Explain the New-Product Pricing Strategies

Pricing strategies usually change as the product passes through its life cycle. The introductory stage is especially challenging. Companies bringing out a new product face the challenge of setting prices for the first time. They can choose between two broad strategies:

     1.    Market-skimming pricing and

     2.   Market-penetration pricing.

Market-Skimming Pricing

Many companies that invent new products set high initial prices to “skim” revenues layer by layer from the market. Apple frequently uses this strategy, called market-skimming pricing (or price skimming).

Example of market-skimming pricing

When Apple first introduced the iPhone, its initial price was as much as $599 per phone. The phones were purchased only by customers who really wanted the sleek new gadget and could afford to pay a high price for it. Six months later,

Apple dropped the price to $399 for an 8GB model and $499 for the 16GB model to attract new buyers. Within a year, it dropped prices again to $199 and $299, respectively, and you can now buy an 8GB model for $99. In this way, Apple skimmed the maximum amount of revenue from the various segments of the market.

Conditions for Market skimming Pricing:

Market skimming makes sense only under certain conditions.

First, the product’s quality and image must support its higher price, and enough buyers must want the product at that price.

Second, the costs of producing a smaller volume cannot be so high that they cancel the advantage of charging more.

Finally, competitors should not be able to enter the market easily and undercut the high price.

Market-Penetration Pricing

Some companies use market-penetration pricing. Companies set a low initial price to penetrate the market quickly and deeply—to attract a large number of buyers quickly and win a large market share. The high sales volume results in falling costs, allowing companies to cut their prices even further

Example of Market-Penetration Pricing

The giant Swedish retailer IKEA used penetration pricing to boost its success in the Chinese market. When IKEA first opened stores in China in 2002, people crowded in but not to buy home furnishings. Instead, they came to take advantage of the freebies— air conditioning, clean toilets, and even decorating ideas. Chinese consumers are famously frugal.

When it came time to actually buy, they shopped instead at local stores just down the street that offered knockoffs of IKEA’s designs at a fraction of the price.

So to lure the finicky Chinese customers, IKEA slashed its prices in China to the lowest in the world, the opposite approach of many Western retailers there. By increasingly stocking its Chinese stores with China-made products, the retailer pushed prices on some items as low as 70 percent below prices in IKEA’s outlets outside China. The penetration pricing strategy worked. IKEA now captures a 43 percent market share of China’s fast-growing home wares market alone, and the sales of its seven mammoth Chinese stores surged 25 percent last year. The cavernous Beijing store draws nearly six million visitors annually. Weekend crowds are so big that employees need to use megaphones to keep them in control.

Conditions for Market-Penetration Pricing:

Several conditions must be met for this low-price strategy to work.

First, the market must be highly price sensitive so that a low price produces more market growth.

Second, production and distribution costs must decrease as sales volume increases.

Finally, the low price must help keep out the competition, and the penetration price must maintain its low price position. Otherwise, the price advantage may be only temporary.