What is Penetration Pricing
Penetration pricing is a marketing strategy used by businesses to attract customers to a new product or service. Penetration pricing includes presenting a low price for a new product or service during its initial offering. The lower price helps to lure customers away from competitors. This marketing strategy relies on the idea of low prices making a customer aware of a new product. The price entices the customer to try the 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, a higher amount of sales can lead to lower production costs and quick inventory turnover.
The major disadvantage, however, is that an increase in sales volume may not lead to a profit if prices must remain low. Also, if the low price is part of an introductory campaign, curiosity may prompt customers to choose the brand initially, but once the price begins to rise or levels with a competing brand, they may switch back to the competitor.
Penetration Pricing Versus Skimming
Skimming is the opposite pricing strategy to penetration pricing. With penetration pricing, companies advertise new products at low prices, with modest or nonexistent margins. Using skimming, they market products at high prices with relatively high margins. This strategy works well for innovative or luxury products where early adopters have low price sensitivity and are willing to pay higher prices. Effectively, producers are skimming the market to maximize profits. Over time, prices will reduce to levels comparable to market prices in order to capture the rest of the market.
Small businesses or those in niche markets can benefit from price skimming when their products or services are differentiated from competitors' and when synonymous with quality and a positive brand image.
Example of Penetration Pricing
Costco and Kroger, two major grocery store chains, use penetration pricing for the organic foods they sell. Traditionally, the margin on groceries is minimal. However, the margin on organic foods tends to be higher. Also, the demand for organic, or natural, foods is growing significantly faster than the market for non-organic groceries. As a result, many grocers offer more extensive selections of organic foods at premium prices to boost their profit margins.
However, Kroger and Costco use a penetration pricing strategy. They are selling the organic foods at lower prices. Effectively, they are leveraging penetration pricing to increase their wallet share. While this strategy may be risky for small grocery stores, economies of scale permit Kroger and Costco to employ this strategy.