Penetration pricing is a marketing strategy that involves the use of highly competitive pricing to introduce a new product to consumers, or to introduce an older product into a new market. The idea behind this type of pricing technique is to entice consumers to try the product, find they like it, and increase their desire to keep using the product. One the product is established in the market and has built up a certain amount of market share, the penetration pricing is abandoned for a price structure that is still competitive, but provides a higher profit margin for the manufacturer.
The idea of penetration pricing is different from another technique known as price skimming. With the skimming approach, a product is introduced at a higher price rather than a lower one. An aggressive ad campaign is normally used to build customer awareness of the product, and thus generate some degree of interest. While sales tend to be somewhat modest at first, the manufacturer earns a higher profit off each unit sold. Once the advertising has captured the attention of consumers, the unit price is then lowered to appeal to a broader consumer base, while also increasing the chances that earlier customers will recommend the product and its new lower price to others.
With penetration pricing, the idea is to generate sales among consumers who look for bargains. The expectation is that once consumers try the product, their focus will be less on the price, and more on the quality. After a reasonable amount of time, the price is increased in small increments, with the impact of each increase on overall sales evaluated closely. When the price has increased as much as possible without losing customers, the manufacture usually identifies that price as the standard retail price, and uses that as the base figure for any special promotions or sales that may occur during the course of the business year.
Businesses that are new and attempting to capture market share from established competitors may find that the penetration price approach is the quickest way to generate interest and begin acquiring customers. Established businesses may also use this strategy as a way of discouraging others from entering the marketplace and attempting to lure away consumers. For example, a large communications company that already generates a large volume of sales may learn that another business is preparing to launch a new line of similar services. With more resources, the established company proactively uses penetration pricing to not only strengthen its ties to current customers, but also to gather in new consumers before the competition has a chance to launch their new line. As a result, the competitor may delay or completely abandon plans to release the product line, since the potential for luring away customers has decreased significantly.