Market penetration pricing is defined as offering a product or service at a lower cost to achieve greater market share in a particular market segment. The seller may sell the product at a loss to gain market share from established players in the market.
It is a very common strategy that is adopted by new incumbents in a market. There are dual advantages associated with market penetration pricing. Number one is that brands are able to market their products at lower costs as the sale of products in itself is a marketing strategy.
Number two is that companies are able to attract customers that may at first be hesitant to try the new product. The company is then able to build on gaining the market share and can then offer high-quality products at a higher price point which can make up for loss associated with using the market penetration pricing.
A huge risk associated with market penetration pricing is that if a company applies this strategy and then raises prices then the customers will be turned off its product as the main reason that they were purchasing the product was due to the low cost associated with the product.
So, to manage this risk companies must use extensive planning and concurrent strategies with Market penetration pricing.
A great example of a market penetration strategy is the same strategy used by Kroger and Costco to attract new customers for its retail operation.
How does market penetration pricing work?
For a company to form an effective market penetration pricing strategy, it must have complete details about its competitors.
As the company plans to be competitive on pricing, it must have knowledge about what its targeted customers are being charged by the competition.
Critical factors that should be kept in mind when using the market penetration pricing strategy
There are three critical factors that must be kept in mind when a company adopts the market penetration pricing strategy. All three of these critical factors are shown in the figure 1 below:
Figure 1: The three critical factors impacting the market penetration pricing
The three most critical factors every company thinking of adopting the market penetration pricing should keep in mind are the product cycle of the targeted market; the consumer that the company is targeting and finally the distribution size or scale of the product. All three of these factors are explained in great deal below:
The product life cycle
The product life cycle is a very important point that the company must keep in mind when using the market penetration pricing strategy. If the company is entering a market whose products are matured, like fans, it is probably not the right strategy for the company to adopt.
If the company is launching a new product, the market penetration pricing strategy is a great strategy. The company, by offering lower prices can quickly gain the majority of market shares while also achieving the economics of scale as they are selling more and more products.
This creates a virtuous circle where a lower price of products attracts more customers, which in turn lowers the per-unit cost of production, which in turn lowers the price of the product, and so on and so on.
It is very important that the company knows the habits of the consumer base that it is targeting. For example, market penetration pricing would not be the right strategy to use when targeting a consumer base for whom the price point is not important. These are the rich class consumer. They are looking for high quality and expensive products.
But, it is a great strategy to use when targeting consumers who belong to the middle or lower-middle class. This is the consumer class for whom price is the most important. They will buy a cheap product even if the quality of the product is not the same as a product that is more expensive.
This is also the consumer class that is most loyal to the brand. Unlike the rich consumer class that follows the trends and does not remain loyal to one brand or product, the middle consumer class returns the favor. So, if a company treats them they will also treat it well.
The distribution and size of the operation are very important. The company must very strategically pick the optimal size and distribution. It not only helps in reducing extra costs but also allows for operations to become profitable over time.
If a company insists on both size and distribution, it is very likely that the company will run into trouble and the whole operation would become unprofitable. This will lead the company into financial troubles. So, the company should focus on one of these operations.
Types of pricing in market penetration pricing
There are three main types of pricing strategy in a competitive environment. These three are as follows:
i) Pricing product above competitors
ii) Pricing product below competitors
iii) Pricing products at the same level as competitors.
Main advantages of market penetration pricing strategy
There are many advantages of using a market penetration pricing strategy in a competitive market environment. These advantages are described below:
1) Gaining market shares from the competitors.
2) Accessing a larger amount of consumers.
3) Gaining scale of economics that reduces per-unit cost of production.
4) Helps driving competitors out of the market.
Main disadvantages of market penetration pricing strategy
The main disadvantages associated with the market penetration pricing strategy are as follows:
1) Driving down the profits of the product.
2) The competitor also starts driving the price down.
3) Excessive competition in the market leads to huge losses.
4) The company starts losing loyal customers as they start viewing this strategy as brand tarnishing.
Market pricing penetration is a great strategy for new companies when they are entering a new market. This allows them to gain market share and scale of economics.