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Market Penetration

Guide to Understanding the Market Penetration Rate

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Market Penetration

How to Calculate Market Penetration?

The market penetration rate is the percentage of the company’s target market that is currently using its products or services.

Before the market penetration rate can be calculated, the size of the company’s target market, i.e. the total addressable market (TAM), must first be estimated.

The higher the market penetration, the more revenue the company generates – all else being equal.

But the size of the market must also be considered, as possessing a 10% market share of a $10 billion market is preferable to possessing an 80% market share of a $100 million market.

In practice, tracking a company’s market penetration helps assess its competitive standing relative to its closest competitors.

The company’s current market penetration can also be insightful in understanding the upside remaining in the market.

If the potential to capture additional market share is limited, then the company might need to consider expanding into different markets to reach more customers.

What is a Good Market Penetration Rate?

The average market penetration rate is different for each market in question, which again returns to the importance of market sizing.

In general, markets that sell products and services to consumers tend to be smaller (on a dollar basis) than those that sell to small-to-mid-sized businesses (SMBs) and large enterprises.

These are some generalized parameters to reference to provide a rough guideline:

  • Consumer Products → 2% to 8%
  • SMB and Enterprise Products → 10% to 40%

Of course, there are outliers such as social media companies, but the above refers to paid customers, as opposed to including all active users on a platform.

Market Penetration Strategy: Market Share Tactics Examples

While market share metric focuses on the percentage of the total market revenue belonging to a particular company, market penetration focuses more on the number of potential customers acquired – albeit, the two are closely tied together.

In particular, companies attempting to disrupt and grab market share from existing incumbents tend to pay more attention to the market penetration rate, which can function as an informative indicator of whether its current strategy and tactics are effective, or if changes are necessary.

Once a company becomes the market leader, i.e. among the top companies in their industry with regard to market share, it now has a target on its back.

Competitors and early-stage companies like startups will start to identify weaknesses in the business model of the market leaders in order to take their existing customers (and thus their future revenue).

Since the market leaders are essentially under attack, it is critical for them to possess an economic moat for their profits to be sustainable over the long run and to take a more defensive approach.

After performing market research and identifying the key demographics (and customer profiles), some common tactics often utilized by new entrants with less market share include the following:

  • Price Reductions (“Undercutting”)
  • Incentives for Switching Providers (e.g. Special Discounts)
  • New Products or Services (or Value-Add Upgrades)
  • Strategic Marketing with Targeting Selling Points (i.e. Bring Awareness to Weaknesses)
  • Build Switching Costs (e.g. Offer After-Sale Services, Long-Term Contracts)
  • Freemium Models and Free Trials

Market Penetration Rate Formula

The formula for calculating the market penetration rate is as follows.

Market Penetration Rate = Number of Customers ÷ Target Market Size

By dividing the number of acquired customers by the target market size, a company can track the percentage of the market its strategies have successfully captured to date and evaluate its pace of progress.

Market Penetration Calculator – Excel Template

We’ll now move to a modeling exercise, which you can access by filling out the form below.

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Market Penetration Rate Calculation Example

Suppose a company ended the fiscal year 2021 with 40,000 customers.

For the sake of simplicity, we’ll assume that the average selling price (ASP) of the products sold by the company and all other market participants is $250.00.

  • Number of Customers = 40,000
  • Average Selling Price (ASP) = $250.00

The product of the customer count and the average selling price (ASP) results in the company’s revenue for 2021, or $10 million.

  • Total Revenue = 40,000 × $250.00 = $10 million

In the next step, we’ll estimate the size of our company’s target market, which we’ll assume comprises of 1 million potential customers (and the ASP assumption is kept constant).

  • Total Number of Customers = 1 million
  • Average Selling Price (ASP) = $250.00

The total addressable market (TAM) comes out to $250 million.

  • Total Addressable Market (TAM) = 1 million × $250.00 = $250 million

With our inputs all set, we can divide our company’s number of customers by the total attainable customers in the market.

Of the target market, our company’s market penetration rate is 4.0%.

  • Market Penetration Rate = 40,000 ÷ 1 million = 4.0%

The market share of our company, as one would expect, given our simplified average selling price assumption, is also 4.0%.

In the real world, however, the market share is not always equal to the market penetration rate because competitors price their products and services at different rates.

Market Penetration Rate Calculator

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