Good strategy…

 …or self-inflicted wound?

Penetration pricing is a strategy in which a company offers lower prices to garner market share. Is this a viable strategy? If so, when will it work?

To answer these questions we need to evaluate the impact this strategy has on each of the three things that all businesses sell – image, innovation and time savings.

If image is the primary factor in your buying decision, how will lower prices impact your buying decision? Imagine that you’re a fan of Belgian chocolates and serving them to your guests affords you the image of international traveler, connoisseur.  How likely are you to buy a new Nestle chocolate even if the product is better and the price lower?

Even if you never serve them to guests, if you buy them purely as an extravagance for your personal enjoyment, will you experience the same joy from the Nestle chocolate? Probably not.

This is not a condemnation of Nestle chocolates, they make very fine products.  Their image, brand if you will, is captured in their tagline “Good food. Good life.”  Implicit in that language is dependability and affordability.  That’s not the “Wow!” image of a Belgian chocolate.

With these thoughts in mind, does penetration pricing make sense, or is the company simply giving up profit margin needlessly?

Let’s assume that you’re a huge Apple fan. You want to be one of the first to own anything it creates. Is the price going to matter to you? Absolutely not.

A simple review of the pricing of two products that have run the full cycle – VCRs and DVD recorders – show how much innovation buyers are willing to pay for innovation.  The initial buyers, innovation buyers, paid about $1,200 for a player, no recording capability and the technology really wasn’t proven yet.

Mass market buyers came in when the player/recorder was priced at around $400.  Would they have come in earlier if the manufacturers had priced the original players at $1,000 instead of $1,200?  Not likely.

Late adopters, those who waited until no one was putting movies onto VHS tapes any longer, paid $85 to $100.  Would they have entered the market earlier if the mass market price was $300 instead of $400? Again, I think not.

What does that mean for innovation companies who use penetration pricing to garner market share? They’ve foregone a lot of profit to no avail.

In an earlier blog, Samsung Gets It Right!, you got a sense for how futile penetration pricing is.  Samsung garnered 89% of the 3D HD TV market at premium prices. It waited to reduce its price until Panasonic and Sony entered the market with competing offerings, thereby depriving both of its competitors the exceptional margins it had enjoyed.

Imagine how much more cash Samsung has to fund future R&D efforts and new product launches because it avoided the temptation to use penetration pricing. Cash that can be used to maintain, or extend, its competitive advantage.

Time savings
If I’m able to save you time and energy, what’s that worth to you? Let me rephrase that question.  If I can produce results more quickly for you, is it worth more or less to you? Isn’t that what time savings is all about, getting results more quickly so that you have time to devote to other interests?

Assume that I claim to be able to get the result you desire more quickly than my competitors AND that I can do it for a lower price, are you going to believe me?  Or is your skepticism going to cause you to question my claims? And if I cause you to question them, to spend time trying to ascertain whether or not my claims are legitimate, have I saved you any time?

As you can see attempts to use penetration pricing to garner market share on time saving offerings simply confuses the market and, potentially, delays or eliminates the possibility of a sale.

It’s counter-intuitive, but penetration pricing is an ill-conceived pricing strategy that limits the profit potential of sellers and deprives buyers of the value they desire.  Prices will decline naturally as products move through the cycle from innovation to decline, as they should. All that I’m suggesting is that we don’t need to accelerate the process by using penetration pricing.

Indeed, doing so limits the ability of companies to meet their customers’ evolving needs, leaving both worse off than they would have been with a pricing strategy that reflects the value buyers get – whether through image, innovation or time savings.