This article describes a pricing strategy used by sellers, typically in markets that suffer from imperfect competition, significant transaction costs or imperfect information.
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Penetration pricing is the practice of charging a low price for a good initially in order for it to achieve good market penetration, in anticipation of raising the price when demand subsequently rises.
Motivation behind penetration pricing
A good enjoys the bandwagon effect if, the more people consume the good, the more it encourages people to consume the good. Goods may enjoy bandwagon effects for multiple reasons: there may be natural network externalities, as for telephone and Internet-based networks. For experience goods, more people using a good may be a proof or indicator of its reliability and usefulness to others. For cultural goods, including creative works, the value of using a good may reside partly in the way others are using it.
Alternative explanations for apparent penetration pricing
Compensation for poorer quality
What appears to be penetration pricing may have many other explanations. In some cases, the seller may be unsure of the quality of the good or the value consumers place on it, so the seller keeps expectations low by charging a low price. Initial releases of a good may have more errors or snags and a low price may make consumers more forgiving.
Low initial prices may also be a form of price discrimination. This holds if people who are willing to take risks with new goods are also people who are less willing to pay huge prices, or alternatively, more willing to hunt for cheaper bargains. For instance, students and young people, who have more time on their hands than money, may be among this category.
For many goods, the reverse is true: early adopters are also likely to be the people willing to spend more. For this reason, price skimming, which is in some respects the opposite of penetration pricing, is also often explained as a form of price discrimination.