For businesses looking to capitalize off customer loyalty in exchange for an early hit in market revenue, the penetration pricing model may be the perfect strategy.
Penetration Pricing 101
Your business has just entered a new market, and the last thing you want to do is scare potential new customers away with an intimidating price tag, so what do you do? You may not need to look any further than the penetration pricing model.
A penetration pricing strategy involves rapidly attracting as much new business as possible and gaining more market share by offering your prospective customers a much lower price than what the product’s initial value is determined to be. This model is essentially designed to try and entice customers to stop using your competitor’s product and to give yours a try instead. In some instances, it may even be used to drive competition completely out of the market. After a certain point where you’ve either onboarded enough new business, or have discouraged enough of the competition to exit the market, you can start to increase your price back to its original amount.
Understanding the Process
To break down this model a little further, lets say a local company – or perhaps a smaller one in the market – prices their product at $10.00, which costs them $5.00 to manufacture. Meanwhile, your company pays the same manufacturing cost, but has a surplus when it comes to production capacity, allowing you to pump out more products quickly. This would put you in a strong position to benefit from the penetration pricing model. By offering the product for a significantly lower price, like $6.00 instead of $10.00, you could find your competitors quickly scrambling to match your price point or abandoning the market entirely due to it being too unsustainable to contend with. Because of your ease in production resources, you can weather the storm much longer than the other players and gain more of the market (or even a monopoly).
This process – which is the polar opposite of price skimming – is best leveraged when your goal is to either attract a large quantity of customers quickly, or to cause market disruption. The key is that your business is able to handle the initial loss incurred by taking a large hit early on what your potential cost per sale could be.
One need not look further than Netflix as an example. The popular streaming service first entered the market at a very low price (under $10 a month), with additional incentives like the first month being free. Since its inception however, we are now seeing annual price increases more often.
Advantages vs Disadvantages
Penetration pricing can offer plenty of benefits for companies. Here are just a few of them:
Rapid Adoption: New customers will quickly embrace a cheaper offering.
Market Disruption: While you’re capitalizing off the increase in customers, competitors will be scrambling to try and find a solution to regain part of the market.
Goodwill: If customers have the perception that they are now purchasing a product of similar quality that was previously $10.00 (using the example listed above) for $4.00 less, it will create goodwill towards your company.
Partner Sentiment: Businesses who are successfully deploying a penetration pricing model will typically have more sales and a higher conversion rate than those who aren’t – meaning resellers and channel partners will be much more keen and content to focus on selling your products.
As with all pricing models, however, there are some major drawbacks that also must be considered before deployment:
Price War: While if all goes well you could see your competition leaving the market, they could alternative fight back and offer an even lower price, creating a price war that could find your company being the one that needs to turn away.
Customer Dissatisfaction: When it comes time to raise your prices back to the standard amount, you run the risk of frustrating a lot of customers and hurting your loyalty rates.
Brand Perception: People may start to look upon your brand as a cheap or bargain brand – which could do some serious damage to your organization’s reputation if you’re actually offering a premium product or service.
Insufficient Long-Term Strategy: Penetration pricing is designed to be a temporary solution. Businesses who leverage this model and have no follow-up plan run a high risk of facing a loss of profits and being unable to recover from the initial lower pricing margins.
If you’ve done your market research and have identified an area where competitor products are overpriced and you can produce the same thing at a more rapid pace – the penetration pricing model may suit your needs perfectly.
With that said, however, it’s paramount that your business fully fleshes out how long this method will be in effect, and what the price raising plan will look like afterwards. Additionally, you’ll also want to ensure that you’re putting together a structured customer loyalty plan to mitigate the impact of customers abandoning ship once you do start to increase the price of your offering.
By putting in the time and effort to chart your course, you’ll maximize your chances at capitalizing off of the penetration pricing model.