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The Guide to SaaS Penetration Pricing

Published on

October 27, 2023

The Guide to SaaS Penetration Pricing

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Penetration pricing is a strategy used by SaaS companies and other businesses to draw in customers for a new product or service by initially setting a lower price. This approach helps the product or service gain momentum in the market and attract customers away from competitors.

When it comes to penetration pricing, elastic goods prove to be the most suitable candidates due to the impact even small price adjustments can have on demand.

However, there is a risk associated with penetration pricing. Although new customers may initially choose the brand, they may choose to switch to a competitor once prices increase. To entice customers, companies often resort to unprofitable strategies, such as offering a "free product" in exchange for a long-term agreement, such as a multi-year service plan.

Other SaaS pricing strategies to look into:

- Cost-plus pricing
- Value-based pricing
- Dynamic pricing
- Skimming pricing
- Captive pricing
- Competitor based pricing
- Demand based pricing

What is Penetration Pricing?

Penetration pricing is a strategic approach employed by companies to enter competitive markets. The objective is to entice customers away from rivals by offering a lower price point. 

By pricing below customer expectations, companies can generate early product awareness and attract customers more swiftly. This strategy enables companies to acquire new customers primarily based on price rather than value. As a result, a business can capture a large part of the market at a quicker rate than with other pricing tactics.

penetration pricing
The concept of penetration pricing for SaaS

Since penetration pricing involves offering lower prices, there will be lower profit margins initially. However, the idea is that the market-share benefit of penetration pricing will ultimately be more valuable than any short-term profit sacrifice. 

How Penetration Pricing Works

By pricing below what consumers typically expect to pay, companies can raise awareness of their product or service early on and attract customers more quickly.

Instead of solely competing with established brands based on the value they offer, this approach allows companies to gain new customers through lower prices.

Once these companies have built a customer base, they can gradually increase prices to take advantage of customers' willingness to pay. However, raising prices can be challenging as customers who switched to the cheaper option are more likely to do so again when prices go up.

Therefore, if you're considering a penetration pricing strategy, it's crucial to focus on developing strong customer relationships from the outset to ensure customer retention.

Benefits of Penetration Pricing

Penetration pricing is an effective strategy for new and lesser-known businesses. By offering your product at a lower price, you can outpace competitors and attract customers early on.

If your business is established but subscriptions have declined, penetration pricing can revive your business temporarily.

Just make sure to communicate to long-time customers that the lower prices are only temporary to avoid any feelings of being deceived.

penetration pricing strategy
The benefits of using a penetration pricing strategy for SaaS

👍 Quickest way to convert a customer

Penetration pricing has a key advantage: it can quickly convert customers. Since many customers lack brand loyalty, offering a lower price is often the easiest way to attract their business.

👍 Strengthens loyalty

Penetration pricing promotes loyalty since consumers directly benefit from the lower price.

However, as a company raises its prices in the long-term, some of this loyalty may be compromised. Consumers may not benefit from conversion tactics as much as they do when companies compete on lower prices.

👍 Fosters economies of scale

Penetration pricing can encourage economies of scale. When pricing is sufficiently aggressive, a large number of customers may be converted.

As a company increases its order quantities and builds infrastructure, it often benefits from lower costs per unit due to manufacturing or operational efficiencies.

Drawbacks of Penetration Pricing 

Penetration pricing is a strategy that can help your company establish itself in competitive markets.

However, it is important to be aware that undervaluing your service may give customers the impression that you are less valuable compared to competitors who offer a more standard pricing.

what is penetration pricing
The drawbacks of using a penetration pricing strategy for SaaS

👎 Building customer loyalty becomes challenging

Customers are often attracted to low prices, but it's important to know that these prices cannot be sustained indefinitely.

The new company aims to eventually make a profit, although certain strategies like penetration pricing may result in short-term losses. During the penetration pricing period, the company needs to temporarily cover expenses if it's not earning enough from customers.

It's important to remember that when customers are enticed by low prices, there is a risk of them leaving when prices are raised.

Additionally, a customer who is attracted by a penetration pricing strategy may also leave if another penetration pricing strategy is introduced. Therefore, the company must be cautious when raising prices, changing contract agreements, and making long-term changes.

👎 Not a long-term strategy

Penetration pricing strategies are not effective for long-term success. These strategies require initial effort to implement and resource allocation to create long-term value.

However, implementing changing strategies can be challenging from a financial perspective. It is crucial to align these strategies to smoothly transition short-term customers into lifetime purchasers.

Example of Penetration Pricing

Netflix initially attracted customers by offering low-priced subscriptions, aiming to gain a significant market share.

Now, as the market leader, Netflix holds 51% of streaming subscriptions in the US and has a loyal customer base, leading to price increases over time.

penetration pricing examples
Source : Statista

Should You implement a Penetration Pricing Strategy for Your SaaS?

If your SaaS product is new and untested, using a penetration SaaS pricing strategy might be beneficial. This pricing model can encourage immediate action. However, it's important to have other pricing strategies in place for the long term.

Here's why: A continuous penetration pricing approach may give the impression that your service is struggling to attract users, making them question its value.

The lower price can become a reference point in a prospect's mind, potentially causing hesitation to pay a higher rate if they missed out on the initial offer.

While the penetration pricing model can be helpful, it should be seen as a first step toward a stronger and more established pricing strategy.

How to Implement Penetration Pricing

Penetration pricing is similar to freemium pricing as a method to acquire customers. However, relying solely on price for customer acquisition is not a sustainable approach for long-term revenue growth.

Let's imagine you're launching a new SaaS tool for project managers in a market dominated by giants like Atlassian, Trello, and Asana. Despite knowing that your product provides more value, potential customers may not be aware of it. To enter the market, you decide to use a penetration pricing strategy.

In this scenario, it's logical to offer a free base tier to match your competitors. However, your basic and premium packages should be priced differently. With penetration pricing, you structure these tiers based on the lowest price customers are willing to pay per user. This approach helps you attract more paying customers to your service.

The key takeaway is that with penetration pricing, quickly establishing relationships with customers becomes crucial.

Once you acquire these customers, you guide them through onboarding and educational content until they become fully engaged with your service. At that point, you can consider increasing the per-user price of your basic and premium packages to align with your competitors' pricing norms.

Additionally, think about how to offer upsells and other expansion revenue opportunities to maximize the lifetime value (LTV) and average revenue per user (ARPU) of your existing customer base. By fostering strong relationships with your customers, they will be more receptive to such price increases.

Tips for a Successful Penetration Pricing Strategy 

Penetration pricing is the initial step of a long-term plan to attract, convert, and build relationships with new customers. To make a penetration pricing strategy effective, it must meet certain criteria or guidelines.

market penetration pricing
Tips to implement a penetration pricing strategy

💡 Pick a high-demand product

Penetration pricing works best when there is high demand for a product. If there isn't a big market for the product, the price becomes less significant, as there are fewer customers to attract and keep.

Therefore, successful penetration pricing strategies rely on larger markets with more visibility, where a single strategy can have the biggest impact.

💡 Don’t engage in price wars

The goal of a pricing strategy is not to get into endless competition with another company.

Penetration pricing isn't about offering the lowest price; it's about gaining market share effectively. Price wars are costly, ineffective, and can harm a company's reputation if handled poorly.

💡 Aim for economies of scale

To increase profits, the company should aim for economies of scale by attracting more customers. This allows for more efficient resource utilization, better pricing, and scaled operations.

For instance, when ordering raw materials for inventory, having more customers and orders enables larger quantity purchases, reducing the cost per unit produced.

💡 Avoid raising prices too quickly

One of the mistakes to avoid with penetration pricing is increasing the price back to normal too soon. This not only gives an opportunity for competitors to implement their own penetration pricing strategy, but it also damages customer trust.

To prevent losing long-term value and maintain customer support, the new company should make changes and raise prices gradually to more profitable levels.

💡 Foster long-term loyalty

To build long-term loyalty, it is important to maintain existing pricing, understand limitations, and prioritize product quality and customer service.

Telecom companies often provide sign-up bonuses or incentives for switching providers, but it is their duty to nurture the business relationship.

Penetration Pricing vs. Skimming

Penetration pricing is when new products are advertised at low prices, often with minimal or no profit margins. On the other hand, price skimming involves marketing products at higher prices, resulting in larger profit margins. 

Price skimming works well for innovative or luxury products, targeting early adopters who are not particularly concerned with price and are willing to pay more.

Essentially, producers maximize profits by capitalizing on initial market demand. Eventually, prices will decrease to match market prices, allowing for broader market capture.

Price skimming can be advantageous for small businesses or those in niche markets when their products or services are unique compared to competitors', associated with quality, and have a positive brand image.

Is Penetration Pricing Ethical?

Penetration pricing is a strategy that involves temporarily offering lower prices to attract customers. It is not unethical or illegal, but there are important considerations for the company once a customer is attracted.

For instance, if a new customer agrees to a long-term contract, the company must honor that agreement even if it is unprofitable and not engage in "bait and switch" tactics.

📚 Recommended Reading

👉 The guide to psychological pricing

Laura Ballarin

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