Penetration Pricing

Pricing method of new product introduction to market that consists of pricing low and promoting heavily in order to gain a large market share and associated economies of scale as quickly as possible and before competition builds. This method assumes that consumers are price sensitive, that product awareness is low, and that competition will build quickly. See also selective penetration.

Method of pricing a standard product. It sets a low initial price for a product in order to gain quick acceptance in a broad portion of the market. It calls for a sacrifice of short-term profits in order to establish a certain amount of market share. One objective is to obtain a committed customer. See also Skimming Pricing.

Penetration pricing is a strategy employed by businesses introducing new goods or services into the marketplace. With this policy, the initial price of the good or service is set relatively low in hopes of "penetrating" into the marketplace quickly and securing significant market share. "This pricing approach," wrote Ronald W. Hilton in Managerial Accounting, "often is used for products that are of good quality, but do not stand out as vastly better than competing products."

Writing in Basic Marketing, E. Jerome McCarthy and William Perreault Jr. observed that "a penetration pricing policy tries to sell the whole market at one low price. Such an approach might be wise when the 'elite' market—those willing to pay a high price—is small. This is the case when the whole demand curve [for the product] is fairly elastic. A penetration policy is even more attractive if selling larger quantities results in lower costs because of economies of scale. Penetration pricing may be wise if the firm expects strong competition very soon after introduction. A low penetration price may be called a 'stay out' price. It discourages competitors from entering the market." Once the product has secured a desired market share, its producers can then review business conditions and decide whether to gradually increase the price.

Penetration pricing, however, is not the same as introductory price dealing, in which marketers attach temporary low prices to new products when they first hit the market. "These temporary price cuts should not be confused with low penetration prices," wrote McCarthy and Perreault Jr. "The plan [with introductory price dealing] is to raise prices as soon as the introductory offer is over."

Skimming Versus Penetration

Some manufacturers of new products, however, take a decidedly different tack when introducing their goods to the marketplace. Some choose to engage in skimming pricing, a strategy wherein the initial price for the product is set quite high for a relatively short time after introduction. Even though sales will likely be modest with skimming, the profit margin is great. This pricing approach is most often used for high-prestige or otherwise unique products with significant cache. Once the product's appeal broadens, the price is then reduced to appeal to a greater range of consumers. "The decision between skimming and penetration pricing," said Hilton, "depends on the type of product and involves trade-offs of price versus volume. Skimming pricing results in much slower acceptance of a new product, but higher unit profits. Penetration pricing results in greater initial sales volume, but lower unit profits."

Further Reading:

"Case Study: How to Price Your Products to Increase Profits." Business Owner. May-June 1995.

Clark, Scott. "Don't Miss the Boat with Strategic Pricing." LI Business News. June 4, 1999.

Cohen, William A. The Entrepreneur and Small-Business Problem Solver. Wiley, 1990.

Fishman, Arthur, and Rafael Bob. "Experimentation and Competition." Journal of Economic Theory. February 1998.

Hilton, Ronald W. Managerial Accounting. McGraw-Hill, 1991.

McCarthy, E. Jerome, and William D. Perreault, Jr. Basic Marketing: A Managerial Approach. Irwin, 1990.

Winninger, Thomas J. Price Wars: How to Win the Battle for Your Customer. St. Thomas Press, 1994.

See also: Pricing