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How penetration pricing works
Business Basics

How penetration pricing works

14 min read

If you are offering a new product or service and need a market penetration strategy, you might implement penetration pricing to give you a strong start in the market. Learn more about what it is, explore the pros and cons, and find out why it might be an option for your business. 

Highlights

  • Penetration pricing means offering a competitively low price for a product or service with the intention of later raising the price. 
  • This pricing strategy is often used for new products or services to quickly gain market share. 
  • The approach can earn you new customers, but those same people might not stick around once prices go up. 

What is penetration pricing?

Penetration pricing is a strategy that involves offering a new product or service for a very low price in order to undercut competitors and get an edge in the market. The company will eventually increase prices, either after a set amount of time or after gaining enough market share to be competitive with similar businesses. 

How does a penetration pricing strategy work? The method creates greater demand as customers switch from competitors’ more expensive options. New customers may become interested due to the low price point, even if they have never purchased a product or service in this category before. 

Once a business has established a strong customer base and the desired level of market penetration, they can raise the price to create a better profit margin. If the strategy works and the business is able to retain customers through the price increase, they will have a higher profit margin and more brand loyalty.  

Advantages and disadvantages of penetration pricing 

This strategy may seem like an easy way to sell a new product, but there are both pros and cons to the tactic. 

Advantages:

  • Penetration pricing can increase market share and sales volume
  • It attracts the attention of price-conscious consumers 
  • You can stand out from competitors 
  • The strategy might convert many customers to your brand before competitors have time to react
  • Penetration pricing requires a plan for expenses—careful budgeting and forecasting will not only help you with this pricing strategy, but also general business efficiency 

Disadvantages: 

  • Offering an inexpensive product could make your brand seem cheap or low quality
  • Keeping newly acquired customers can be a challenge; they may form long-term expectations of your short-term prices
  • You may trigger a price war, in which competitors try to undercut your already low prices

Example of penetration pricing 

Let’s say you are opening a coffee shop in a neighborhood with lots of coffee and dining options to choose from. The people who live nearby probably already have a favorite coffee shop, so as the new guy in town you have to have a way to differentiate yourself. You might do this by selling your coffee drinks for 25% less than your competitors. 

This might give you a more narrow profit margin in the short term, but if you advertise these prices it will likely get the attention of customers who have gotten used to paying more for coffee. More people could stop by to try the bargain coffee, like the drinks and the vibe of your shop, and become loyal customers. 

Later, as your brand awareness increases along with your sales, you can raise prices back to the level of your competitors so you can start pulling in more capital

Penetration pricing vs loss-leader pricing, predatory pricing, and price skimming

Loss-leader pricing is similar to penetration pricing, but has a slightly different approach and a very different motive. It involves selling products or services at below market costs in order to generate other sales that are more profitable—and it is illegal in many US states. An example of loss-leader pricing is a store that sells kitchen wares promoting a waffle maker for less than half of its usual retail price, hoping that people will buy the waffle maker in addition to other items with higher profit margins. 

Predatory pricing is penetration pricing taken to the extreme, and it is illegal in the entire US under antitrust laws. This strategy involves using low prices to drive out competition from the market in order to create a monopoly. For example, if an appliance store started selling refrigerators at prices so low that they cannot make a profit, and continues to do so until all other, smaller refrigerator retailers run out of business, that’s predatory pricing. 

Price skimming is almost the opposite of penetration pricing, because it involves setting prices unusually high for a short period of time. This works for products or services with high demand, and it can help give the impression of high quality. For example, if a tech company offered a virtual reality console, they might charge much more than the cost of producing the product. This can make the product feel high end and exclusive, and the tech company can always lower the prices later to appeal to more frugal shoppers. 

While you want to avoid predatory pricing—and possibly loss-leader pricing, depending on the laws in the states where you do business—penetration pricing might be a good way to make a name for your product or service. Be sure to weigh the pros and cons to see if it is the right choice for your business. 

No matter where you are on your business roadmap, Divvy can help you build your business credit and track business expenses—without expense reports. Schedule a demo to learn more. 

The information provided on this page does not, and is not intended to constitute legal or financial advice and is for general informational purposes only. The content is provided “as-is”; no representations are made that the content is error free.

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