One of the most significant components of the marketing mix is ‘price’. The price of a product takes into account its production cost as well as the profit margin that the company wishes to charge from its customers, which would be its major source of income. A company considers three aspects when determining the price of its products, i.e. cost, competition and consumer demand. In addition, as the product moves through its life cycle, its pricing strategies are adjusted accordingly.
The most challenging stage in this regard is the introductory stage, where the company has to determine the price of its new product for the first time. There are two strategies that companies can choose from in this stage: price-skimming strategy and market-penetration pricing strategy. In this article, we will explain these two strategies in detail.
Definitions and explanations
Penetration pricing strategy
In penetration pricing strategy, the new product is introduced at a low price in the market so that it penetrates the market as quickly as possible. The company adds a nominal markup to its cost of production while setting the price of the product. The low price of the product compels a large number of customers to buy the product, thus generating high sales for the company. Hence, though the profit margin for the company is low, it can generate profits through greater number of sales. Because of greater sales, the company is able to decrease its costs, which allows companies to further decrease their price.
Companies adopt penetration pricing for products that are already being offered in the market by other brands. Hence, when their low-priced product is launched in the market, customers who are already aware of the products of other companies make a shift to the new product. Penetration pricing also discourages new entrants in the market. When competitors are unable to create and distribute the product at such low margins, they stay away from the market, which allows the company to increase its brand recognition.
Penetration pricing strategy is effective when certain conditions are present in the market. Firstly, the market should be highly sensitive to price, which means that when a low-priced product is available in the market, customers shift to that product. Hence, low price would bring about market growth and draw a significant number of customers. Secondly, with an increase in sales volumes, the company should be able to decrease its production and distribution costs, i.e. there should be economies of scale. Finally, the low prices should be effective at driving out competition from the market.
Skimming pricing strategy
In this strategy, a high price is initially charged for the product, with the intention of skimming the “cream” from the market. The company sets a high introductory price for their products so that they gain maximum profits in a short time by targeting those customers that are ready to pay a high markup for the products. The company sells a lesser number of products in the beginning, but the profit margin is high. With the passage of time, the price is gradually decreased so as to attract the next segment of the market, i.e., those customers who are willing to adopt the high-priced product at a reduced price.
To adopt a skimming price strategy, there are certain conditions that have to be fulfilled. Firstly, the product should be one that is unique and introduces features for the first time in the market. Such product has no substitute in the market, and customers pay the high price because of the uniqueness of the product. Secondly, the company should be able to sustain its distinctiveness, i.e., product should not be copied easily by competitors. Finally, there should be a category of customers in the market who give value to the unique product and wish to be the first ones to buy it; hence, they pay a surplus or premium to acquire it.
Differences between penetration pricing and skimming pricing strategies
The difference between penetration pricing and skimming pricing strategies is discussed below:
Penetration pricing strategy is one in which the price of the product is set low at the time it is launched so as to draw a greater number of customers. In price-skimming, however, the price of the product is high in the beginning so that maximum profit is attained by targeting the cream of the market.
The objective of penetration pricing is to acquire a greater share of the market by offering products at low prices. In contrast, price-skimming seeks to acquire the greatest profits by charging a high markup for the product.
3. Profit margin
The profit margin for penetration pricing is low, while it is very high for skimming pricing strategy.
4. Price sensitivity
In penetration pricing, the market is highly sensitive to pricing. In such markets, low price leads to higher share of the market as customers prefer to use low-priced products. On the other hand, in skimming pricing, there is low price elasticity, and customers are ready to pay high prices to acquire the product.
5. Class market segments
There are some customers who are willing to pay the high price to acquire an exclusive product before it becomes mainstream. Hence, in markets where customers are willing to pay a price differential to acquire a latest product, skimming pricing is more relevant. On the other, penetration pricing is more appropriate for markets that do not have such class segments.
Penetration pricing vs skimming pricing – tabular comparison
A tabular comparison between penetration pricing and skimming pricing is presented below:
|The strategy in which low prices are fixed for new products to penetrate deeply into the market in a short time||The strategy where prices are set high for new products so that highest profits are obtained|
|Acquire a greater share of the market||Acquire greater profits by charging a high markup|
|Class market segments|
|Lack of market segmentation as customers are more focused on acquiring products with lowest prices||Presence of class segments that value a product for its uniqueness and pay a high price to be the first ones to acquire it|
Conclusion – penetration pricing vs skimming pricing
Penetration pricing is appropriate for markets where there is little or no differentiation among the products. On the other hand, for product that has no competition in the market, the skimming pricing strategy is more pertinent. Before companies choose a pricing strategy for their new product, they should perform a thorough research of the market, as this decision is very important and determines the success or failure of a product.