In this post we’re going to go over the market penetration pricing strategy. We’ll see what it is, under which circumstances it can be a helpful tool to grow your business, and what the risks of using a penetration price may be, so that you can assess if they apply to your specific situation, and if they do, create a risk mitigation plan.
What is a penetration pricing strategy?
What is penetration pricing? A market penetration pricing strategy consists of launching your products or services at a price intentionally below their value, so that you speed up the adoption rates.
The point is to induce trial, get initial sales fast, and gain market share. And, you use the low price as a tool to stimulate demand.
One thing that may generate some confusion, is that a market penetration strategy, and a low price strategy, aren’t the same thing.
With a low price strategy, you intend to keep your prices permanently low (it's a positioning).
However, with a market penetration pricing strategy, you may only intend to keep prices low during an introductory stage (it's a temporary sales booster). Once you achieve your goals, the price is risen to reflect the product’s value.
And an important thing to keep in mind, is that a penetration price isn’t necessarily a low price.
It’s below what you would charge for your product or service considering the value it creates for the customer, but that doesn’t mean it’s low.
It's just a great value for money.
This is extremely important to keep in mind, as we'll see when we talk about where a penetration strategy can go wrong.
Another important aspect, is that although usually we talk about penetration pricing in the context of new product launches, you may need to use it at some other stage of your product lifecycle in case you see a need to further penetrate the market.
But let’s try to understand if penetration pricing is something that you should be using (or avoiding) to help your products or services penetrating a market.
When to use a penetration pricing strategy
In no particular order, these are the main reasons why an attractive deal can be a good (if not required) incentive to try your product or service, allowing you to penetrate the market:
Reason #1 to use penetration pricing: decrease costs per unit
Often, it is a lot more expensive to produce a unit of a product when you are producing small quantities than when you are producing in large batches.
In this case, the point of the penetration price is to increase initial demand as fast as possible, to allow you to increase production volume, and save on your production costs per unit.
So, a low introductory price may in time compensate due to the efficiencies gained in production due to the higher production level (aka economies of scale). Needless to say, this only makes sense if you are able to keep the high volume up.
Reason #2 to use penetration pricing: target customers are loyal to supplier
The second situation in which a penetration price may be useful, is because in your particular target market, given it’s characteristics, clients tend to stick to a supplier.
Not because they love him dearly, but because either it’s in their best interest, they’re afraid of changing, or they simply can’t be bothered.
Regardless of the reasons, in this cases, getting people to try your product or service may require an additional push, and that's where the penetration pricing strategy comes in.
This unwillingness to try different suppliers typically happens in markets where there’s a switching cost, trust or compatibility are important, or there’s a network effect.
Let’s look at these one by one:
These may be due to the need for an installation, or a learning curve for clients when they switch, or even because clients need to cancel a service and they don’t want to bother.
Regardless of the reason, consumers sometimes keep using a product because changing has a cost they want to avoid (monetary or not).
After all, better the devil you know than the devil you don’t, right?
When a high level of trust is required, customers may prefer to stick to a tested and proven option, even if they know that it could be improved, than risk trying a new one and getting worse results.
When several products are used together, they need to be compatible. So, although there may be a better alternative available for one of the products, in case it isn’t compatible with the rest of products that are being used together, the customer can’t switch.
At least not without switching several more (which leads us back to the high switching cost).
Sometimes people just use a service because their friends or acquaintances use it. As a consumer, you probably have quite a bit of experience with this effect.
Do you use a social network because everyone you know is there? or a messaging service? or an online game? Go to a gym because your friends go there? Or take a class, maybe? Something tells me that you do, or did at some point, at least one of these.
In these situations where clients tend to stick to a particular provider, and/or there is a network effect, it is important to be the first one to get the client, or if you missed that chance, offer them an incentive to switch to you.
Reason #3 to use penetration pricing: hard to convey product or service value
Another reason why a penetration pricing strategy may be helpful, is because sometimes it is hard to explain to the potential client how much value your new product will create for him/her.
This is particularly difficult in case of highly innovative products; the potential client may simply not understand what your product is supposed to do for him. If you’re lucky, he may even understand the features. But, understanding how features translate into a benefit, may be a whole different story.
Another type of new product that may have a hard time entering the market at a price that reflects its value, is one whose value you can’t objectively measure.
How do you transmit how an unknown product or service will improve the potential client's life before he tries it, or hears about how wonderful it is from a trusted source?
The point of the penetration price in these cases, is to encourage trial, that can then be transformed in positive reviews, repeat purchase (depending on what the product is), or both.
Because unless your product’s price has very little weight on your potential client’s budget, he is likely to think twice before buying it.
So, as products’ prices start approaching what would be considered an investment (and this is very personal), potential clients will want to make sure that they will get their money’s worth. And a penetration price can help us giving them a little push towards trial.
Which leads us to the closely related last reason why a penetration price may be a great help: brand building
Reason #4 to use penetration pricing: brand building
This one is closely related to the previous reasons.
Depending on your industry, your ability to get potential clients to trust that your product or service will be a good investment will be heavily influenced by your ability to provide previous clients’ references, positive reviews, and sometimes, show a previous body of work.
As seen above, a low introductory price can help you win your first clients, which are so important to build a portfolio and social proof, that will afterwards help you landing more new clients.
So, as seen, using penetration pricing can be a great strategy. Unfortunately, it can also be a high risk one.
Penetration pricing strategy risks
A poor penetration pricing strategy, or a poorly implemented one, can cause a lot of issues, some of which are very hard to recover from (if at all possible). And these issues aren’t necessarily price-related. You can get in trouble on the marketing and operational sides too.
Let’s see how.
Penetration pricing strategy risk area #1: pricing issues
A penetration pricing strategy can get you into pricing trouble in two ways. The first one, is that:
Customers don’t accept higher prices later on
Depending on your industry, raising prices can be easy, or close to impossible.
First, let’s imagine your product is an online course. Each customer only buys it once. In this case, raising your price should be easy. You just raise it. Existing clients aren’t affected. And if you’re afraid of how this will affect your image, you can always close enrolment, make some minor improvements, and relaunch at the higher price.
But what happens when your clients purchase frequently? Or you have a subscription model, or perform a recurrent service? In these cases, you will be selling the same thing, to the same clients, for a higher price; and they may not be happy about it.
One way to lessen the pain of existing clients when your penetration price phase comes to an end, is to announce that this will happen beforehand.
Instead of simply putting a lower price tag on our product, you put a price tag with you future full price, and offer the lower penetration one through a “launch” discount. This way at least you can’t be accused of lack of transparency. (And it can even make the penetration price more effective; who doesn't like a bargain?)
Unfortunately, if what you attracted were just bargain hunters, there is a real chance that they will leave after the price rises. And there’s nothing you can do about that.
Competitors may copy your introductory price
Sometimes, your business will be too small to be noticed by competitors, or cause them to react. But what if they do? You think that your clients leaving after the price rise is bad?
Well… now imagine that your competitors match that price, so it doesn’t even serve as an incentive for potential clients to try your product.
In this case, there is a very real risk that you don’t reach your sales target, forego your margin, and trigger a price war, potentially destroying everyone’s future profits.
So… as said, this can be a high risk strategy, depending on your product and market. You must think carefully if it is something you want to pursue.
But for now, let’s move on to the next type of problems it can cause.
Penetration pricing strategy risk area #2: marketing
This is probably where I see the most confusion about penetration pricing strategies.
You see, you want the price to induce trial, but it should not be so low as to lead to confusing positioning.
If your penetration price is too low compared to your long term target price, you may just confuse your potential clients.
But in general, if your long term goal isn't to have a low-priced product, you don't want your product to be perceived as a low-priced one due to the penetration price.
Apart from creating a confusing positioning, the type of customers you'll be attracting through this penetration price will be too different from the ones you want to serve.
Remember that the goal is to offer a great value for money to induce trial by your target clients, who will hopefully keep buying from you, or spread the word about it to other target clients, while providing an accurate description of your offer (you don’t want people just focusing on how great of a deal they got).
The point isn't to induce trial by absolutely everyone; it’s to induce trial by people who will buy again at the regular price, of who can put your product in front of others who will.
And this is why it's so important to understand that a penetration price, and a low price, are very different things. (rememebr those bargain hunters I talked about before?)
Anyway, let’s move on to the third type of issues.
Penetration pricing strategy risk area #3: operations
Yes, a pricing strategy can get you into operational trouble too.
Let’s say you launch your new product with a penetration price, and the strategy is so successful, that your sales are higher than your most optimistic forecasts.
Great! Right? That’s a great problem to have!
Well… actually, that can get you in trouble if you can’t keep up with demand, or can’t provide an adequate level of service to those who buy.
Operational problem #1: You can't keep up with demand
If you can’t keep up with demand, your penetration price is too aggressive. You are letting go of more profit than would be necessary to reach your sales target. And with some luck, this will be the worst of your problems.
With a little less luck, you have successfully convinced you potential clients that they need a product like yours, and they get something kind of similar from a competitor, because they don’t want to wait for you to be able to supply them.
And then, if you try to serve too many customers at once, you may not be able to provide adequate service.
Operational problem #2: You can't provide adequate service
This one is particularly problematic if the reasons why you decided to use price penetration were to gain potential clients’ trust, get recommendations and positive reviews, or improve social proof to start building your brand. If that was the case, failing your clients on your first chance, isn’t the best idea.
And finally a word of caution:
If price isn’t the issue, changing it can’t be the answer
You need to always keep in mind that a penetration price strategy can help getting new clients and grow market share. But, only to the extent that the price is the barrier to making the sale.
If the potential client has no interest whatsoever in your product, there isn’t a price that’s low enough to get him interested.
You need to work on your value creation and/or value communication strategies first.
So, summing up, the disadvantages of a penetration pricing strategy are that you can run into several issues, but, the advantages of penetration pricing can far outweigh them, depending on your specific situation.
At the end of the day, the degree to which you can benefit, or shoot yourself in the foot with a penetration price strategy, will depend to a large extent on your industry, and your product or service.
So, before you implement a penetration strategy for your next product launch,
- making sure that it makes sense to use one. And
- making sure that you anticipate its potential consequences, taking into account the nature of your business and product.
If you do that, you’ll be in a better place to decide whether to move forward with the penetration price, and how to implement and communicate it.
You need to think your strategy through, properly, so that you can implement the required measures to avoid or mitigate any negative outcomes.
At the end of the day, I believe a penetration pricing strategy can be a great one to induce your products’ or services’ trial, and to build your brand when you’re starting from scratch. It’s not without risks, but if carefully thought out, it can be a great help.
And that's it for today! I hope it was helpful!