Penetration Pricing Strategy: Is It Smart For Startups To Lose Money?
Penetration Pricing Strategy: Is It Sensible For Startups To Lose Money?
Your author has been working with a number of startups in various sectors in recent months and the question arises – as to which pricing strategy is most appropriate for a business at an early stage in its development. In some regards, startups can be a very strange sector as only 1-2% go on to achieve brand name recognition (through a recognisable logo etc) – but it is those successes that people look at to form their own commercial strategies and when making a business plan.
If we look at some of the major success stories in the startup sphere we realise that very few of them actually were profitable at the beginning – despite being valued at very high valuations i.e. in the billions. For example:
Amazon – since launch in 1995, Amazon has seen huge revenue growth, but only marginal if any profitability. We could certainly argue that Amazon has pursued a volume seeking strategy to grow market share.
Uber – as at time of writing, Uber is still considerably loss making as it seeks to grow market share (after it entered the market in country after country) and follows a penetration pricing strategy versus competitors. Note – Uber practises a number of interesting pricing techniques including dynamic pricing and surge pricing which we will cover in future blog posts.
The video below covers 10 major brand names that are loss making – or were until very recently as they pursued market share through a penetration pricing strategy. This may be fine if you have infinite investors billions to burn – but of course that is not most startups!
Is a penetration pricing strategy suitable for your business?
An argument can be made for a penetration pricing strategy if your business model is seeking to gain market share for a number of reasons – potentially if the business is a network business – i.e. where if you lock someone in to a product, they will continue to buy more items from you on an ongoing basis. Think of photocopiers and ink in this context or in a more modern setting – Apple Itunes and buying movies and music. In the latter case – Apple pursues an ultimate penetration pricing strategy – they give the player technology away for free as the sales of videos, games and movies is so profitable.
In this instance – the penetration pricing strategy makes a lot of sense – i.e. they grow market share and then have a captive audience – or at least a market with real costs of moving who they can make continuing sales to.
An other variation is the Amazon style model above. Amazon has grown market share continually (of a seemingly terminally declining book market in developed nations). This growth has been funded in reality by shareholders and investors that are happy to continue buying shares in, and debt issued by the business.
When you are building a startup in tech or offering a new technology – the second option will be a much harder sell when seeking funding from potential investors. If you have seen “Shark tank” or “Dragon’s Den” you will be aware that most investors will finance a penetration pricing strategy for a period of time – only if that will enable them to charge profitable prices at a later point in time.
We are all in business to make a long term profit – and every business needs to have a forecast of when they will break even. Many of the huge internet startups we hear about can be making a loss in their growth years – but they need to be forecasting a profit at some point soon.
Many companies who have achieved many free users – have found it tricky to start monetising those users or implement higher prices – and many turn to advertising in this area (think Facebook). Growing a huge free user base can be great as long as it enables marketing strategies to win new paying customers.
It is one thing to attract customers when the service is free – even charging a low initial price can make it much more difficult. See our blog on price floors.
When will your business start making profits?