What is penetration pricing? Definition and pricing strategy examples - LogRocket Blog (2024)

Your product is looking great, things are falling into place, and you’re almost ready for launch. You’re reviewing all the go-to-market material and you find yourself constantly revisiting and reviewing one particular section: pricing.

Pricing is one of the hardest puzzles product managers have to solve, especially when there’s a lot of uncertainty.

For example, determining the optimal penetration price for your product can be a daunting task, but it’s critical to capture your target market share quickly.

So, what can you do to get the most out of your pricing strategy?

What is penetration pricing?

Penetration pricing is a marketing strategy that involves setting a low initial price for a new product or service to quickly gain market share, attract customers, and establish brand presence.

Penetration pricing is often a temporary strategy companies employ to establish an initial customer base. Companies may raise prices after they have successfully captured their targeted market share. It is important to use this strategy carefully because it can create an expectation of low prices, making it difficult to sustain customers long term.

If done well, penetration pricing can help you quickly gain a foothold in the market, whether it’s for a new product or when entering a new market.

For example, when Microsoft launched the Xbox gaming console in 2001, it sold the console at a loss to undercut market competition, mainly from the Sony PlayStation 2. This strategy helped Microsoft quickly gain significant market share in the gaming industry.

Price skimming vs. penetration pricing

Price skimming is the inverse of penetration pricing. While penetration pricing lowers the price of products to quickly gain market share, price skimming is a strategy where you set the price of your product higher than the current market price.

This pricing strategy aims to target early adopters who are willing to pay more for a unique product or its value, based on the perception that the product or service is unique or the best in the market.

Price skimming allows you to generate revenue and market products as high-quality and exclusive items. Companies might gradually reduce the price of the product to sustain and expand their customer base.

For example, Apple’s iPhone is initially introduced at a much higher price point than other phones in the market and gradually lowered over time. Tesla cars also use premium pricing to attract early adopters.

How to do market research for penetration pricing

Market research is a critical part of creating a successful penetration pricing strategy. Taking the following steps that can help you design an effective pricing strategy:

• Target market analysis
• Competitive analysis
• Demand estimation
• Customer interviews
• Price testing and monitoring

Target market analysis

Defining your target market is fundamental to understanding customer requirements, preferences, and their willingness to pay for your product features and services. Target markets can be defined by behavioral and psychological characteristics, which can be used as a foundation for setting a penetration price.

You can use methods such as surveys, focus groups, and interviews to understand what motivates your customers to buy. You can also gather data on your competitors to compare how they price their products and services.

This information will help you get a clear picture of the market demand and the pricing points that are most attractive to potential customers.

Competitive analysis

Identify and research your competitors to analyze their products and services, as well as their pricing and positioning strategies. Understanding your competition will help you differentiate your product and create a competitive penetration pricing strategy.

One way to evaluate your competitors is to use a SWOT analysis to identify your competitors’ strengths, weaknesses, opportunities, and threats. The main objective of a SWOT analysis is to raise awareness of the variables that influence business decisions and strategies. In other words, you are examining the internal and external factors that affect your company.

It’s important to keep in mind that you should not base your pricing solely on what your competitors are charging. Instead, use their pricing as a benchmark and think about how you can add value to your product or service to justify a higher price point.

Additionally, consider factors such as distribution channels, brand image, and customer loyalty when crafting your competitive analysis.

Demand estimation

Perform market research to estimate potential demand for your product at different price points. This will help you create an optimal penetration pricing strategy to obtain market share and maximize revenue.

A few ways to estimate demand include surveys, historical sales data, and conjoint analysis.

Conjoint analysis is a powerful tool that allows you to measure how customers value different features of your product and make trade-offs between them. It can help you understand which features are most important to your customers and how much they are willing to pay for each feature.

By estimating demand at different price points, you can determine the optimal price point that will maximize revenue while still attracting customers. This information will also help you develop pricing strategies that take into account changes in market conditions and customer preferences over time.

Customer interviews

Interviewing customers or gathering feedback through surveys and focus groups help you understand customer requirements and their willingness to pay for your product or service.

Customer interviews are an excellent way to gather qualitative data on your target audience. Through one-on-one conversations, you can gain insights into users’ pain points, motivations, and expectations — insights that can and should inform your pricing strategy.

When conducting customer interviews, be sure to ask open-ended questions that encourage detailed responses and allow customers to share their thoughts and opinions freely. Additionally, consider incentivizing customers for their time with discounts or SWAG to show your appreciation for their participation.

Price testing and monitoring

Experimenting and testing different pricing strategies can help determine the optimal penetration price to obtain market share and maximize profits. Based on the insights you gather, you want to keep adjusting your pricing strategy and continue to monitor it over time. Evolve your strategy with changing marketing conditions and customer feedback.

Price testing and monitoring are ongoing processes that allow you to evaluate the effectiveness of your pricing strategy. It’s essential to track how customers respond to changes in your pricing, including whether they are willing to pay more or less for your product or service.

It’s also important to monitor market trends and adjust your pricing strategy accordingly. For example, if a competitor lowers its prices, you may need to adjust yours to remain competitive.

Regularly analyzing data from price testing and monitoring will help you make informed decisions about when it’s time to adjust your prices.

Types of pricing strategies

Pricing strategies come in many different forms. Some are even used as hybrid strategies throughout the product lifecycle.

Depending on the nature of your product and your target market, here’s a list of pricing strategies you can choose from:

• Cost-based
• Demand-based
• Competition-based
• Value-based

Cost-based

In a cost-based pricing strategy, the pricing is based on the production and maintenance costs incurred by the product. It also includes a markup to cover overhead costs and a profit margin.

Here are some cost-based pricing strategies:

• Cost-plus
• Markup
• Break-even

Cost-plus

With a cost-plus strategy, you set the market price by adding a markup to the product’s unit cost. The markup cost is intended to generate a profit after the company has covered expenses related to production.

First, you need to calculate all the costs incurred by your product in terms of both direct and indirect costs.

The formula to calculate cost-plus price is:

Selling price = Cost + (Cost x Markup percentage) + Additional expenses

Cost-plus pricing provides a predictable profit margin, which is why it’s commonly used in industries such as manufacturing and construction where the production cost can be measured easily.

You might need to adjust your cost-plus strategy based on market conditions and competitors.

Markup

Think of the cost-plus pricing strategy, but without including additional expenses incurred during the production and maintenance of your product.

The formula for markup pricing is:

Selling price = Cost + (Cost x Markup %)

Markup pricing can be effective for companies that want a simple way to determine consistent prices. Since this strategy is only focused on product costs, it can be an inaccurate representation of the total cost incurred by the product.

Break-even

In a break-even strategy, you set the price of a product at a level where you generate enough revenue from its sales to cover both fixed and variable costs related to production. When the price reaches a point where the total revenue generated by the product is equal to the total product cost, that point is called the break-even point.

Calculate both the fixed and variable costs of the product to get to the break-even point.

The formula for break-even pricing is:

Break-even price = (Total fixed costs / Unit contribution margin) + Variable cost per unit

Unit contribution margin refers to the amount by which the price of a product unit exceeds its variable cost per unit. This pricing can be useful when launching new products because it ensures that you are covering costs while offering competitive prices to gain market share.

Demand-based

In this type of strategy, the demand generated by customers influences the pricing of the product or service. Higher customer demand allows for the price to be set higher and vice versa.

Demand-based pricing strategies include:

• Penetration pricing
• Price skimming
• Dynamic pricing

Penetration pricing

This strategy is often used when launching a new product or service. You typically set the price of the product lower than market competition to gain traction and capture market share.

This encourages new customers to experience your product and gets your foot in the door. Over time, you can build your brand and establish a solid customer base.

Price skimming

Established brands leverage this strategy to create a buzz with their existing customers. By targeting the early adopters, they are able to command a higher price for their newer, exclusive, more valuable products.

This allows you to maximize profits and quickly recover investments made in research and development.

Dynamic pricing

Sometimes, shifts in demand and supply impacted by customer demand, time, location, or inventory and cause the pricing to change frequently. This strategy is leveraged to maximize sales and, thus, profits.

Dynamic pricing is sometimes also known as surge pricing when the demand is high and the supply is low, causing prices to significantly jump.

Competition-based

In a competition-based pricing strategy, competitors influence the value of your offerings. While you do want to create reasonable profits, you also have to consider how to either match the pricing of your competitors or provide exceptional customer value to command higher prices.

Here are some competition-based pricing strategies:

• Discount pricing
• Premium pricing
• Freemium pricing

Discount pricing

Discount pricing means offering your product at a percentage lower than its market price. This makes it easier to sell the product to customers who are not willing to pay the expected price. However, it should still be high enough to create a profit margin.

Some examples of a discount pricing strategy include:

• Seasonal discount pricing— Discounts offered to customers during a specific season or holiday such as Christmas or Black Friday
• Volume-based discount pricing — Discounts offered to customers who buy products in bulk quantities

Premium pricing

Strong and established brands often set their prices higher than the average market price. This allows them to position their products as high-quality, exclusive, and a cut above the average market competition.

Some examples of premium brands include luxury cars and watches, fashion brands, exclusive resorts, and Michelin-starred restaurants.

Freemium pricing

Sometimes, it can be advantageous to offer a basic version of a product or service for free while charging for additional features or upgrades. This strategy, known as freemium pricing, helps you establish your brand with new customers who might otherwise be unwilling to try out your product.

Take for example, YouTube, where you can watch videos and listen to music for free, but your videos are interrupted with ads to cover the cost of providing the free-tier service. If you pay the YouTube subscription fee, then you get a much better experience with more functionality and fewer ads.

Value-based

In a value-based strategy, the pricing is determined by how customers perceive and value your product or service. If customers find your product valuable and favorable, they are willing to pay more for it, even more than the average market price or price set by your competitors.

It’s important to gather customer feedback when leveraging a value-based pricing strategy.

Value-based pricing is primarily employed by companies that operate in industries like professional services where it is hard to compare prices with competitors. However, it can also be applied to products where customer behavior is driven by perceived value.

How to decide which pricing strategy to adopt

Your pricing strategy is a critical business decision that requires a series of careful considerations. Here is a checklist of factors to take into account when determining your pricing strategy:

• Value proposition — Understand the unique value your product or service brings to customers. This can help you decide whether to adopt a premium value-based pricing strategy or to price the product more competitively
• Market and competition — Gather market data and conduct market research to understand the current pricing in the market. This will help you create an understanding of price ranges and the features competitors are providing at various price points
• Target audience — Understanding your target audience based on factors such as demographics and psychographics, which determine customers’ willingness to pay, is critical to selecting the right pricing strategy
• Product costs — Calculate how your production and maintenance costs impact revenue and understand how this influences your pricing strategy
• Test and update — Test and evaluate your pricing strategy for effectiveness. It should be flexible and adaptable to changing market conditions and customer feedback

Overall, selecting a pricing strategy requires a solid understanding of customer requirements and market competition. It is important to consider all factors and select a pricing strategy that aligns with your company’s brand, product features, and its ability to do business sustainably.

Examples of pricing strategies

Let’s go over some some real-world examples of pricing strategies:

• Penetration pricing
• Dynamic pricing
• Price skimming

Penetration pricing

Imagine a new coffee shop just opened in your area.

There are already other coffee shops in the neighborhood, so competition is tough. To attract customers initially and establish the brand, the company chooses to offer drinks at half the price. Then, once it has regular customers, the coffee shop chooses to discontinue the discounts.

Dynamic pricing

Say you’re planning to travel. You go to book your flight and you see that the prices vary from day to day.

As you get closer to the date of the flight, the price becomes more and more expensive as availability starts to decrease. This is an example of dynamic pricing.

Price skimming

Manufacturing companies that have high-end products may use the price skimming strategy.

Take Dyson vacuum cleaners, for example. Every other year, Dyson produces a new model of their vacuum cleaner. When a new model comes out in the market, it is priced at a higher price point than other variants. When the next new variant comes out, the price of the previous versions are lowered.

Conclusion

The pricing strategy for your product or service is a critical decision and an important factor for driving adoption. Understanding market competition and customer requirements will help you design the most appropriate pricing strategy.

Changing market conditions, among other factors, should impact your pricing strategy. Keep monitoring and adjusting your strategy so that you can adapt and pivot as needed while still achieving your product goals.

Penetration pricing may or may not be the right strategy for your product or service. Understanding the pros and cons will help you determine the optimal price.

You should also establish your branding in the market and create a targeted user base, which will ultimately increase sales and lead to higher revenue over time.

Understanding the pitfalls of your pricing strategy will help you avoid them and become more confident in deploying it to your customers.

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