90% of people believe they are equally or more loyal than they were a year ago. It’s why we always buy the same items at the supermarket. Or why do we shop at the same stores
This isn’t good news for new brands or companies launching new products. Add to that the intense competition that small businesses face, particularly when competing against large corporations. When you’ve been using the same products from long-standing brands, it’s difficult to bet on new entrants.
Both issues are addressed by penetration pricing. And in this post, we’ll take a closer look at this pricing strategy to help you understand the basics and decide if it’s right for you. Understanding what penetration pricing is, its benefits and drawbacks, and looking at some examples can help you decide whether it’s worth your time.
What is Penetration Pricing?
Penetration pricing is a marketing strategy used by businesses to attract customers to a new product or service by offering it at a lower price during its initial launch. A lower price assists a new product or service in entering the market and luring customers away from competitors. Market penetration pricing is based on the strategy of initially charging low prices to make a large number of customers aware of a new product.
A price penetration strategy’s goal is to entice customers to try a new product and gain market share, with the hope of retaining the new customers once prices return to normal levels.
Examples of penetration pricing include an online news website providing one month of free service for a subscription-based service or a bank providing a free checking account for six months.
Businesses use penetration pricing to attract customers to a new product or service by initially offering a lower price.
A lower price assists a new product or service in entering the market and luring customers away from competitors.
Penetration pricing carries the risk that new customers will initially choose the brand, but will switch to a competitor if prices rise.
Understanding Penetration Pricing
When used correctly, penetration pricing, like loss leader pricing, can be a successful marketing strategy. It can frequently boost both market share and sales volume. Furthermore, increased sales can result in lower production costs and faster inventory turnover. The key to a successful campaign, however, is keeping the newly acquired customers.
A company, for example, might advertise a buy-one-get-one-free (BOGO) campaign to entice customers to visit a store or website. Following a purchase, an email or contact list should be created to follow-up and offer additional products or services to the new customers at a later date.
However, if the low price is part of an introductory campaign, customers may initially choose the brand out of curiosity, but once the price begins to rise to or near the price levels of the competing brand, they may switch back.
As a result, one significant disadvantage of a market penetration pricing strategy is that an increase in sales volume may not result in an increase in profits if prices must remain low to retain new customers. If the competition lowers their prices as well, the companies may find themselves in a price war, which will result in lower prices and lower profits for an extended period of time.
Example of Penetration Pricing
Market penetration pricing is used by Costco and Kroger, two major grocery store chains, for the organic foods they sell. Groceries have traditionally had a low profit margin. Organic foods, on the other hand, have a higher profit margin. Furthermore, demand for organic, or natural, foods is growing at a much faster rate than the market for non-organic groceries. 1 As a result, in order to increase their profit margins, many grocers offer larger selections of organic foods at higher prices.
Kroger and Costco, on the other hand, use a penetration pricing strategy. They sell organic foods at a lower cost. They are effectively leveraging penetration pricing to increase their wallet share. While this strategy may be risky for small grocery stores, Kroger and Costco can use it due to economies of scale. Economies of scale imply that larger companies can offer lower prices because they buy in bulk at a volume discount. Because of the lower costs, Kroger and Costco can maintain their profit margins while undercutting their competitors’ pricing.
To crack the code to success, use penetration pricing
By incorporating penetration pricing into your marketing strategy, you can reduce the friction associated with introducing new products. This allows you to gradually build a customer base before shifting to a high price point and earning a spot in a competitive market.
This strategy, however, is not for everyone. SMEs must determine whether this is the best strategy for their company. The penetration pricing examples provided above should have given you an idea of what would be appropriate for your company.