ABC has a large amount of excess production capacity, and so has an incremental cost of only $6.00 for the product. The current market price for a blue one-armed widget is $10.00. Example of Penetration PricingĪBC International wants to enter the market for blue one-armed widgets. This approach can work well in a mass market environment where large numbers of very similar products are sold, since it creates the opportunity for someone to drive down prices over very large production volumes. Related AccountingTools CoursesĪ business intent on following the penetration pricing strategy should have substantial financial resources, since it may incur significant losses during the early stages of this strategy. If a company obtains sufficient sales volume through this pricing strategy, it can become the de facto industry standard, which makes it easier to defend its position in the market. It is particularly likely when the new entrant has a product that it cannot differentiate from those of competitors in a meaningful way, and so chooses to differentiate on price. It is relatively common for a new entrant into a market to engage in penetration pricing, in order to grab an initial block of market share. Another reason is to use excess production capacity that the seller has available its marginal cost to produce using this excess capacity is so low that it can afford to sustain the penetration pricing for quite some time.

Another reason is to obtain so much market share that the seller can drive down its manufacturing costs due to very large production and/or purchasing volumes. The first reason is to drive competitors out of the marketplace, so the company can eventually increase prices with little fear of price competition from the few remaining competitors.

There are three reasons why someone would engage in penetration pricing. While the seller may not initially make a profit at this low price point, it is building awareness with customers, who may like the features of the seller’s product so much that they stick with it once the seller eventually raises prices back to a more sustainable level. The low price is likely to attract price-sensitive customers, thereby increasing the seller’s market share. Penetration pricing is the practice of initially setting a low price for one's goods or services, with the intent of increasing market share.

Companies using penetration pricing