Market Penetration Pricing – Example and How Does It Work?

Introduction

Market penetration pricing is defined as offering a product or service at a lower cost to achieve a 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 new incumbents adapt in a market. There are dual advantages associated with market penetration pricing.

Number one is that brands can market their products at lower costs as the sale of products in itself is a marketing strategy.

Number two is that companies can attract customers who may initially be hesitant to try the new product. The company can then build on gaining the market share and offer high-quality products at a higher price point, which can make up for the 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, the customers will be turned off its product because the main reason 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 their retail operations.

How Does Market Penetration Pricing Work?

A company must have complete details about its competitors to form an effective market penetration pricing strategy.

As the company plans to be competitive on pricing, it must know about what the competition is charging its targeted customers.

Related article  How Can Blockchain be Used in Accounting?

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 figure 1 below:

Figure 1: The three critical factors impacting the market penetration pricing

The three most critical factors every company thinking of adopting 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:

1) The product life cycle

The product life cycle is a very important point the company must keep in mind when using the market penetration pricing strategy.

If the company is entering a market with matured products like fans, it is probably not the right strategy for the company to adopt.

Market penetration pricing is a great strategy if the company is launching a new product. 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 product price, and so on and so on.

2) Targeted Consumers

The company must know 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 unimportant.

Related article  4 Best Account Payable Books of All Time - Recommended

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 more expensive product.

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.

3) Distribution size

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, the company will likely run into trouble and the whole operation will 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 strategies in a competitive environment. These three are as follows:

i) Pricing product above competitors

ii) Pricing products below competitors

iii) Pricing products at the same level as competitors.

Main advantages of market penetration pricing strategy

Using a market penetration pricing strategy in a competitive market environment has many advantages. 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 drive 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.

Conclusion

Market pricing penetration is a great strategy for new companies entering a new market. This allows them to gain market share and scale of economics.

Related article  What Is The Difference Between Direct and Indirect Overhead?