Penetration Pricing Law & Legal Definition

Penetration pricing is one of two contrasting but attention-grabbing techniques for introducing new products or services to a market. In penetration pricing, the price is set low in order to acquire a following and market share. Once the product/service is established, price may move to a higher level. In its article on the subject, Wikipedia, the online encyclopedia, lists the following key advantages of penetration pricing:

• Speed. The seller can achieve rapid penetration by pricing low and also surprise its competition.
• Goodwill. All-important early adopters will welcome the product and spread news of it by word of mouth.
• Cost control incentives. Having to price low, the introducer will feel pressure to be as efficient as possible—for long-term benefit.
• Barrier to others. Low pricing will discourage competitors from matching the offering.
• Channel benefits. The technique can produce rapid turnover of stock and thus gain a following among distributors and retailers.
• Marginal cost pricing can be used so that a predicted volume will cover fixed costs and extra units will only bear variable costs.

The technique is particularly applicable when demand for a product is very elastic, i.e., people will buy more when the price is low. Gasoline purchases are relatively inelastic, for example, because people cannot store much gasoline. They also have to buy gas at almost any price to get to work, alternatives being difficult to find and slow to develop. A new kind of candy, however, may be very elastic.

The technique has disadvantages as well. If the product is not very sharply differentiated from competitors' offerings (i.e., has "commodity" status), low prices may attract "switchers" while the price is low but won't build the desired brand loyalty: switchers will leave again. The low initial price may build price expectations and it may be difficult, later, to raise prices without causing a market reaction. If the low price becomes part of the brand image, changing price will disturb that image in the consumer's mind. To counter this problem, penetration pricing is sometimes used in a disguised form. The pricing intended to be used later is applied to the product in outlets, but coupons are distributed very widely and for a long period of time to let consumers acquire the product at its penetration price. The coupons may be actually part of the package so that no additional marketing steps are needed to get them to the consumer.

The other method of price-based product introduction is called skimming. It works in the opposite way. The product initially carries a very high price and is intended to gather a small, elite, but influential following. In the case of skimming, volume will, of course, be low but profits will be high. The technique is well-suited for technology-based categories expected ultimately to have wide use. By pricing high the company attracts "early adaptors" who are often leaders and/or "show-offs" and thus give the product free publicity. Thus, here, too, word of mouth has an effect. High pricing will discourage would-be imitators unless the latter are fully aware of the seller's very high margin.

Both techniques may be used in relatively inexpensive ranges of product (sodas, candy, textiles) as well as very expensive categories (appliances and the like). Penetration pricing is more likely at the lower end, skimming at the high. Neither technique—penetration or skim pricing—should be confused with periodic sales pricing of goods, either to clear inventories or to price products as loss leaders.