What is 'Penetration Pricing'
Penetration pricing refers to a marketing strategy used by businesses to attract customers to a new product or service. Penetration pricing is the practice of offering a low price for a new product or service during its initial offering in order to lure customers away from competitors. This marketing strategy relies on the idea that low prices can help make a customer aware of and more willing to buy a new product.
BREAKING DOWN 'Penetration Pricing'Penetration pricing, similar to loss leader pricing, can be a successful marketing strategy when applied correctly. It can often increase both market share and sales volume. Additionally, the high sales volume can also lead to lower production costs and higher inventory turnover, both of which are positive for any firm with fixed overhead. The chief disadvantage, however, is that the increase in sales volume may not necessarily lead to a profit if prices are kept too low. As well, if the price is only an introductory campaign, customers may switch out of curiosity but then leave the brand once prices begin to rise to levels more in line with rivals.
Penetration Pricing Versus Skimming
Skimming is roughly the opposite pricing strategy as penetration pricing. Rather than offering products at low prices with low or nonexistent margins, marketers using the skimming strategy offer products at high prices with relatively high margins. By attracting people who love luxury or people who simply like to show off, this pricing strategy effectively skims an elite group of shoppers out of the consumer pool. The idea behind the practice is that as early adopters or trendsetters buy the product, it becomes more attractive to the rest of the market, essentially creating free advertising and increasing allure.
Example of Penetration Pricing
Costco and Kroger, two major grocery store chains, both use penetration pricing on organic foods. Traditionally, the margin on groceries is very small, but the margin on organic groceries tends to be a bit higher. In addition, the demand for organic foods is growing significantly faster than the demand for conventional groceries.
As a result, many grocers are stocking organic options to boost their profit margins. Kroger and Costco, however, are taking another approach. Rather than enjoying the increased profit margin of organics, these grocery giants sell organic food with very low margins. They are leveraging penetration pricing to get customers through their doors and to earn a bigger stake in the market. While this strategy may be too risky for small grocery stores to pull off, Kroger and Costco can manage it, primarily because of their large sizes and well established supply chains.