There are several different pricing strategies methods that can be used and these are broadly categorized into: cost-based methods, competition-based methods, market-based methods, perception-based methods and pricing strategies for introducing new products.
Pricing strategies for new products
Two different approaches to setting prices when introducing new products to the market can be found in this category depending on the marketing objectives of the business. The pricing strategies include penetration pricing and price skimming (market skimming).
1. Penetration pricing
Penetration pricing involves setting a relatively low price in the beginning when the new product is launched to the market in order to attract customers. This strategy is often supported by strong promotion to achieve a high volume of sales. The price is then increased after a certain period of time.
When is penetration pricing used?
Penetration pricing sets a relatively low price, or an introductory price, to help establish a new product by gaining brand recognition over time on the market. It is suitable for mass market products especially for Fast Moving Consumer Goods (FMCG) that are sold in large quantities. Uses of penetration pricing include being used for new products that are competing with very similar products already established in the market. Because the firm aims to gain large market share, it uses a mass marketing targeting strategy. After the product gains a desired market share, the original price will be slowly increased.
China’s largest automakers including Changan Automobile, Geely Group, Great Wall Motors, SAIC Motor, Chery Automobile, FAW Group, Dongfeng, BYD, GAC Group, Brilliance, Foton Motor often launch their cars in foreign market at price around 10%-20% lower than the prices of rival car companies from Europe, Japan, USA or Korea. When Netflix first entered the streaming market, it launched its monthly subscription at a very low price in order to gain a significant market share by attract a large number of initial customers.
✅ Advantages of penetration pricing:
The low price set at a lower level from similar products already on the market encourages consumers to try the new product allowing for high volume of sales and building customer loyalty. Hence, it can attract customers quicker and helps the product to become established in the market and increase market share quickly. Once customer loyalty has been built up for the product, the price will be increase to a level similar to that of its main competitors to maintain profit margins.
❌ Disadvantages of penetration pricing:
Setting prices too low can cause customers to perceive the product as of having poor quality. This may discourage some customers from buying it; therefore cause loss of revenue due to lower prices. When the business cannot recover any development costs quickly enough because the life cycle of a new product is too short, then the profit will never be made causing the firm to cover the loss.
2. Price skimming (market skimming)
Price skimming involves setting a relatively high price in the beginning when the new product is launched to the market in order to maximize short-term profits. This strategy is often used when a firm has a unique or highly differentiated product with low price elasticity of demand. The price is then decreased after a certain period of time.
When is price skimming (market skimming) used?
Price skimming sets a relatively high price to project an exclusive image for the product and maximize short-term profits before competitors enter the market with a similar product. It is suitable for niche products, especially for innovative, technologically advanced and complex products. Uses of price skimming include being used for new products that are unique or very different from any other product already available in the market. As New Product Development (NPD) tends to be very expensive, an initial helps to recoup the considerable costs of research and development. After competitors launch similar products, it may be necessary to reduce the original price.
MEDICINES: Pharmaceutical producers such as Pfizer, Merck or AstraZeneca, who often have a legal protection for a certain number of years after inventing new medication, charge a very high price for the product which they have spent many millions of dollars researching and developing. When the legal protection starts expiring and other drug products start entering the market with generic drugs, the prices are often reduced. TECHNOLOGY: Games consoles such as PlayStation 5, smartphones such as iPhone and high-definition flat-screen televisions had all been sold at very high prices at the launch while the prices dropped after a few months.
✅ Advantages of price skimming (market skimming):
Consumers are willing to pay more for the latest technology, so the short-term profit earned using price skimming can be very high. Consumers may also want the status of owning the latest version of a unique product and are prepared to pay a high price for this. The high initial price can help to create that prestigious image for the product. As there are unlikely to be any substitutes, the firm can charge a premium price to maximize profits. The high price enables the firm to recover research and development costs which are often very high for products such as pharmaceutical and hi-tech products.
❌ Disadvantages of price skimming (market skimming):
Some potential customers who would like to buy the product, but are price sensitive, will not be able to purchase the product because of its high price. This means a loss of sales and loss of sales revenue. Due to the high potential profits that can be made resulting from the high price, other business will eventually be attracted to enter the industry. When competitors enter the market with similar products, the business will gradually reduce its price. As these cheaper competitor products drive prices down, this will lead to lowering potential profit margins. Finally, price skimming can only be successful, if it is supported by other elements of Marketing Mix such as intensive promotion and extensive distribution network.
