Market Penetration: Pricing for New Products and Services

Establishing an effective pricing strategy is crucial for attracting customers and securing a dominant position in the market. It is in this context that the penetration pricing strategy emerges as a powerful tactic, designed to quickly capture and expand market share by initially setting low prices. This approach seeks not only to offer a significant competitive advantage but also to lay the foundations for a lasting relationship with customers. However, I want to emphasize that this strategy starts with low prices for the product or service but will only be successful to the extent that the brand manages to increase its prices in the long term, thereby capturing greater value from those segments less sensitive to price, which is not the same as an “always-low” pricing strategy whose goal is to seduce a massive audience that little identifies with the intangible and emotional attributes of the brand.

In the sections that follow, I present in more detail the main characteristics of this strategy, how it compares with other alternatives, its advantages and disadvantages, the ideal conditions for its success, in addition to some success stories.

The Penetration Strategy at Glance

A penetration pricing strategy is characterized mainly by establishing an initial low price for products or services with the goal of quickly attracting a broad customer base and achieving rapid market share acquisition. This approach seeks not only to capture a significant portion of the market from the start but also to build a solid base of loyal consumers. The logic behind this strategy is that by setting low prices, the company can incentivize consumers to switch from existing brands or providers to its offer, potentially displacing competitors and establishing a firm presence in the market.

The effectiveness of a market penetration strategy largely depends on its ability to attract a sufficiently large volume of new customers to compensate for the lower profit margins resulting from reduced initial prices. It is crucial that, through this strategy, the brand can sustain the costs associated with maintaining low prices, while ensuring the quality and perceived value of its offering. In the long term, the success of this strategy is linked to the brand’s ability to gradually increase prices without losing customer loyalty, once a solid base has been established and a significant market share has been obtained.

Therefore, the penetration strategy focuses not only on the initial acquisition of customers but also on retaining them over time, thus maximizing the lifetime value of the customer and the return on investment for the company.

Penetration vs. Skimming

The penetration and skimming strategies represent opposite approaches in the spectrum of pricing strategies. While the penetration strategy focuses on setting low prices from the beginning to attract a broad customer base and quickly capture a significant market share, the skimming strategy opts for initially setting high prices, targeted at market segments less sensitive to price and valuing other attributes such as exclusivity, innovation, or prestige. The latter approach seeks to maximize profit margins per unit sold in the early stages of a product launch, targeting consumers willing to pay more to be among the first to acquire it. As the market saturates or competition emerges, prices can be progressively reduced. The choice between a penetration and a skimming strategy depends on various factors, including the price sensitivity of the target market, competition, production cost, and the company’s long-term goals regarding market share and brand loyalty building.

Penetration vs. Freemium

While the penetration pricing strategy focuses on attracting customers by initially setting low prices and then potentially increasing them, the “freemium” strategy is based on offering a basic version of the product or service for free to later encourage the purchase of upgrades or premium features. Both strategies seek to maximize adoption and market share but differ in their approach to pricing structure and long-term revenue generation.

Advantages of the Penetration Strategy

A penetration strategy offers several key advantages for companies looking to establish or expand their presence in the market:

  • Rapid market share acquisition: By setting low prices from the start, companies can quickly attract a large number of customers. This is especially effective in highly competitive markets where the entry barrier for consumers is primarily price. Rapid market share acquisition can be crucial for establishing an early leadership position. Key question: why is it necessary to be the leader, does that guarantee profitability in this category?
  • Building a customer base: Affordable prices facilitate the building of a broad customer base, including those who might be willing to switch from competing brands. This strategy can be especially effective for introducing new products or services to the market, ensuring a transition of consumers towards the brand’s offer.
  • Network effect and brand loyalty: In markets where the network effect is significant, such as in digital services or online platforms, quickly reaching a critical mass of users can enhance the value of the service for all users. This, in turn, can increase loyalty to the brand and create barriers to exit for consumers.
  • Economies of scale: The penetration strategy can lead to a significant increase in production and sales volume, allowing companies to leverage economies of scale. This can result in a reduction in unit costs, improving profit margins in the long term despite the initial low prices.
  • Discouraging potential competitors: Establishing low prices from the start can act as an entry barrier for new competitors, as it would be more difficult for them to compete on price without sacrificing profit margins. This tactic can protect the company’s market share and consolidate its market position in the long term.
  • Maximizing Customer Lifetime Value: By attracting customers from the start with low prices and then retaining them through product quality or additional services, companies can maximize Customer Lifetime Value, increasing the overall profitability derived from each customer over time.

Disadvantages of the Penetration Strategy

A penetration pricing strategy, while offering various advantages for quickly capturing a significant market share, also presents certain disadvantages that brands must carefully consider:

  • Initially reduced profit margins: The main disadvantage of adopting a penetration strategy is that it involves setting low prices that can significantly reduce profit margins per unit sold in the early stages. This can limit the capacity for reinvestment in the business and slow growth if sales volume does not compensate for the reduction in margins.
  • Perception of low quality: Significantly low prices can lead to a perception of low quality of the product or service, especially if consumers associate price with the quality of substitute products or services. This perception can be difficult to change, even when the company decides to increase prices later.
  • Difficult to increase prices in the future: Once customers get used to low prices, it can be challenging to increase prices without facing resistance or without customers seeking cheaper alternatives. Changing the pricing strategy may require significant marketing efforts to re-educate the market about the product or service’s value.
  • Dependence on sales volume: The penetration strategy critically depends on achieving and maintaining a high sales volume to be sustainable. This can be particularly risky in volatile markets where demand can fluctuate widely due to external factors, such as economic changes or the emergence of new competitors.
  • Potential market saturation: Quickly attracting a large part of the potential market can lead to premature saturation, leaving little room for future growth. Companies may find that they have quickly captured most of the customers willing to buy, limiting opportunities for additional sales without innovation or market expansion.
  • Risk of price wars: Entering the market with low prices carries the risk of triggering a price war with established competitors looking to protect their market share. This can result in even greater erosion of profit margins, not just for the company but also for the industry as a whole.
  • Resources to scale production: Initial success with low prices may require a rapid increase in production to meet demand. This can be a challenge if the company does not have the resources, infrastructure, or production capacity necessary to scale efficiently, which could affect product quality and customer satisfaction.

Ideal Conditions for the Success of a Penetration Strategy

The ideal conditions for the success of this strategy include several key factors that can facilitate the effectiveness of this pricing tactic in capturing and expanding market share:

  • Market price sensitivity: A penetration strategy is particularly effective in markets where consumers are highly sensitive to price. This means that a significant reduction in price can decisively influence the purchase decision, attracting a large base of potential customers to the product or service offered.
  • High price-demand elasticity: The strategy works best in situations where there is a direct correlation between price reduction and an increase in demand. That is, markets in which small decreases in price lead to substantial increases in the quantities sold are ideal for implementing this strategy.
  • Ability to achieve economies of scale: The company must be able to reduce its unit costs as production increases, allowing it to maintain or even improve profit margins despite the initial low prices. This is crucial for sustaining the strategy in the long term without eroding profitability.
  • Market growth potential: The penetration strategy is more successful in expanding markets where there is a large number of potential consumers not yet captured. This allows the company to quickly capture a significant market share and establish a dominant presence before the market saturates.
  • Production and distribution strength: The company must have the operational and logistical capacity to respond quickly to the increased demand generated by low prices. This includes having efficient supply chains, scalable production capacity, and an effective distribution network.
  • Strategic positioning for future price increases: The strategy must be designed with a clear plan to eventually increase prices without losing customers. This can be achieved through a plan for continuous product or service improvements that in turn increase its perceived value, differentiation, and brand loyalty building during the low-price period. That is, from the start, it must be clear what will be the enhanced product that in the future will allow charging more to customers.

These conditions create a conducive environment for a penetration strategy to be effective not only in terms of immediate market share capture but also in building a solid foundation for growth and sustained profitability in the long term.

Example Case: Netflix

Netflix is a success case in the application of a penetration pricing strategy, and the following image allows illustrating its implementation over more than 10 years.

Source: Own elaboration with data from TomsGuide

Netflix launched its streaming service in 2007. Initially, the streaming service subscription was included at no additional cost to subscribers of its DVD rental by mail service, which was the company’s main business model at that time. That is, subscribers could enjoy both DVD rental and streaming for the same price. However, it was at the end of 2010 when the company launched its streaming-only subscription plan in the United States at a price of 7.99 dollars a month. As can be seen in the graph, the service has increased its prices and plans since its launch in 2010, to the point that today it is offered in 3 different options that capture value from segments with different preferences regarding image quality and the number of devices connected simultaneously (see the following table).

 2 devices4 devices
Ultra HD 4K —Premium
$22.99
Full HDStandard
$15.49

Standard + Ads
$6.99
— 
Source: Netflix USA, 03/2024

However, the most interesting thing is that Netflix has been able to gradually increase the price of its services and has avoided a substantial loss of subscribers, thanks to understanding how its customers perceive value and responding with plans that cater from the most price-sensitive segment to the most demanding.

Conclusion

The penetration pricing strategy constitutes a powerful tool for entrepreneurs and marketing professionals aiming to quickly establish a dominant presence in the market. However, it is crucial to conduct a detailed analysis of the target market and ensure the operational capacity necessary to sustain initial growth. Moreover, understanding how customers perceive value to innovate in the offer is essential, so that it is possible to increase prices once a leadership position in the market has been consolidated. Careful strategic planning and consideration of potential challenges are essential to maximize the benefits of this strategy and ensure informed decisions that align with the company’s long-term goals.

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