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Unlock This CoursePrice is one of the four key elements of the marketing mix (the 4Ps: Product, Price, Place and Promotion). How a business sets its prices can make or break its success in the market. Today, we're focusing on a specific pricing strategy called market penetration pricing.
Key Definitions:
Penetration pricing is like offering a special deal to get your foot in the door. Businesses set prices lower than competitors to attract customers quickly. The goal isn't immediate profit but rather to build a large customer base rapidly. Once customers are hooked and market share is gained, prices may gradually increase.
This strategy works best when:
- The market is price-sensitive
- The product has potential for high sales volume
- There are economies of scale (costs decrease with increased production)
- You want to discourage competitors from entering the market
Market penetration pricing follows a simple but strategic approach:
The key is finding the right balance the price needs to be low enough to attract customers but not so low that it creates suspicion about quality or prevents the business from eventually becoming profitable.
- Quickly builds market share
- Creates barriers to entry for competitors
- Generates word-of-mouth marketing
- Achieves economies of scale
- Builds customer loyalty early
- Initial low profit margins
- Potential price wars with competitors
- Customers may resist price increases
- Can create perception of low quality
- May attract only price-sensitive customers
- Market price elasticity
- Production capacity
- Long-term profit goals
- Competitor responses
- Brand positioning
To understand penetration pricing better, let's compare it with other common pricing strategies:
Price skimming is essentially the opposite approach. With skimming, businesses set high initial prices to "skim" maximum profit from customers willing to pay premium prices for new products. Prices are gradually lowered to attract more price-sensitive segments.
Example: While Netflix used penetration pricing with low subscription fees to gain market share, Apple often uses skimming for new iPhones, setting high initial prices that decrease over time.
Cost-plus pricing simply adds a markup to the cost of producing a product. This approach focuses on ensuring profitability rather than market positioning.
Example: A local bakery might use cost-plus pricing by calculating the cost of ingredients and labour, then adding 40% for profit. In contrast, a new chain bakery might use penetration pricing, selling at just above cost to quickly establish a customer base.
When Spotify entered the music streaming market, it faced established competitors like iTunes. Spotify offered a freemium model a free, ad-supported tier alongside a low-cost premium subscription (£9.99/month).
This penetration pricing strategy allowed Spotify to rapidly build a massive user base. By 2021, Spotify had over 365 million users worldwide, with 165 million paying subscribers. The company gradually introduced family plans and student discounts to target different market segments while maintaining its core penetration approach.
The result? Spotify now dominates the music streaming market with approximately 31% market share globally, ahead of Apple Music's 15%.
Let's look at some successful examples of penetration pricing in action:
Netflix initially offered subscriptions at much lower prices than traditional cable TV. This helped them quickly build a massive subscriber base before gradually increasing prices as they added more content and features.
Three UK entered the market with significantly lower prices than established competitors like O2 and Vodafone. Their "all you can eat data" plans at competitive prices helped them gain market share quickly.
Aldi and Lidl used penetration pricing to enter the UK grocery market, offering products at prices 15-30% lower than traditional supermarkets. This helped them grow from niche players to major market forces.
Penetration pricing isn't right for every business or product. Here's how to determine if it might work for you:
- High price elasticity (demand increases significantly when prices drop)
- Potential for economies of scale
- Product has mass-market appeal
- Low customer switching costs
- Threat of competition entering the market
- Long product life cycle expected
- Low price elasticity (luxury or specialist products)
- Limited production capacity
- High unit costs that won't decrease with scale
- Desire to position as premium/exclusive
- No threat of immediate competition
- Short product life cycle
Amazon Prime is a masterclass in penetration pricing. When launched in 2005, it offered unlimited two-day shipping for just $79 per year (£49 in the UK) when competitors charged per delivery.
This low price point attracted millions of subscribers. Amazon gradually added benefits like Prime Video, Prime Music and Prime Reading while slowly increasing the price. By 2022, Prime cost £79 annually in the UK, but customers remained loyal due to the expanded benefits and their established shopping habits.
The strategy worked brilliantly Prime members spend an average of £1,000 per year on Amazon compared to £500 for non-Prime customers. The initial penetration pricing created a massive loyal customer base that continues to generate significant revenue.
If you decide penetration pricing is right for your business, follow these steps:
Remember that penetration pricing is a long-term strategy. You may need to accept lower profits initially to achieve greater market share and profitability in the future.
How do you know if your penetration pricing strategy is working? Monitor these key metrics:
The ultimate test of successful penetration pricing is whether you can eventually raise prices while maintaining most of your customer base and achieving long-term profitability.