HOW PENETRATION PRICING WORKS
Penetration pricing is a strategy employed by businesses introducing new goods or services into the market place. 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 often is used for products that are of good quality, but do not stand out as vastly better than competing products. A penetration 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 policy 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. 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 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 penetrating pricing depends on the type of product and involves take-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.
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