It’s hard to resist a good bargain, right? That’s the philosophy behind penetration pricing, which starts off with lower-than-market rates to draw consumers to choose a particular brand.
It’s partly how Redbox — those DVD kiosks in front of your local grocery store — competed with Blockbuster. 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 $2.99 to $4.99 per rental, plus late fees. Around the same period, a DVD subscription service called Netflix started gaining popularity, and the rest is history.
So, what does penetration pricing mean exactly? And is it right for your business? Let’s take a closer look:
- What is penetration pricing?
- Penetration Pricing Strategy
- Penetration Pricing Examples
- Tips for Successful Penetration Pricing
What is penetration pricing?
Penetration pricing is a vigorous pricing strategy in which a business enters the marketplace offering their product or 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.
Goals of Penetration Pricing
The primary goal of this pricing model is evident from the name itself — market penetration. It’s tough for new entrants to tussle with the big whales and make a name for themselves in the industry. But what can they quickly compete on? Price.
PWC’s February 2023 Global Consumer Insights Pulse Survey of over 9,000 consumers reveals that 96% of shoppers intend to take up cost-saving behaviors over the coming six months. Having the right price likely matters.
Penetration pricing offers an effective way to win over more cost-conscious customers by providing them with a greater bang for their buck.
This strategy requires companies to slash prices to almost below market value, so 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, Dunder Mifflin, an established Scranton paper company, sells reams of paper for $12.00 per ream. If new startup Michael Scott Paper Company enters the market at $4.00 per ream — when it costs $3.50 to produce a ream of paper — this would be considered penetration pricing.
Michael Scott Paper Company can’t possibly enjoy sustainable growth by selling their paper at $4.00 per 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.
If you’re thinking about leveraging penetration pricing, there are some key points you need to consider.
What to Have in Mind When Creating a Penetration Pricing Strategy
Price-elastic products — ones with demand that fluctuates with price changes — can typically play into effective penetration pricing strategies.
If your product is released during a crucial launch period, higher prices could hurt sales and limit your growth. In many cases, a low price can provide a foot in the door for new businesses with price-elastic offerings.
Is your strategy legal?
Loss leader pricing is when a company sells certain products at a loss to sway customers to buy its higher-priced, more profitable offerings.
How much faith do you have in your product or service?
A penetration pricing strategy rests on the assumption that consumers will be willing to eventually pay more than the lower price you breach the market at. If you want to leverage the tactic, you need to believe that your value proposition will hold up in the future.
Advantages and Disadvantages of a Penetration Pricing Strategy
As with all strategies, leveraging penetration pricing has pros and cons. Explore the table below before you move forward with this pricing strategy.
Penetration Pricing Advantages
Penetration Pricing Disadvantages
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.
Customer dissatisfaction. Eventually, you must raise prices to grow your business. This can cause frustration for customers and bring about retention issues.
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.
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 pushback when you try to price your product or service higher.
Market disruption. Offering a product/service at such a low price gives your business a Robin Hood persona. Customers wonder why they’ve been paying so much for the same product or service elsewhere. You win their business and dominate the marketplace.
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.
Turnover. This is especially key if you run a retail business. The low price and market disruption mean your product or service flies off the shelves, which benefits retail companies and distributors.
Inability to raise prices. There’s also the chance that when you try to raise prices, customers just won’t accept it and will take their business elsewhere.
The proof is in the numbers. And we’ve got a resource to keep things simple. HubSpot’s Sales Pricing Strategy Calculator can help you evaluate if penetration pricing is the ideal fit for you or if another pricing technique might be better suited.
Penetration Pricing Examples
Now that you know the basics of penetration pricing, let’s dive into the companies that have successfully leveraged the strategy. Check out our favorite examples below.
Do you grumble when 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 done right.
Netflix opened shop in 1997, five years before Redbox became a threat to Blockbuster. It took a little while to build buzz, but they used low prices (a subscription fee as low as $1.00) 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 we all know how that success story goes.
Internet and Cable Providers
Free HBO for six months? 150 extra channels? Complimentary DVR? These are just a few ways internet and cable providers practice penetration pricing.
They offer impossibly low introductory pricing 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.
This athletic clothing brand offers you access to a two-piece outfit valued at around $100 for only $59.95. This is cheaper than other popular athleisure brands like Lululemon or Athleta, which typically sell a single pair of full-length tights starting at around $100.
The hook? Fabletics is a subscription service. You join their VIP program and receive one “member credit” every month unless you hit the “skip a month” feature before the fifth. This credit can be used to redeem a two-piece outfit.
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 its members.
In 2003, Frito Lay introduced Lay’s Stax, a brand of baked potato chips tailored to compete with Pringles brand chips — with a similar shape, texture, taste, and packaging.
Initially, Frito Lay radically undercut its competition by selling cans of Stax for as low as $0.69. Once the chips got traction, the company raised its price to reflect what its competition charged.
Costco leverages a penetration pricing strategy with its organic grocery products.
Generally speaking, the margin on typical groceries isn’t particularly high — but that’s not the case for organic foods, which have more impressive returns. In turn, many grocers sell their organic products with a high markup.
On the other hand, Costco sells organic foods at lower prices — slightly undercutting the market with its own penetration pricing strategy. That said, this is a very specific brand of penetration pricing that not every company can sustainably employ. Since the corporation is as massive as it is, it has more leeway to use this strategy than a smaller, growing grocer.
Tips for Successful Penetration Pricing
Setting a low price isn’t enough. Your penetration pricing strategy needs to factor in consumer behavior, promotional prices, and your resourcing. We’ll explore helpful tips to guide you below.
Ensure you have adequate resources for penetration pricing.
It’s sink or swim — especially when trying to penetrate the market and lure business away from the competition.
Before taking the leap and implementing penetration pricing, be certain that you have the resources (financial, operational, legal, and marketing, among others) to keep you afloat during this time.
If this model will force your company to get into deep debt or you don’t have a solid roadmap to ensure continual growth, it’s critical to reevaluate whether this pricing strategy is for you.
Remember: The customer is royalty.
Without customers, you’d have no one to sell to and, thus, no revenue. So, don’t resort to underhand tactics that can put off your trusted customers or spoil your reputation. Customer satisfaction matters when playing the long game.
A survey of over 17,000 consumers revealed that a positive customer experience makes consumers 3.5 times more likely to buy again and 5.1 times more likely to recommend an organization.
So, it’s important to have a sound strategy to move customers up the value ladder once they’ve bought from you or a concrete path to boost profitability — without making your existing customers feel like they’re forced to upgrade.
Combine penetration pricing with promotions.
Explore applying a penetration pricing strategy in conjunction with certain promotions such as limited-time deals, festive offers, and so on.
Offering low prices in the form of promotions has three distinct advantages:
- Customers feel like they’re getting a great deal (at a steal!) and thus associate positive feelings with the brand.
- Improved profitability as the business has to contend with lower margins only for the duration of the promotion.
- No disgruntled prospects or customers when prices go up, as it’s clear that these low rates were only valid for the promotional period.
Track results and make pricing adjustments as necessary.
This is not a set-it-and-forget-it situation. It’s critical to monitor the revenue coming in, profitability, customer response, competitor movement, and other factors to modify pricing when needed.
Just like a basketball player adjusts his shot based on external variables, it’s essential to refine pricing to ensure sustained success.
Before you go…
Penetration pricing can be an effective pricing strategy for some businesses, but it could just as easily fall flat for others. If you’re interested in leveraging the tactic, make sure you understand how it will affect your business plan before implementing it.
Price can directly impact company growth, so it’s vital to invest time to get it right.
Editor’s note: This post was originally published in April 2019 and has been updated for comprehensiveness.