Win Customers in Competitive Markets with Penetration Pricing

You’ve created a new product. You’ve invested time, effort, and resources, meticulously preparing it for the market—it’s just about ready for launch.

But even with a great product, there’s no guarantee customers will notice, let alone buy. To make the matter more difficult, you're dealing with competitors who already have a foot in the door.

You need a strategy to grab attention, spark demand, and win over customers right from the get-go. 

That strategy is penetration pricing.

In this article, we cover what this approach entails and why you should use it. Then, we cover three real-world examples, along with pros, cons, and metrics to keep an eye on.

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What is Penetration Pricing?

Penetration pricing is a pricing and marketing strategy where a company sets an initial price that’s significantly lower than the typical market price. It’s a short-term pricing strategy designed to gain a foothold in competitive markets, even at the cost of immediate profit. 

This tactic can be especially effective in industries where there is little product differentiation; demand is highly elastic (meaning demand shifts according to pricing), and products are suitable for markets catering to a broad audience. 

Take streaming services as an example.

While Netflix, Hulu, and Disney+ libraries are different, the core offerings between these three competitors are almost identical. People are often willing to try out competitors if they’re cheaper, and the industry caters to a broad customer profile.

Why Do Businesses Use Penetration Pricing Strategies?

Penetration pricing attracts customers, builds market share, and undercuts competitors. This approach typically increases a company’s sales volume, and enables them to generate demand and take the first steps toward building brand awareness and loyalty.

Alongside these benefits, businesses that employ this strategy are also better positioned to upsell other products. While customers may have been attracted by the lower price point of one of your products, they’re more likely to make other purchases once they’re confident in your brand.

‍Arvind Rongala, CEO of Edstellar, notes exactly how short-term low prices helped to sell his EdTech SaaS solution:

We used penetration pricing to quickly win market share. With our platform being 40% cheaper than its peers during the first six months, we caught the eye of cost-conscious early adopters.

That approach helped us gain a 25% market share in our target segment within a year. Small education businesses that didn’t have a traditional LMS platform considered our price point an easy sell and quickly migrated.

Arvind Rongala CEO at Edstellar LinkedIn

What Happens After a Penetration Pricing Strategy?

Lower prices will initially entice customers to buy your product or service and enable you to win market share, but it’s not sustainable in the long run. You’ll need to raise prices further down the line to prioritize profit.

This should be a gradual process of incrementally increasing prices while focusing on improving customer retention through loyalty programs, enhancing quality, and providing superior customer service.

Companies are typically ready to increase their prices once they've: 

• Captured and secured a significant market share 
• Improved their products enough to justify higher prices
• Achieved lower costs per unit with higher production costs; otherwise known as realizing economies of scale

2 Real-world Examples of Penetration Pricing Strategies

Penetration pricing is nothing new. In fact, many household names have successfully used it to gain a competitive foothold in their respective markets. Here are two examples.

1. Xiaomi’s Entrance Into The Smartphone Market 

Xiaomi is a textbook example of penetration pricing currently unfolding in the smartphone industry. The electronics company entered the market with affordable smartphone alternatives to tech giants Samsung and Apple. In fact, Xiaomi's average selling price is 40% lower than Samsung, and 75% lower than Apple’s.

Data suggests that Xiaomi’s strategy has significantly helped them grow their customer base. At the start of 2023, Xiaomi only had 11% of the global smartphone market share, while Apple had 21%, and Samsung enjoyed 22%. 

By the second quarter of 2024, Xiaomi's market share rose to 15% while Apple fell to 16% and Samsung to 19%. While it’s still not the biggest smartphone company, Xiaomi rapidly gained market share in a highly-competitive market

2. Kroger’s Organic Food Line

While many companies charge high prices for organic food, Kroger took a different approach when entering the market. By introducing organic options at lower prices than the competition, they were able to attract more consumers to their brand and expand their already enormous customer base. 

The logic behind this move is to bring customers to the store for lower-priced organic food, during which they’ll also purchase other goods with standard pricing. Plus, Kroger is often credited with making organic food more accessible to people, winning its brand recognition and loyalty. Penetration pricing has been an all-round winner for Kroger.

The Risks of Penetration Pricing

If you’re thinking about using this marketing strategy for your next product launch, it’s important to consider the challenges it can often present:

• Initial losses: In most cases, penetration pricing should generate enough sales volume to guarantee profitability. However, it’s not uncommon for businesses to suffer short-term losses and reduced profit margins because of lower prices.
• Risk of starting price wars: An established market competitor might respond to your lower pricing by undercutting your undercut. This race to the bottom makes profitability for both you and competitors increasingly difficult. 
• Customer churn after price increases: Even if you gradually raise prices, many customers still might leave. Losing a portion of your newly acquired market share is almost inevitable if customers are staying with your product purely because of pricing. 
• Brand perception misalignment: Penetration pricing isn’t an effective strategy for all industries. For example, attempting to sell luxury goods at lower prices can cause many to associate your brand with low quality.

‍Priyansh Kothari describes some of the challenges he’s faced with implementing this approach at Stargazer:

“The strategy attracted customers who expected premium service at a discounted rate, which wasn't sustainable for us financially. This led to lower lifetime value per customer and overall reduced revenue in the short term. This was a huge drawback along with increased customer support requests from these clients.”

Penetration Pricing Best Practices

So, how can you avoid these risks and make penetration pricing work for you? Here are four best practices to help ensure it's a success:

• Focus on building relationships: That way, when you raise prices, customers will be confident in your brand and more likely to stick around.
• Don’t increase pricing too quickly: Keeping low prices forever won’t be sustainable. But increase them too suddenly, and you’ll lose a chunk of your customer base. Instead, gradually raise prices so you don’t send your early adopters packing.
• Invest resources in improving the product: Enhancing your product solidifies customer loyalty and justifies higher prices. Collect customer feedback and use it to improve your product before raising prices.
• Measure success to evaluate effectiveness: You won't know if penetration pricing works unless you measure it. And for that, you need metrics…

Analyzing Penetration Pricing: 5 Key Metrics

Penetration pricing isn’t a one-and-done strategy. To gauge its effectiveness, businesses need to monitor five main key performance indicators:

1. Sales growth: One of the main goals of this approach is to quickly boost sales. Monitoring sales growth helps you assess if your strategy is driving increased customer purchases.
2. Customer acquisition rate: You’ll want to know how many customers are drawn in by your new strategy. A high acquisition rate indicates that it’s proving effective, while lower rates suggest that you may need to adjust your pricing, marketing, or distribution strategies. 
3. Market share: Another core objective of penetration pricing, market share helps you assess if you’re securing a dominant position amongst competitors or if you're staying stagnant despite your strategy.
4. Profitability: Lower pricing often sacrifices short-term profitability for long-term gains. However, it’s still important to monitor this metric and ensure that you’re not taking unsustainable losses that put your business at risk in the short term.
5. Customer retention and churn rates: Higher retention means that customers are staying, despite rising prices. Higher churn rates indicate customers are leaving. 

Short-Term Pricing for Long-Term Success

Penetration pricing is just one piece of a long-term game. Sure, it gets customers through the door, but ultimately you want them to stay. The only way to get your product to stick is by continuously improving both it and your relationships with customers over time. 

There are many moving parts to this pricing strategy, all of which you need to keep a close eye on. Building trust, improving your product, and winning customer loyalty are big undertakings—ensure you map out your market penetration plan from start to finish, to maximize your chances of successfully implementing a penetration pricing strategy.