Penetration pricing is a business’s method of establishing an initial low price for goods and/or services, with the intention of raising the company’s market share. The price could be established so low that the business may not be able to gain profits in the short term. Nevertheless, this is not an irrational business strategy, as evidenced by the objectives of penetration pricing below.
The objectives of penetration pricing can be to:
- push competitors outside of the market, so that the business can gradually increase its prices, without having to worry over price competition with its remaining competitors;
- acquire much of the market share so that the business can decrease its manufacturing costs because of the very huge purchasing volumes and/or production; or
- employ unused production capacity; its marginal cost to produce using this extra capacity is low, so it can manage to maintain the penetration pricing for a period of time.
It is usual for a new business to use penetration pricing so it can take a portion of the market. In addition, when a new business has a product that cannot stand out among its competitors, it would choose instead to stand out using low pricing.
A business using penetration pricing should have sufficient financial resources available because this pricing strategy can mean early considerable losses.
Penetration pricing can thrive in an environment where there are huge numbers of almost homogenous products because it opens opportunities for competitors to bring down prices for exceptionally big production volumes.
Advantages of Penetration Pricing
- Barrier to Entry. If a business carries on with its method of penetration pricing for a period of time, probable market entrants will be dissuaded by the low pricing.
- Decreased Competition. Competitors that are financially weaker will be pushed outside of the market or maybe into smaller niches inside of the market.
- Dominance of the Market. It is probable to gain dominance in the market using this method; however, penetration pricing would have to persist for a long period to force away a substantial number of competitors.
Disadvantages of Penetration Pricing
- Defense Branding. Competitors could have a robust product or service branding, so that its customers are unwilling to move to another alternative business, even if it is priced lower.
- Loss of Customers. If a business only uses penetration pricing, but does not improve customer service or product quality, customers may leave the moment the business increases its pricing.
- Perception of Value. If a business decreases its prices sufficiently, it builds views among customers that its product or service is not as valuable. This can impede with succeeding actions with the aim to raise prices.
- Price War. There may be the possibility that competitors will retaliate with much lower prices so that a business cannot acquire any share of the market.