What is a penetration pricing strategy?

As a new business, you need to stand out from your competitors to attract customers. Your pricing strategy can be a powerful tool to entice potential customers to buy from you. 

Penetration pricing is when companies attempt to attract customers to a new product or service by offering a lower price at the beginning. But how does it work, and how can you create your own penetration pricing strategy?

This guide will cover:

• What penetration pricing is, and how it works
• Some examples of penetration pricing strategies
• Pros and cons of this strategy
• How to create your own penetration pricing strategy

When using the penetration pricing strategy, you set a lower price to ‘penetrate the market’ (hence the name) and draw customers away from your competitors. 

These low prices serve the purpose of making a vast number of customers aware of your new product or service and enticing them to try it. When you create enough demand, you raise your prices to normal levels.

The overarching goal of penetration pricing is to:

• Capture market share (how much of the total market your business takes up).
• Create brand loyalty (learn more here).
• Move customers away from competitors.
• Create demand for your solution.

This pricing strategy works better in some situations than others, mainly when: 

• Your solution is similar to your competitors’.
• Demand depends on the price (called ‘price elasticity’).
• The solution is suitable for large-scale production.

Now that you know what a penetration pricing strategy is, let’s look at some real-life examples to give you a better idea of how it works.

Companies like TalkTalk and Sky often offer perks like free streaming services or extra channels in the first months to draw in subscribers. These bonuses help these companies stand out in a market overflowing with options. 

Brands like Starbucks and Costa tend to introduce new products and flavours at low prices to get customers to try them. Once you become addicted to that new coffee flavour, these brands start selling them at a non-discounted price. 

Ever been offered a new iPhone for free in return for a long-term, slightly more expensive contract? That’s another version of penetration pricing. 

The phone brands do it, too. Android, for example, often price their phones low to attract customers looking for a good smartphone at a reasonable price. 

Penetration pricing is an effective way for some companies to enter the market. Advantages of this strategy include:

• Fast adoption – A low price tag makes the purchase seem less risky to customers, meaning they’ll be more likely to try the new product right away.
• Goodwill – People love a good deal. Starting with a lower price makes your new product or service seem like a bargain. As a result, deal hunting customers will flock to you.
• Less competition – A new business with low-price products or services can catch competitors off-guard. So you could face less competition if you use penetration pricing in the early stages of your business launch. 
• Cost control – Penetration pricing requires lots of budgeting and planning to make sure you can afford it. During this process, you may discover areas to improve efficiency, lower costs and control business expenses. 

As with most things in life, a penetration pricing strategy also has drawbacks. For example:

• Less customer loyalty – You risk growing a customer base of “switchers”, or people who switch for bargains and leave once prices increase. To avoid a regular customer turnover, implement price increases wisely. 
• Low brand reputation – While you want to set attractive prices, making them too low poses the risk that customers become suspicious. They might assume the quality or utility of your products isn’t up to par.
• Narrow margins – Low prices put pressure on sales. Since you’ll make less profit per sale, it’s essential to make sure you can afford it. Keep a close eye on inventory levels and avoid oversupplying. Also, follow through on planned price increases to get the most out of this strategy. 
• Aggressive competition – Penetration pricing may catch competitors off guard, but it could also cause them simply to lower their prices. Competing with established companies in a so-called “price war” could be challenging for a new business. 

See also: what is psychological pricing in marketing?

A penetration pricing strategy will look different depending on your business. To make it easier to grasp, we’ll use a specific example here.

Let’s say you’ve started a new small coffee company, and you’re up against brands like Starbucks and Costa. While you know that your coffee is fantastic and you offer more value than these companies, consumers won’t. 

So you put together your most delicious blend and best ingredients to create beverages that make customers fall in love. Then you offer them at a price that customers can’t pass up. 

On top of that, you offer excellent customer service and add a personal touch to every coffee you make. 

Once customers realise how delicious your coffee is and you begin attracting more and more people to your business, you can consider raising your prices. Just make sure you’ve done your research, so you know:

• What the average coffee price is.
• How much your target audience is willing to pay.

You can get this information through market research. See also: how to start a business plan for a coffee shop.

The key is to be strategic about your price increase. You want to raise prices enough to make a profit, but not so much that you put customers off. So use the information from your market research to find the right increase. 

Since this pricing strategy takes a lot of budgeting and planning, it’s essential to keep up with your finances. This is much easier with a tool like Countingup. 

Countingup is the business current account and accounting software in one app. It allows you to easily track your income and expenses and view useful business insights to help you monitor your financial performance.

Get started for free.