As we discussed earlier in our blog, finding the right pricing strategy is an essential key for the success of your business. This article takes a look at Penetration Pricing, a strategy that aims to increase market share of a product, providing the opportunity to increase price once this objective has been achieved.
Penetration pricing is the pricing technique of setting a relatively low initial entry price, usually lower than the intended established price, to attract new customers. The strategy aims to encourage customers to switch to the new product because of the lower price.
One company that is very good at this pricing strategy is Wal-Mart. The company promotes itself with an "Always the low prices" mantra and has been the target of criticism because of its ability to enter small communities, attract customers from local businesses, and eliminate competition. As a long-term strategy, penetration pricing requires the company to maintain low-cost operations, including inventory costs, labor, supply chains, and operations. However, penetration pricing may not work as a long-term play for a small business, unless you have unique access to low-cost suppliers and run highly efficient operations.
The following are advantages of using the penetration pricing method:
- Entry barrier. If a company continues with its penetration pricing strategy for some time, possible new entrants to the market will be deterred by the low prices.
- Reduces competition. Financially weaker competitors will be driven from the market, or into smaller niches within the market.
- Market dominance. It is possible to achieve a dominant market position with this strategy, though the penetration pricing may have to continue for a long time in order to drive away a sufficient number of competitors to do so.
The following are disadvantages of using the penetration pricing method:
- Branding defense. Competitors may have such strong product or service branding, that customers are not willing to switch to a low-price alternative.
- Customer loss. If a company only engages in penetration pricing without also improving its product quality or customer service, it may find that customers leave as soon as it raises its prices.
- Perceived value. If a company reduces prices substantially, it creates a perception among customers that the product or service is no longer as valuable, which may interfere with any later actions to increase prices.
- Price war. According to Entrepreneur magazine : "Penetration pricing means pricing more aggressively than neutral. It can be used to gain market share relative to your competition -- but be careful. This can and does start price wars" (Entrepreneur, 2015, "What you need to know about pricing")
Penetration pricing is therefore most useful for large companies that have sufficient resources to lower prices substantially, and fight off attempts by competitors to undercut them. It is a difficult approach for a smaller, resource-poor company that cannot survive long on lower margins.
Read the first article in this series: A look at Product Line Pricing.