Penetration pricing is the practice of setting a low initial price for a product or service to entice customers. It is a competitive marketing strategy that aims to increase sales by attracting a wide number of customers to new products at initial low prices. Along with great customer service, advertising, promotions, and other marketing strategies, penetration pricing can help increase your revenue and grow your business.
Penetration pricing is designed to entice discriminating customers searching for the lowest prices. It involves initially pricing items or services lower than the competition to attract a large number of customers.
Buy-one get-one-free (BOGO) is a common penetration pricing strategy, as is heavily discounting an item or offering it for free when purchased with a related product.
For retailers, the objective of penetration pricing is to attract customers to your business in the hope that:
- Prices can eventually be normalized once the advertising objectives have been obtained and your customer base has increased.
- The customer will also purchase other products at normal or higher than normal prices.
- You are able to bundle the product with additional services that are highly profitable, such as a contract for monitoring services with the sale of a new security system.
Penetration pricing generally works best when you are the first, or one of the first, to market with a new product.
As with any marketing strategy, there are advantages and disadvantages to penetration pricing that should be considered before implementing this plan.
Advantages of Penetration Pricing
The advantages of this type of marketing practice include:
- Quickly gain attention to your business, build a customer base, and gain positive word of mouth.
- Put your competition on the defensive—or fend off new competition who may consider selling the same products.
- Capture a larger share of the market and eventually become the "go-to" business for a particular product.
- Keep your focus on efficiency and cost reduction to maximize profits.
- Rapidly clear out excess or slow-moving inventory.
In addition, if you sell enough of your product or service at the lower price, you may be able to take advantage of economies of scale and maintain a profitable margin by negotiating lower wholesale costs with your supplier, or if you are the manufacturer, implementing newer facilities or production methods that will lower your per-unit costs
Disadvantages of Penetration Pricing
The disadvantages of using this strategy include the following:
- Penetration pricing means lower profits and is not sustainable from a cash-flow perspective if you are selling products at a loss and not making up the difference with sales of other products or you cannot reduce costs to compensate for lower pricing.
- Customers may only be enticed to buy the discounted product and nothing else if they notice that lower prices do not apply to other items. If so, they may go elsewhere once the product pricing returns to normal levels.
- To maintain its market share, the competition may retaliate by lowering their prices on the same or similar products. They may even lower them below yours and create a price war that will further cut into your profits.
- Penetration pricing may alienate some customers if they perceive that your products are inferior in quality due to lower pricing, or if your discounted product advertising appears "gimmicky" or of the bait-and-switch variety.
Examples of Penetration Pricing
The following examples will help you recognize penetration pricing at work:
- A restaurant advertises a substantial discount on a new menu item. Customers may be enticed by the lower price on the new item, but when ordering may decide on a different item at the regular price.
- Phone, cable, and internet service providers are notorious for penetration pricing strategies. For example, mobile phones are steeply discounted when purchased with a subscriber package; or the first six months of a cable or ISP package may be half price.
- Printer manufacturers typically sell new consumer units at a very low price, but replacement ink or toner cartridge markups of 300% are not uncommon. In fact, it is standard practice for inkjet printers to be sold at cost or even at a loss to later profit from the sales of consumables.
- Airlines are huge practitioners of penetration pricing; for example, the practice of advertising off-season discount fares to attract travelers is common. Often there is very limited seating at the reduced price, the route involves multiple stops, change fees are exorbitant, and extra baggage charges or other fees apply.
Gain consumer attention, which increases cash flow
Capture large market share
Clear out excess inventory
Inability to sustain low prices, which negatively affects cash flow
Competition lowers their prices to capture market share
Customers buy their goods elsewhere if prices normalize
Predatory pricing is penetration pricing taken to extreme levels to drive competition out of the market and establish a monopoly, with the eventual goal of normalizing prices after the competition has disappeared. Predatory pricing is illegal under anti-trust laws in most jurisdictions but is generally difficult to prove and is viewed by the courts as beneficial to consumers, at least, in the short run.
In today's competitive marketplace, retailers must constantly think of new ways to attract customers to keep their businesses viable. One strategy is penetration pricing, which initially sets the price of new products or services below the competition.
It's important to weigh the pros and cons of this practice before implementing it to minimize the risk of it negatively impacting your business. Also, once you've brought customers to your door, you will need to consider how to keep them.