Switching brands isn’t a popular move among consumers. In fact, 90.2% of people consider themselves just as loyal, or more loyal, than they were a year ago.
That’s why we keep buying the same products at the supermarket. Or why we head to the same stores to buy clothes. For new brands, or companies launching new products, that’s not exactly good news.
Add to that the fierce competition small businesses face, especially when they’re up against large corporations. It’s hard to bet on newcomers when you’ve been using the same products from long-established brands.
Penetration pricing offers a solution to both problems. And in this post, we’ll take a closer look at this pricing strategy to help you learn the fundamentals, so you can decide whether it’s right for you.
What is penetration pricing?
Penetration pricing is a pricing strategy that involves offering new products or services to buyers at a lower price (marginal cost). The low price lowers the barriers to conversion, making it easier for emerging brands and products to gain a foothold in the market.
New market players also use penetration pricing to set themselves apart from the competition. This strategy allows them to:
- Build brand loyalty
- Win market share
- Generate substantial demand
- Disrupt the market
- Attract new business from competitors
Penetration pricing is often carried by the merchant, since they’re cutting into their own profits to give consumers a reason to like and trust their brand.
The trade-off is often worth it. If your product is top-notch, lowering prices is just a “hook” to reel customers in. Done right, they’ll be more than willing to do business with you.
Advantages of penetration pricing
Some of the key advantages of penetration pricing include the following.
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Become a market leader. A penetration pricing strategy catches competitors off guard. It gives you time to steal the spotlight (and their customers, too).
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Greater customer interest. This depends on the type of retail customer you’re targeting. But, broadly speaking, offering affordable options can lead to a high adoption rate and get people talking, ultimately resulting in free word-of-mouth marketing referrals.
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Economies of scale. A penetration pricing strategy aims to convert a lot of users, especially for mass-market products. A higher sales volume offsets your low-price strategy. Another benefit is that fast-moving products may also qualify for volume discounts.
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Increased goodwill. Who doesn’t love a bargain? Bargains can lead to repeat business. A higher level of goodwill increases a customer’s lifetime value.
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Reduced competition. Some companies can’t lower their prices significantly, which keeps them from joining the race you’re running. But as you raise your prices in line with your projected profit margin, you’ll need to figure out a way to compete effectively with them.
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Increased customer loyalty. This strategy is one of the fastest ways to build loyalty around a product launch. Low prices draw people in, but a great product keeps them coming back, even if the price goes up.
Disadvantages of penetration pricing
Penetration pricing has a few drawbacks. Here are the ones to keep in mind.
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Insufficient funds for production. Small businesses often struggle to reduce their cost per unit, especially when competing with large companies. That’s because low profitability can put their business at risk.
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Missed opportunities. Many luxury shoppers would overlook “cheap products.” If you offer luxury goods, your brand image can suffer and your target market might turn away from you. Another way to lose potential customers is to set low prices initially and then raise them.
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Reduced market prices. Price matching is common among competitors, particularly if their products are similar. If your competitors decide to play your game, this can lead to a price war, which will hurt you and the industry as a whole.
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Failure to deliver results. Not every market penetration pricing strategy is a success. Setting the lowest price is also often unrealistic in lower-cost industries.
3 types of penetration pricing strategy
To break through entry barriers, new retailers need to come up with strategies to attract and retain new customers. When you leverage penetration pricing strategies, you learn to play the long game. You may take losses at first, but if it works for you, you’ll be rewarded.
A key part of making this strategy work is setting a deadline for your penetration pricing promotions. Deadlines motivate buyers to act soon, limiting your loss of profit.
These three examples illustrate how penetration pricing works. Discover how it can benefit you.
Low launch price
The most common way to penetrate the market is with a low launch price. Promoting a new product or service with a launch discount can capture your customers’ attention.
When you’re confident in your new product or service, this strategy helps you get as much exposure as possible. Just make sure to build a product pricing plan where you won’t lose too much money. After generating enough awareness, you can raise the price to recover any short-term losses.
Lowering the price of your initial offering only works in your favor if people buy it regularly (think: everyday items). If you offer a food subscription service and discount the annual fee, it will take you longer to break even.
That’s why we often see small and medium-sized businesses leveraging this strategy.
Buy one, get one free
This is a common penetration pricing strategy (and a type of sales promotion) that involves giving away an item with a related purchase. It works better than offering 50% discounts because the word “free” has a powerful psychological effect.
Instead of selling a product at a fraction of its original price, the customer buys other items at regular or higher prices, which can offset the discounted product.
It’s a popular way to move dead and slow-moving stock, but it’s also a great way to introduce new products. These new products can be bundled with best-sellers in a similar category.
Free trial
We often see free trials on subscription-based products and services. When you give your target audience a free sample of your service, you let it speak for itself. Once the free trial ends, customers can choose to commit to regular billing if they’re satisfied with it.
And if they’re not, you can use their feedback to improve your product and make it more competitive.
Netflix and Amazon are great examples of companies that leverage this type of penetration pricing strategy. But this approach isn’t limited to software providers and streaming services, SMBs can implement it too by offering a short trial period for their products.
The length of the trial is up to you. It can range from a week to a month. As long as you give people the chance to try your product, you can ease their fear of commitment and encourage them to keep an open mind.
Use penetration pricing to crack the code and achieve success
Building penetration pricing into your marketing strategy can reduce the friction associated with introducing new products. This lets you build a customer base over time before switching to a higher price point and earning a spot in a competitive market.
But this strategy isn’t for everyone. SMBs need to figure out whether it’s the right strategy for their business. The penetration pricing examples above should have given you an idea of what would work for your business.