the product as inferior.
- The challenge lies in retaining customers when the price increases at a later date.
Predatory Pricing: An Extreme Form of Penetration Pricing
In predatory pricing, the price on offer is lower than the cost price. As it is an unhealthy strategy, it is illegal and banned in many countries including the US. In 2000, Walmart was fined for violating anti-trust regulations in Germany for selling staple goods much below the cost price to end local retailers.
With the data insights MetricsCart provides, you can choose a pricing strategy for your product that aligns with your business goal. Reach out to us today for data-driven solutions that can help you get an overview of your business’s digital shelf. With our data, you can develop a strategy to establish a foothold in your chosen industry.