How Penetration Pricing Attracts Customers to New Products
Give Your Customers a Reason to Try Out Your New Product or Service
In a crowded retail landscape it can be very difficult to entice new customers and increase your market share. Relying on better customer service may not be enough when discriminating customers are always on the lookout for the lowest prices. In such a competitive marketplace, one tried and true method for increasing sales is to use penetration pricing to attract customers to new products.
What Is Penetration Pricing?
Penetration pricing is the practice of setting a low initial price for a product or service. Having the lowest price among your competitors will immediately draw attention to your business. 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 customer base increased, or
- The customer will also purchase other products at normal or higher than normal prices, or
- 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 to market with a new product (or one of the first).
Advantages of Penetration Pricing
- Quickly gain attention to your business, build the 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
- If you are able to sell enough of the product/service at the lower price you may be able to take advantage of economies of scale and maintain a profitable margin by: 1. negotiating lower wholesale costs with your supplier, or 2. if you are the manufacturer, implement newer facilities and/or production methods that will lower your per-unit costs
- Rapidly clearing out excess or slow-moving inventory
Disadvantages of Penetration Pricing
- Penetration pricing means lower profits and is not sustainable from a cash-flow perspective if you are selling product(s) at a loss and not making up the difference with sales of other products or you cannot reduce costs to make up 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 their 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.
Examples of Penetration Pricing
- 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 percent are not uncommon. In fact, it is standard practice for ink jet printers to be sold at cost or even at a loss in order 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.
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.