Raise your hand if you miss Blockbuster? Raise your hand if you also high-tailed it to the nearest Redbox when they popped up in front of your local McDonald’s.
When Redbox entered the movie rental market in 2002, they led with an aggressively competitive price of $1.00/per day for DVD rentals and no late fees. It was drastically cheaper than Blockbuster’s rental prices of $2.99 or $4.99 per rental, plus late fees of approximately $1.00/day.
This is an example of penetration pricing and the beginning of the end for Blockbuster. In 2009, the once-great video giant tried matching Redbox with its own $1/day rental program, but it was too late. By then, a DVD subscription service called Netflix was gaining huge swaths of the video rental market.
So, what is penetration pricing exactly, and is it right for your business? Find out below.
What is penetration pricing?
Penetration pricing is a vigorous pricing strategy in which a business enters the marketplace offering their product/service at an extremely low price. The goal of penetration pricing is to disrupt existing businesses by luring customers away with a much lower price.
Because this strategy requires companies to slash prices to almost below market value, it’s usually employed by new businesses in a high-growth phase that are prepared to absorb initial losses. These losses are viewed as a necessary sacrifice to gain market share and entice customers away from competitors.
For example, let’s say Dunder Mifflin, an established Scranton paper company, is selling reams of paper for $12.00/ream. If new startup Michael Scott Paper Company enters the Scranton paper market selling reams for $4.00/ream -- when it costs $3.50 to produce a ream of paper -- this would be considered penetration pricing.
Michael Scott Paper Company can’t possible enjoy sustainable growth by selling their paper at $4.00/ream. But they can use their initial low prices to disrupt the Scranton paper market, earn a few customers away from Dunder Mifflin, and boost brand recognition.
Penetration Pricing Strategy
A penetration pricing strategy might be effective if your business is new or breaking into a different marketplace. The goal is to lure customers away from established competitors, build brand loyalty, and generate demand for your offering. You might even push competitors out of business, if you’re lucky.
Advantages of a penetration pricing strategy
New customers - Everyone will like you … for a minute, at least. Consumers love a good deal, so companies offering penetration pricing are often adored and flocked to when they break onto the scene with steeply discounted offers.
Long term gains - The economies of scale come into play here. Employing penetration pricing nets a high volume of sales that may offset the lower price tag.
Market disruption - Offering a product/service at such a low price gives your business a Robin Hood persona. Customers begin to wonder why they’ve been paying so much for the same product/service elsewhere. You win their business and dominate the marketplace, pushing competitors back -- or out of the business completely.
Turnover - This is especially key if you run a retail business. The low price and market disruption mean your product/service flies off the shelves, which benefits retail businesses and distributors.
Disadvantages of a penetration pricing strategy
Customer dissatisfaction - Eventually, you must raise prices to grow your business. This can cause frustration for customers and bring about retention issues.
Loss of brand value - When you price and market yourself like a discount brand, you earn a lot of business. But people also start to think of you as a discount brand, causing push back when you try to price your product/service higher.
Price war - The gamble with implementing a penetration pricing strategy is that your competitors might retaliate. A pricing war leads to decreased profitability for the market as a whole and benefits no one.
Inability to raise prices - There’s also the chance that when you try to raise prices on your customers, they just won’t accept it and will take their business elsewhere.
Penetration Pricing Examples
Do you grumble a bit every time you receive an email that says your Netflix monthly subscription is going up? Me too. But I also close the email and go back to what I was doing without giving it a second thought. Netflix is a great example of penetration pricing gone right.
Netflix opened up shop in 1997, five full years before Redbox became a threat to Blockbuster. It took a little while to build buzz, but they used low prices (a subscription fee of as low as a dollar) to distract consumers from the fact they had to wait up to two days to receive their DVDs in the mail. In 2007, they introduced a streaming service, and the rest is history.
Low prices and convenience were enough to lure customers away from Redbox. More than two decades later, they’ve been able to grow their market share. In fact, 51% of streaming subscriptions in the United States are to Netflix.
Internet and Cable Providers
Free HBO for six months? 150 extra channels? Complimentary DVR? These are just a few of the ways internet and cable providers practice penetration pricing. They offer impossibly low introductory pricing in order to tempt customers away from competitors.
Once that introductory period is over, the prices will gradually -- or sometimes very steeply -- increase to catch up to the rest of the market.
The company is famous for giving their razors away for free. Money is made when customers buy expensive blade replacements, attachments, and other accessories.
Printers are another product often sold at cost with the hope that consumers will buy highly priced ink cartridges and paper.
This athletic clothing brand sends you a three-piece outfit valued at around $100 for only $49.99. This is vastly cheaper than other popular athleisure brands like Lululemon or Athleta which sell a single pair of tights starting at around $100.
The hook? Fabletics is a subscription service. You join their VIP program and receive one “outfit” every month unless you hit the “skip a month” feature before the fifth. Prices this low would likely not be sustainable for the brand without the sheer volume of recurring monthly subscription prices and one-off purchases from their members.
Penetration pricing can be an effective pricing strategy for some businesses. Make sure you understand how it will affect your business plan before enacting it.