Penetration pricing
Penetration pricing is appropriate for new products into a market - those at the introductory stage of its life cycle. The price is deliberately pitched at a low level to build demand and to capture market share from existing products. The price will normally be advertised as a 'special introductory price'. This pricing strategy will only be suitable if customer demand is price elastic (responsive to price changes).
At this relatively low introductory price, the firm may be making a loss and cash flow may be negatively affected. It is expected, therefore, that at some time in the near future the price will rise, so the firm may have a relatively short time to build brand loyalty.
If the firm entering the market is large, and/or aggressive, it may put some competitors out of business. This is why small retail shops fear the entry of large multiple retailers into their area. The character of a shopping area may be dramatically altered when the 'big boys' arrive.
The expected lifespan of the product will affect the decision to adopt a price penetration strategy. If the product is likely to have a short life, low prices will probably not allow for initial costs (e.g. research and development) to be covered. In addition, firms will normally only use price penetration for non-durable products, such as 'Fast Moving Consumer Goods' (FMCGs) sold in high volumes. There is little point in charging a low price for a product that will last several years (durable good), like a laptop or car.
As the firm establishes market share it is likely to gain economies of scale, which will increase its profit margin.
