When I was first starting my business, I had to make a lot of tough decisions. One of the biggest decisions I had to make was what pricing strategy to use. After doing some research, I decided on penetration pricing. Penetration pricing is when you price your products or services below the market rate to attract customers and gain market share. It’s a risky strategy, but if it works it can be very beneficial for your business. Of course, like with any decision, there are pros and cons to using penetration pricing. In this blog post, we’ll take a look at penetration pricing advantages and disadvantages so that you can decide if it’s the right choice for your business
Penetration Pricing Advantages and Disadvantages
Penetration pricing is a strategy in which a company sets a low price for a new product or service in order to attract customers. As demand for that new service increases, they will increase the price of the item.
There are several penetration pricing advantages and disadvantages.
While it can quickly build market share and generate word-of-mouth marketing, there is also a need to sacrifice profits in the short term and the risk of customers switching to cheaper alternatives when prices are raised.
What is Penetration Pricing?
Penetration pricing is a strategy where you set a low initial price for your product to entice customers who may be reluctant to pay a high price. This strategy can be very beneficial in gaining a large share of the market.
Understanding Penetration Pricing
Penetration pricing is usually done by companies who want to increase their profits once the competition has been eliminated.
One reason a company might engage in penetration pricing is to gain a large market share. With more customers, the company can order supplies in bulk, which often leads to lower manufacturing costs. In turn, the company can sell its products at a lower price than its competitors and still make a profit.
One reason why companies may opt to engage in a penetration pricing strategy is to take full advantage of any spare production capacities they have. If the cost to produce using those extra resources is relatively low, they may be able to sustain penetration pricing for a long period. This can help the firm acquire a greater market share.
It’s fairly common for new entrants into a marketplace to offer low prices on their products, to gain a foothold in the market.
If companies can use penetration pricing and can consistently sell enough volume, they can become the standard, making it harder for competitors to compete. This is because when companies have a high enough volume of sales, it makes it harder for smaller companies to compete with them.
When to Use Penetration Pricing
A business with deep pockets should pursue the penetration pricing model, as it requires considerable investment in the early stages.
Penetration pricing is a strategy where a business sells a product at an extremely low price to drive sales. This can be effective when there are many similar products on the market, as competition can drive up the price of those products and force other businesses to lower prices.
Advantages of Penetration Pricing
The benefits of using penetration pricing are:
Low Entry Barrier
If a business continues to charge low fees for its services, it is likely to deter new competitors from entering the market. This would give the business an advantage over its competitors.
Companies with less money will be forced out of the market, or into more niche markets within it.
A dominant market share can be attained through price penetration, but you may have to aggressively lower the price of your product for a prolonged period to discourage competition.
Disadvantages of Penetration Pricing
The disadvantages to using penetration pricing are:
If a competitor has a strong brand, customers may be unwilling to switch even if they offer a lower price. This can be a difficult obstacle for new businesses to overcome.
If a business only focuses on lowering its prices, it may find itself losing customers to competitors who focus on improving its product and customer experience.
If a business lowers its prices for a product or service, it can create a perception that the service or product isn’t worth as much, which may affect any attempts to raise the price in the future.
If competitors respond to the price drop, they may drop their prices even lower, causing you to have to drop your prices even more. This could lead to you losing more profits and customers.
Example of Penetration Pricing
XYZ Corporation wants to enter the market for blue widgets. The going rate for one of these is $10.00.
Because it has such a large excess of production capacity, XYZ’s incremental cost is only $6.00. As such, it can enter the market at a $6.25 price point, which it believes will be sustainable for the immediate future.
Competitors see this and rapidly evacuate the market, leaving XYZ as the dominant seller.
Is Penetration Pricing Effective?
There are several reasons why the penetration pricing model is so successful.
First, when the price of a product drops, the demand for that product increases by a larger percentage than the price change.
This is because consumers are, in general, very cost-conscious. They may not remain faithful to a brand or product.
Or, existing products are not good enough.
When companies offer new products at low prices, many people will buy them.
Second, as sales increase, companies can lower costs through increased production. This allows them to spread their overhead over more units, resulting in a lower price for each unit.
Penetration pricing can help improve your profit margins while adopting this strategy.
Third, the product will be for the mass market, allowing the demand to benefit from economies of scale.
In today’s market, firms can increase their profits by lowering production costs.
In the mass market, consumers are more likely to switch their brands if they find a cheaper alternative.
Fourth, the new product may face stiff competition. Penetration pricing is typically a short-term strategy.
If the company adopts penetration pricing as a long-term strategy, it will invite competitive reactions from its competitors that could potentially lead to a price war.
If a business is unable to compete with the larger, more well-known companies, it may simply have to leave the market. This can happen if it fails to gain a large enough customer base.
Fifth, because the product is relatively standardized, consumers are unlikely to choose one particular company over another. Therefore, the strategy of using price cuts to gain market share may work well.
The company wants to expand its customer base and to do this, they need to get as many people interested and buying their product as soon as possible.
If the market has matured, then growth will be low because consumers have already bought or used the product. For there to be growth, consumers must keep buying the product.
By simply stealing away their competitors’ existing customers, they can increase sales of their new product line.
When companies employ penetration pricing, they run the risk of having their competition view this as a threat. This could lead to them taking certain actions, such as price wars, to push them out of the market before they’ve had the chance to establish themselves.
How Penetration Pricing Impacts The Company
At the beginning of implementing this pricing strategy, the business makes less profit. However, it sells more units, but at a cheaper price.
As sales grow, companies should be able to spread their fixed production cost over more units, lowering the average cost per unit.
Profits can also improve when a company increases its prices gradually.
The success of this method will depend on how the company follows up in the future and whether it can keep its customers loyal.
If the strategy is successful, it could lead to higher customer loyalty, which could, in turn, lead to increased sales, lower costs, and a larger share of the market.
Penetration pricing can be a great way to attract customers and gain market share. However, it’s important to weigh the penetration pricing advantages and disadvantages before deciding if it’s right for your business. Be sure to consider all factors carefully before making a decision.