Penetration pricing

Penetration pricing is the pricing technique of setting a relatively low initial entry price, a price that is often lower than the eventual market price. The expectation is that the initial low price will secure market acceptance by breaking down existing brand loyalties. Penetration pricing is most commonly associated with a marketing objective of increasing market share or sales volume, rather than short term profit maximization.

The advantages of penetration pricing to the firm are:

• It can result in fast diffusion and adoption. This can achieve high market penetration rates quickly. This can take the competition by surprise, not giving them time to react.
• It can create goodwill amoung the all-important early adopter segment. This can create valuable word of mouth .
• It creates cost control and cost reduction pressures from the start, leading to greater efficiency.
• It discourages the entry of competitors. Low prices act as a barrier to entry (see: porter 5 forces analysis).
• It can create high stock turnover throughout the distribution channel. This can create critically important enthusiasm and support in the channel.
• It can be based on marginal cost pricing, which is economically efficient.

The main disadvantage with penetration pricing is that it establishes long term price expectations for the product, and image preconceptions for the brand and company. This makes it difficult to eventually raise prices. Some commentators claim that penetration pricing attracts only the switchers (bargain hunters), and that they will switch away from you as soon as you increase prices. There is much controversy over whether it is better to raise prices gradually of a period of years (so that consumers don’t notice), or employ a single large price increase (which is more efficient). A common solution to the price expectations problem is to set the initial price at the long term market price, but include an initial discount coupon (see sales promotion). In this way, the perceived price points remain high even though the actual selling price is low. Another potential disadvantage is the low profit margins may not be sustainable long enough for the strategy to be effective.

Price Penetration is most appropriate when:

• Product demand if highly price elastic.
• Substantial economies of scale are available.
• The product is suitable for a mass market (ie.: sufficient demand).
• The product will face stiff competition soon after introduction.
• There is inadequate demand in the low elasticity market segment for price skimming.
• In industries where standardization is important. The product that achieves high market penetration often becomes the industry standard (eg.: Microsoft Windows) and other products, even very much superior products, become marginalized.

In interesting variant of the price penetration strategy is the bait and hook model (also called the razor and blades business model) in which an initial product is sold at a very low price but subsequently purchased products (such as refills) are sold at a higher price.

See also : pricing, marketing, microeconomics, production, costs, and pricing, business model, price skimming

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