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Unlock This CourseImagine you're launching a new streaming service to compete with Netflix and Disney+. How do you get customers to switch from their current provider to yours? One powerful strategy is penetration pricing - setting your prices deliberately low to attract customers quickly and gain market share.
Penetration pricing is a bold pricing strategy where businesses set their prices below competitors to enter a market and build a customer base rapidly. It's like offering a "too good to refuse" deal that gets people talking and trying your product.
Key Definitions:
Companies using penetration pricing deliberately sacrifice short-term profits for long-term gains. They set prices so low that they might even lose money on each sale initially. The goal is to attract customers away from competitors and build loyalty before gradually raising prices.
Penetration pricing isn't just about being cheap - it's a calculated business strategy with specific goals. Companies use this approach when they want to establish themselves quickly in competitive markets or when launching innovative products that need widespread adoption.
Businesses choose penetration pricing to achieve several important goals that can transform their market position and future success.
Breaking into established markets where competitors already have loyal customers. Low prices make it easier for new customers to try your product without much risk.
Rapidly increasing the percentage of market sales your company controls. More customers mean more influence and better negotiating power with suppliers.
Building a large customer base that becomes loyal to your brand. Once customers are happy with your service, they're less likely to switch to competitors.
When Netflix launched its streaming service in 2007, it used penetration pricing by offering unlimited streaming for just £5.99 per month - much cheaper than buying or renting individual films. This low price helped Netflix quickly build a massive subscriber base, even though the company lost money initially. Once established, Netflix gradually increased prices and invested in original content, becoming the market leader we know today.
Penetration pricing offers several powerful benefits that can transform a business's market position, though it requires careful planning and sufficient resources to execute successfully.
Low prices remove barriers for customers to try new products. When prices are attractive, customers are more willing to switch from familiar brands, helping new businesses establish themselves quickly in competitive markets.
Aggressive pricing can force competitors to lower their prices too, potentially damaging their profit margins. This strategy works particularly well when your business has lower costs than competitors.
Additional Benefits Include:
While penetration pricing can be highly effective, it also carries significant risks that businesses must carefully consider before implementation.
Companies may lose substantial money during the penetration phase. If the strategy fails to build sufficient market share or customer loyalty, businesses might struggle to recover these losses and achieve profitability.
Very low prices might make customers question product quality. Some consumers associate higher prices with better quality, so penetration pricing could damage brand perception and attract only price-sensitive customers.
Other Significant Challenges:
Uber used penetration pricing extensively during its global expansion, offering rides at prices significantly below traditional taxis and sometimes even below cost. In many cities, Uber subsidised rides to attract both drivers and passengers. While this strategy helped Uber quickly dominate markets worldwide, it also led to billions in losses. The company only achieved profitability in 2023, over a decade after its launch, demonstrating both the power and risks of penetration pricing.
Penetration pricing isn't suitable for every business or situation. Success depends on specific market conditions and company capabilities that make this strategy viable and effective.
Works best in large, price-sensitive markets where customers are willing to switch brands for better deals. The market should have room for growth and multiple competitors.
Companies need sufficient financial resources to sustain losses during the penetration phase. Strong cash flow or investor backing is essential for long-term success.
Businesses must be able to scale production quickly to meet increased demand without compromising quality or significantly increasing costs per unit.
Understanding how penetration pricing compares to alternative pricing strategies helps businesses choose the most appropriate approach for their specific situation and goals.
While penetration pricing starts low and gradually increases, price skimming does the opposite - starting with high prices for early adopters then lowering them over time. Apple often uses price skimming with new iPhones, charging premium prices initially before reducing them as newer models launch.
Competitive pricing matches rival prices, while penetration pricing deliberately undercuts them. Competitive pricing is safer but less aggressive, suitable for established businesses rather than new market entrants.
When Amazon launched Prime in 2005, the £79 annual fee for unlimited free shipping seemed incredibly low given typical delivery costs. Amazon used penetration pricing to build Prime membership rapidly, knowing that Prime members spend significantly more on the platform. Today, with over 200 million global members, Prime generates billions in revenue and creates customer loyalty that extends far beyond free shipping. This demonstrates how penetration pricing can create long-term value even when initial margins are thin.
Successful penetration pricing requires careful planning, clear objectives and a well-defined exit strategy to transition from low prices to sustainable profitability.
Companies must consider several critical elements to maximise the effectiveness of their penetration pricing strategy and avoid common pitfalls.
Essential Planning Elements:
Examining how successful companies have implemented penetration pricing provides valuable insights into effective strategies and common mistakes to avoid.
Sony's PlayStation consoles often use penetration pricing, selling hardware at a loss initially to build market share. They recover profits through game sales, online subscriptions and accessories. This strategy has helped PlayStation maintain market leadership for decades.
Chinese smartphone manufacturers like Xiaomi used penetration pricing to challenge established brands like Samsung and Apple. By offering high-quality phones at significantly lower prices, they rapidly gained global market share and built strong brand recognition.
These examples demonstrate that penetration pricing works best when companies have alternative revenue streams or long-term customer value strategies that justify initial losses.