Penetration vs Skimming Pricing Strategy

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The pricing strategy for a new product should be developed so that the desired impact on the market is achieved while the emergence of competition is discouraged. Two basic strategies that may be used in pricing a new product are skimming pricing and penetration pricing.

Skimming Pricing Skimming pricing is the strategy of establishing a high initial price for a product with a view to “skimming the cream off the market” at the upper end of the demand curve. It is accompanied by heavy expenditure on promotion. A skimming strategy may be recommended when the nature of demand is uncertain, when a company has expended large sums of money on research and development for a new product, when the competition is expected to develop and market a similar product in the near future, or when the product is so innovative that the market is expected to mature very slowly. Under these circumstances, a skimming strategy has several advantages. At the top of the demand curve, price elasticity is low. Besides, in the absence of any close substitute, cross-elasticity is also low. These factors, along with heavy emphasis on promotion, tend to help the product make significant inroads into the market. The high price also helps segment the market. Only nonprice-conscious customers will buy a new product during its initial stage. Later on, the mass market can be tapped by lowering the price. If there are doubts about the shape of the demand curve for a given product and the initial price is found to be too high, price may be slashed. However, it is very difficult to start low and then raise the price. Raising a low price may annoy potential customers, and anticipated drops in price may retard demand at a particular price. For a financially weak company, a skimming strategy may provide immediate relief. This model depends on selling enough units at the higher price to cover promotion and development costs. If price elasticity is higher than anticipated, a lower price will be more profitable and “relief giving.” Modern patented drugs provide a good example of skimming pricing. At the time of its introduction in 1978, Smithkline Beecham’s anti-ulcer drug, Tagamet, was priced as high as $10 per unit. By 1990, the price came down to less than $2; it was sold for about 60 cents in 1994. (Tagamet was to lose patent protection in the United States in 1995, unleashing a flood of cheaper generics onto the American market.)6 Many new products are priced following this policy. Videocassette recorders (VCRs), frozen foods, and instant coffee were all priced very high at the time of their initial appearance in the market. But different versions of these products are now available at prices ranging from very high to very low. No conclusive research has yet been done to indicate how high an initial price should be in relation to cost. As a rule of thumb, the final price to the consumer should be at least three or four times the factory door cost. The decision about how high a skimming price should be depends on two factors: (a) the probability of competitors entering the market and (b) price elasticity at the upper end of the demand curve. If competitors are expected to introduce their own brands quickly, it may be safe to price rather high.

On the other hand, if competitors are years behind in product development and a low rate of return to the firm would slow the pace of research at competing firms, a low skimming price can be useful. However, price skimming in the face of impending competition may not be wise if a larger market share makes entry more difficult. If limiting the sale of a new product to a few selected individuals produces sufficient sales, a very high price may be desirable. Determining the duration of time for keeping prices high depends entirely on the competition’s activities. In the absence of patent protection, skimming prices may be forced down as soon as competitors join the race. However, in the case of products that are protected...
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