Penetration Pricing

What is Penetration Pricing?

Penetration pricing is a pricing strategy where a business introduces customers to its product at a low price, often significantly below the eventual market price, to draw them in and gain market share quickly. Once it gains enough traction (i.e., market penetration), the business will either increase the price to a sustainable level or keep it low to continue drawing new customers.

A penetration price could either be temporary or baked into its long-term growth strategy. Examples include:

• A buy-one-get-one-free (BOGO) offer for this weekend only
• A special six-month discount for switching from a competitor
• A low-cost beta version of a SaaS product that’s set to rise in price after launch
• Free listings to attract sellers to a marketplace

Similar to loss leader pricing, its main goal is to attract the maximum number of potential customers, even if it means reducing profit margins or taking a loss. The idea behind this strategy is that with a greater market share and higher sales volumes, a company can eventually lower production costs and turn over inventory more quickly.

Since penetration pricing works on the assumption that customers will be happy enough with the product to pay a higher price, product-market fit, overall quality, and customer retention efforts are essential to its success. Vendors must also be transparent about their intention to raise their price so as to not frustrate the customers they gain.

Synonyms

• Market penetration strategy
• Penetration pricing strategy

Why Companies Use Penetration Pricing

Companies use penetration pricing when they’re chasing brand awareness, sales volume, or user adoption over short-term revenue and profitability. The penetration price isn’t meant to be sustainable — it’s meant to increase over time (and hopefully retain a loyal customer base with it).

Because of its versatility, all types of companies use it. Ecommerce brands, SaaS businesses, streaming services, telecom companies, professional services providers, and countless other industries often use price penetration to gain a competitive advantage.

Test Product-Market Fit

For new companies that aren’t quite sure where their product fits into the marketplace, some revenue is better than none.

SaaS companies frequently do this when they’re rolling out a new product or adding new paid features. Since they don’t know who it’s best for (or if it works at all), gathering user data and feedback is more important than immediate profitability.

Companies selling physical products use this method too. If they aren’t sure how their product is differentiated, they’ll sell it to small groups of buyers at low initial prices to test customer reactions or understand how they actually use the product.

Whether it’s for a software or physical product, a price penetration strategy gives the vendor the chance to refine it, understand its use cases, and zero in on its marketing strategy before fully launching it and justifying its full value.

New Product Launches

New businesses (especially those in saturated markets) need an edge to get noticed and build momentum.

On Amazon, the world’s largest ecommerce marketplace, it’s common for new users to significantly discount their products and forego profits at first. Once they have enough consistent sales and reviews to improve their visibility, they’ll increase prices to their true market value.

Some organizations generate buzz around new product launches and run promos that undercut competitors. A clothing brand might host a private sale to celebrate its new autumn/winter collection, for example.

Digital services like streaming services, SaaS product vendors, and telecom companies often use this strategy to scoop up market share. They’ll offer the first 3-6 months at a promotional rate, for example, or throw in incentives like free trials, discounts, and add-ons.

Vendors can also use a “freemium” model where a customer signs up for a free, bare-bones option and — ideally — converts to a paid version upon familiarizing themselves with it.

Understand Price Sensitivity

High price elasticity is generally a prerequisite for penetration pricing. Products with low elasticity (i.e., customers tend to buy regardless of the price) are less likely to benefit from a price drop than those that are more sensitive to changes in prices.

If a company knows its audience and their purchasing habits, it can use this strategy to find out just how much they’re willing to pay for a product or service. If customers abandon their product altogether when the price rises, perhaps lowering it to a sustainable level would be more effective in the long run.

A penetration pricing example for such a case could be an introductory offer like, “25% off your first purchase or 10% off for life.” — something that can still bring in some revenue while seeing how well customers respond to discounts.

In some cases, an organization may realize total addressable market reacts better to a slightly lower price (e.g., 10% off for life). Price optimization may mean lowering it to this price to capitalize on sales and become more profitable over time.

Gain Market Share

Once a product becomes popular, it’s easier for other competitors to copy it — so if you want to stay ahead of the pack, you must offer something unique and attractive.

For companies with an already-established market presence, penetration pricing is a great way to increase market share and capture new customers.

One way to do this is by dropping the price (or making it cheaper than competing options). This can help differentiate a product in a crowded market and give customers an easy decision-maker (i.e., “the cheapest one”).

This pricing technique works particularly well when there’s a high switching cost, such as with streaming services like Netflix or telecom providers like AT&T and Verizon.

Build Brand Loyalty

Sometimes, it isn’t about the money. One of the biggest advantages of penetration pricing is the potential to build loyalty and trust with new customers.

The same way nearly 20% of customers convert after a free trial, a penetration price could be the push a semi-interested customer needs to finally pull the trigger.

Once they’re familiar with it, customers may be more likely to stick around even when prices go back up — especially if switching costs are high or the customer was already invested in similar products before.

For example, a digital music streaming service could offer an introductory price of $5 per month. Even if they double it after the first few months, chances are good the brand will retain its customer loyalty (assuming the platform works as it should).

Market Disruption

Mass market disruption is a powerful tool to shake up an industry and take market share from incumbents. It works best when a new product challenges the current most-popular business model in a market.

Startups with little-to-no brand recognition usually use price penetration to gain traction in the marketplace, since customers are more likely to switch to them if it’s cheap enough.

Uber did this when they launched their ride-hailing service: they kept prices low for riders, made it easy for them to use, and made it possible for drivers to work on their own terms, which helped them undercut traditional cab companies.

Interestingly enough, this is part of the reason Uber is worth $90 billion, yet the company has never had a profitable year.

Disadvantages of Penetration Pricing

The penetration pricing method is a risky approach — its success depends heavily on the industry, product, and timing.

Briefly, there are a few potential disadvantages to using penetration pricing:

1. Lower profit margins. Initially low prices can erode profits, and it might take some time to recover these losses even after increasing prices.
2. Perceived value may be tarnished. If customers believe the penetration price of a product fairly suits its value, they will be unwilling to pay more for it.
3. Customers may respond poorly to pricing hikes. If prices are increased too quickly or too steeply after the initial penetration phase, customers might feel deceived. This can harm the company’s reputation and customer loyalty.
4. Competitors may be able to meet the lower price. If competition can afford to match or undercut the penetration price, this strategy may not be as effective at gaining market share. In some cases, it could spark a price war, further eroding profit margins for all companies involved.
5. Rising prices pose business challenges. Once customers are accustomed to low prices, they may resist when prices are increased, even if higher costs or improved product features justify the increases.
6. Potential new customers may see the product as low-quality. If customers interpret a low price tag as “cheap,” the brand’s image and reputation will suffer (and users still won’t adopt it).
7. Penetration pricing has a volume dependency. Since it’s based on the principle of economies of scale, it only becomes profitable when a certain sales volume is reached. The strategy could lead to significant losses if the anticipated volume isn’t achieved.
8. There are barriers to market exit. If the strategy doesn’t work out and the company decides to exit the market, the low price point may have attracted too many customers to withdraw without significant repercussions.

Because of these factors, it works best in markets where price is a major factor in consumer decision-making and there is a clear potential for significant economies of scale.

Data Required for Effective Penetration Pricing

Successful penetration pricing strategies rely on pricing intelligence to be successful. Without the right data, businesses will find it practically impossible to price their products effectively.

Target Market

Understanding the target market forms the basis of a successful penetration pricing strategy. Businesses need to know who their potential customers are, what they value, and their price sensitivity.

Conducting thorough market research through surveys and market intelligence tools will uncover their purchasing habits, income levels, and preferences.

Pricing History

Historical pricing data allows companies to compare prices of similar products on the market and identify pricing trends and competitors’ pricing strategies.

When a company already has an established foothold in the marketplace, its stakeholders can examine their own historical pricing data to identify patterns and determine the optimal pricing strategy.

Competitive Analysis

Competitive intelligence (e.g., pricing, promotions, and strategies) can also provide valuable insight into market dynamics. Companies need to know what techniques work and which ones don’t for their competitors.

Competitor analysis should include product features, pricing history, customer feedback, promotional campaigns, and other factors that could affect the success of a penetration pricing strategy.

Sometimes, other companies will have used a penetration pricing strategy for a product launch (in which case, it might be well-documented). If so, companies can use this information to inform their own strategy.

Customer Data

Data from current customers can help companies identify their customers’ preferences, behaviors, and loyalty. It also tells them how well customers respond to current prices.

With current customers, gathering additional intelligence through surveys, promotions, and loyalty programs is sometimes helpful. This helps businesses understand what will be most attractive to customers in terms of pricing (e.g., introductory prices, discounts for long-term customers).

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