# Penetration Pricing Explained: Effective Strategies and Real-World Examples

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*— Investopedia / Mira Norian*

## What Is Penetration Pricing?

Penetration pricing is a strategic [marketing](https://www.investopedia.com/terms/m/marketing.asp) approach where businesses offer new products or services at lower prices to capture market attention and pull customers from competitors. Tactics like offering a month of free access to services or no-fee banking for six months help grow market share, with the goal of retaining these customers as prices return to normal. This strategy boosts visibility and sales while allowing companies to scale efficiently over time.

### Key Takeaways

*   Penetration pricing is used to attract customers to new products by offering lower initial prices to gain market share.
*   This strategy can be risky, as customers might not remain loyal when prices increase, potentially favoring competitors' offerings.
*   Economies of scale can be a benefit of penetration pricing if the strategy effectively increases sales volume and reduces production costs.
*   Penetration pricing is often employed by new market entrants and established brands launching new products to shift market dynamics.
*   While effective for short-term gains, penetration pricing must be carefully managed to build long-term customer relationships without sparking damaging price wars.

## Navigating the Penetration Pricing Strategy

Penetration pricing, similar to [loss leader pricing](https://www.investopedia.com/terms/l/lossleader.asp), can be a successful marketing strategy when applied correctly. It can often increase both market share and sales volume. Additionally, a higher amount of sales can lead to lower production costs and quick inventory turnover. However, the key to a successful campaign is keeping the newly-acquired customers.

For example, a company might advertise a buy-one-get-one-free (BOGO) campaign to attract customers to a store or website. Once a purchase has been made; ideally, an email or contact list is created to follow-up and offer additional products or services to the new customers at a later date.

New entrants often use penetration pricing strategy to quickly steal a portion of the market share. Because its brand is not yet known, it must rely on favorable pricing to differentiate itself from other, more established market participants. Once a company has attracted customers via penetration pricing, it often changes strategy to create brand loyalty, convert customers into long-term consumers, and drive competitors out of the market.  

> **Important**
>
> Penetration pricing may be temporary (i.e. an offer for this weekend only) or embedded into the company's long-term strategy (i.e. a deal whenever a customer switches from a competitor).

## Effective Tips for Achieving Penetration Pricing Success

Penetration pricing is the first step in a long-term plan to attract and keep new customers. In order for a penetration pricing strategy to work, it must often meet the following criteria or adhere to the following guidelines.

### High Product Demand

Penetration pricing works best when there is high demand for the product. If there isn't a large market for a product, price matters less because there are fewer consumers to attract and retain. Therefore, the most successful penetration pricing strategies rely on broader markets with more exposure where a single penetration pricing strategy can have the greatest effect.

### Avoid Price Wars

The goal of a pricing strategy is to avoid a downward pricing battle with another company. The purpose of penetration pricing is to capture market share, not just offer low prices. Price wars can be expensive, ineffective, and may publicly damage the reputation of a company should the battle ineffectively evolve.

### Pursue Economies of Scale

As a company gains new customers, it must aim for [economies of scale](https://www.investopedia.com/terms/e/economiesofscale.asp). With more customers, the company should be able to more efficiently use resources, obtain pricing, and scale operations. For example, consider a company ordering raw materials for inventory. With more customers and more orders, the company should be able to purchase larger quantities and reduce its cost per unit produced.

### Gradually Make Changes

A bad strategy in penetration pricing is raising prices too quickly. Not only does this open the door for a competitor to swoop in an employ their own penetration pricing strategy, but quickly making changes breaks customer trust. With the customer on board with the new company, the new company must slowly make changes and gradually raise prices to more profitable levels, else it will face the risk of losing the long-term value.

### Build Long-Term Loyalty

Though penetration pricing is a short-term strategy, the ultimate goal is to foster long-term loyalty. That means honoring existing pricing where applicable, understanding limitations on what can be offered, and still emphasizing value in product quality and customer service. As many telecom companies offer sign-up bonuses or one-time incentives to switch providers, it is then their responsibility to foster the business relationship.

> **Fast Fact**
>
> Companies that employed penetration pricing themselves may be exposed to penetration pricing counterstrategies when they finally decide its time to raise prices.

## Key Players in Penetration Pricing

There are three primary users of penetration pricing, each of which are discussed below.

### New Companies

Most often, penetration pricing is used by new competitors entering a market for the very first time. These companies do not have an existing presence in the market and are often not known or may be young. These companies may have limited resources, so they may not be able to deploy capital for aggressive marketing campaigns. The ultimate goal of these new companies is to steal market share from market leaders.

### Established Brands Offering New Products

In other cases, more established companies may introduce new products to the market. Although the [brand name](https://www.investopedia.com/terms/b/brand.asp) may be recognized and known, the company may not be known for some specific products. Because the company may have a large stockpile of resources, it often is able to sacrifice short-term profits in favor of establishing itself in a new market.

### Price-Elastic Brands

Last, some companies may use penetration pricing for items that have high [price elasticity](https://www.investopedia.com/terms/p/priceelasticity.asp). Price elasticity is the relationship between demand and price for a good; if a small change in price creates a large change in demand, the price is said to highly elastic. In these cases, a company may very slightly reduce its price to achieve the benefits of the price elasticity.

> **Fast Fact**
>
> Penetration pricing may occur every time you use a coupon, as a company or product is trying to lure you into paying a lower price in exchange for your business relationship.

## Weighing the Pros and Cons of Penetration Pricing

### Pros of Penetration Pricing

The primary advantage of penetration pricing is that is may be one of the quickest ways to convert a customer. Many customers may not be loyal to a specific brand. In these cases, it may be easiest to simply offer a lower price to attract their business. Whether a company is a service company, [retailer](https://www.investopedia.com/terms/r/retail-sales.asp), or manufacturer, all types of companies can offer penetration pricing strategies.

Companies can successfully use this short-term strategy and leverage new customers into long-term success. Companies can capitalize on goodwill earned when their pricing discounts were available, and this may foster brand recognition for being one of the low-price providers in an industry. As long as consumers associate the penetration pricing company as the low-cost provider, there will always be long-term brand equity created via penetration pricing.

Penetration pricing also fosters loyalty because consumers directly benefit from the lower price. Though loyalty may be tested as prices rise, consumers benefit most from lower-price battles.

Penetration pricing may also help naturally foster economies of scale. If pricing is aggressive enough, a massive amount of customers may be converted. As a company has larger order quantities and is able to build greater infrastructure, it often experiences less cost per unit due to manufacturing or operational efficiencies.

### Cons of Penetration Pricing

Though customers are attracted by a very low price, it may not be feasible to offer that price forever. The new company is trying to eventually make a profit, and some penetration pricing strategies result in [short-term losses](https://www.investopedia.com/terms/n/netloss.asp). A company must be able to temporarily cover its expenses if it is not earning enough from customers during the penetration pricing period.

Once customers are lured, there is a significant risk of consumers leaving once prices are increased. Consider the fact that a consumer lured by penetration pricing may leave because of another penetration pricing strategy. Companies must be careful when raising prices or changing contracts over time.

Some consumers may view penetration pricing as an unfavorable marketing tactic. A company may get the reputation of having lower-quality goods should consumers inappropriately associate low prices with product quality. Consumers may also see through the strategy and not appreciate the attempt to be bailed by short-term marketing tactics.

As other companies take wind of what is happening, they may decide to price match or further reduce their own price. In addition, many companies now offer price matching and may have a greater warranty or customer service process. Companies must move delicately as creating an expensive price war often leaves the new company in a less favorable position than before.

Last, penetration pricing strategies are not useful as long-term strategies. They take effort to create, then a company needs to change direction again and deploy more resources to create long-term value. These changing strategies may be burdensome to finance and must be aligned in order to effectively streamline a short-term customer into a lifetime purchaser.

### Penetration Pricing Pros and Cons

Pros

*   May be one of the fastest ways to convert a customer
    
*   Can be used by a variety of types of companies
    
*   May foster brand recognition as the low-price provider
    
*   Directly benefit consumers
    
*   May foster economies of scale
    

Cons

*   May result in short-term losses
    
*   Must be gradually phased out as customers may leave as easily as they were lured
    
*   May result in price war which leaves the new company in a worst position than before
    
*   Not useful as a long-term strategy by itself
    

## Comparing Penetration Pricing and Skimming Strategies

With pricing penetration, companies advertise new products at low prices, with modest or nonexistent margins. Conversely, a [skimming](https://www.investopedia.com/terms/s/skimming.asp) strategy involves companies marketing products at high prices with relatively high margins. A [skimming strategy](https://www.investopedia.com/terms/p/priceskimming.asp) works well for innovative or luxury products where early adopters have low price sensitivity and are willing to pay higher prices. Effectively, producers are skimming the market to maximize profits. Over time, prices will reduce to levels comparable to market prices in order to capture the rest of the market.

Small businesses in niche markets can use price skimming if their products are unique and known for quality.

## Real-World Applications of Penetration Pricing

Costco and Kroger, two major grocery store chains, use market penetration pricing for the organic foods they sell. Traditionally, the margin on groceries is minimal. However, the margin on organic foods tends to be higher. Kroger and Costco use a penetration pricing strategy when they sell organic foods at lower prices. The lower costs allow Kroger and Costco to maintain their profit margins even while undercutting the pricing of their competition.

Cell phone carriers also implement penetration pricing by offering the latest cell phones when a new consumer agrees to a long-term service contract. For example, T-Mobile (and other carriers) now offer a free phone when a customer switches to a T-Mobile plan from a plan with another company. The company can't simply survive forever by giving away these phones for free.

## Is Penetration Pricing Ethical?

Yes, penetration pricing is a valid strategy is that is used to temporarily offer lower prices to attract a customer. There is nothing unethical or illegal about it, though there are very strong considerations a company must make once a customer has been attracted. For example, once a new customer has agreed to a long-term contract, it is the company's responsibility to honor that agree even it is unprofitable and not "bait and switch" the customer.

## When Would a Company Use Penetration Pricing?

A company uses penetration pricing when it does not have a presence in a given market. Whether it is a brand new company or an old company introducing a new product, most penetration pricing strategies occur when new products are introduced and a company wants to steal market share from existing companies.

## What Types of Products Are Most Successful With Penetration Pricing?

The most elastic goods are often the most successful with penetration pricing. These goods often have the largest changes in demand with very subtle changes in price. Goods such as internet, cable, banking services, groceries, airline tickets, or hospitality services are often easier to use penetration prices with as small changes in price may more easily swing demand.

## The Bottom Line

Penetration pricing is an aggressive strategy used to capture market share by offering new products or services at a low initial price, enticing customers away from competitors. While this approach can lead to short-term financial losses, businesses aim to convert these new customers into long-term loyal patrons as prices are gradually increased. Successful implementation requires careful management of economies of scale and a focus on building lasting brand loyalty without provoking detrimental price wars. Businesses must also ensure customer trust is maintained as pricing strategies evolve over time.

> **Article Sources**
>
> 1.  T-Mobile. "[Free Phone Online Deal When You Switch to a T-Mobile Plan](https://www.t-mobile.com/switch/free-cell-phone-with-plan)."