Penetration Pricing Definition Example How It Works

Penetration Pricing Definition

Example

A new telecommunication company in the market has offered to provide one-month free internet services to its subscribers. Such is an example of penetration pricing since the telecommunication company, to enter the market, has provided its internet services for free for an initial period of one month.

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Penetration Pricing Strategy

Consider the following diagram, which explains how penetration pricing works.

Here, the price and the quantity expected to be sold are represented on the vertical and horizontal axes. Thus, against price “P1”, a quantity expected to be sold is “Q1”. The price is kept at a relatively higher side. As a result, less quantity of goods is expected to be sold. If the price is further reduced to P2, more quantities, i.e., Q2, could have been sold. Thus, the graph represents that a lower price attracts the sale of a higher quantity, which is the subject matter in the case of penetration pricing.

Importance

Penetration pricing is generally used by sellers who are new to the already developed economy Developed EconomyA developed economy is the one that has a high per capita income or per capita GDP, a high degree of industrialization, developed infrastructure, technical advances, and a relatively high rank in human development, health, and education.read more. When a seller enters an existing market of a current product, he may find it difficult to attract customers being a newcomer. Such a seller can introduce penetration pricing and reduce its product prices for an initial period to attract customers to leave the competitors and connect with the seller. Sellers usually adopt this strategy for a particular set of products and simultaneously continue to sell the other products at their normal prices to maintain a reasonable profitability margin. The plan is useful for those products where the demand is elastic to its price.

Penetration Pricing vs Price Skimming

Penetration pricing is a pricing strategy wherein a seller introduces its products at a low price for a particular time to attract a larger market share. The school of thought behind the plan is that lower prices will attract more customers and help a company develop a good market share by shifting the customers’ focus from competitors. Afterward, the company increases the product’s price to its normal price.

On the other hand, price skimmingPrice SkimmingPrice skimming refers to a pricing strategy where the producers sell new, innovative, or improvised products or services at a high price for a short period targeting high-end customers and subsequently, reduces the price to tap remaining market segments.read more is a pricing strategy wherein a company aims to maximize its profits by charging high prices for its newly introduced product. After that, the costs are reduced to a normal price. This type of pricing strategy is adopted in case of unique products for which the customers may be willing to pay higher costs. A classic example of the price skimming policy is high technology-driven mobile phones, wherein customers are willing to pay higher prices owing to the phone’s features.

Advantages and Disadvantages of Penetration Pricing

Advantages

It helps a company establish its market share quickly and leaves the competitors with a lesser response time.It creates goodwillGoodwillIn accounting, goodwill is an intangible asset that is generated when one company purchases another company for a price that is greater than the sum of the company’s net identifiable assets at the time of acquisition. It is determined by subtracting the fair value of the company’s net identifiable assets from the total purchase price.read more for a company since customers promote the products automatically by word of mouth.Since prices are set at the lower end, it encourages the company to maintain cost controlsMaintain Cost ControlsCost control is a tool used by an organization in regulating and controlling the functioning of a manufacturing concern by limiting the costs within a planned level. It begins with preparing a budget, evaluating the actual performance, and implementing the necessary actions required to rectify any discrepancies.read more, leading to resource efficiency.Such a pricing strategy discourages new competitors from entering the market.

Disadvantages

As the prices are low, it may not result in sufficient profitability for the company even if a substantial quantity of the product is sold.If the prices are initially kept lower, it becomes difficult to justify the increase in the costs later.The pricing strategy will not be useful for products with a shorter life cycle as the loss suffered by the company due to penetrative pricing in such a shorter life cycle may be substantial.If the sales do not rise quickly, it may be difficult for a company since the working capital will get blocked, leading to a shortage of funds.

Conclusion

Based on the type of the product and the level of competition, one may decide whether it will be beneficial to opt for penetration pricing or other pricing strategies such as skimming pricing strategy.