Pricing Strategies

New Product

Penetration and skimming are two strategies employed in pricing new products.

Learning Objectives

Compare penetration and skimming as two strategies for setting a price level

Key Takeaways

Key Points

  • Penetration pricing in the introductory stage of a new product ‘s life cycle involves accepting a lower profit margin and pricing relatively low.
  • Price skimming involves setting the price relatively high to generate a high profit margin.
  • A premium product generally supports a skimming strategy.

Key Terms

  • pull strategy: communication not demanded by the buyer
  • Price skimming: This involves the top part of the demand curve. The price is set relatively high to generate a high profit margin, and sales are limited to those buyers willing to pay a premium to get the new product.
  • Penetration pricing: The introductory stage of a new product’s life cycle means accepting a lower profit margin and to price relatively low. Such a strategy should generate greater sales and establish the new product in the market more quickly.
  • push strategy: communication demanded by the buyer

With a totally new product, competition does not exist or is minimal. What price level should be set in such cases? Two general strategies are most common: penetration and skimming. Penetration pricing in the introductory stage of a new product’s life cycle involves accepting a lower profit margin and pricing relatively low. Such a strategy should generate greater sales and establish the new product in the market more quickly. Price skimming involves the top part of the demand curve. Price is set relatively high to generate a high profit margin, and sales are limited to those buyers willing to pay a premium to get the new product.

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Price Skimming: Video game systems, such as the Sony PS3, usually employ the classic new product pricing strategy, known as skimming.

Which strategy is best depends on a number of factors. A penetration strategy would generally be supported by the following conditions: price-sensitive consumers, opportunity to keep costs low, the anticipation of quick market entry by competitors, a high likelihood for rapid acceptance by potential buyers, and an adequate resource base for the firm to meet the new demand and sales. A skimming strategy is most appropriate when the opposite conditions exist. A premium product generally supports a skimming strategy. In this case, “premium” doesn’t just denote high cost of production and materials, it also suggests that the product may be rare or that the demand is unusually high. An example would be a $500 ticket for the World Series or an $80,000 price tag for a limited-production sports car. Having legal protection via a patent or copyright may also allow for an excessively high price. Intel and their Pentium chip possessed this advantage for a long period of time. In most cases, the initial high price is gradually reduced to match new competition and allow new customers access to the product.

Differential

Differential pricing exists when sales of identical goods or services are transacted at different prices from the same provider.

Learning Objectives

Analyze the situations in which price differentiation works

Key Takeaways

Key Points

  • Product heterogeneity, market frictions, or high fixed costs (which make marginal-cost pricing unsustainable in the long run) can allow for differential pricing to different consumers, even in fully competitive retail or industrial markets.
  • Price differentiation requires market segmentation and some means to discourage discount customers from becoming resellers and, by extension, competitors.
  • There are two conditions that must be met if a price differentiation scheme is to work. First, the firm must be able to identify market segments by their price elasticity of demand. Second, the firm must be able to enforce the scheme.

Key Terms

  • arbitrage: Any market activity in which a commodity is bought and then sold quickly, for a profit which substantially exceeds the transaction cost

Price differentiation, or price discrimination, exists when sales of identical goods or services are transacted at different prices from the same provider. In a theoretical market with perfect information, perfect substitutes, and no transaction costs or prohibition on secondary exchange (re-selling) to prevent arbitrage, price differentials can only be a feature of monopolistic and oligopolistic markets, where market power can be exercised. However, product heterogeneity, market frictions, or high fixed costs (which make marginal-cost pricing unsustainable in the long run) can allow for some degree of differential pricing to different consumers, even in fully competitive retail or industrial markets.

Price differentiation requires market segmentation and some means to discourage discount customers from becoming resellers and, by extension, competitors. This usually entails using one or more means of preventing any resale: keeping the different price groups separate, making price comparisons difficult, or restricting pricing information. The boundary set up by the marketer to keep segments separate is referred to as a rate fence. Price differentiation is thus very common in services where resale is not possible, such as airlines and movie theaters.

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Price Differentiation: The airline industry implements price differentiation schemes.

Price differentiation can also be seen where the requirement that goods be identical is relaxed. For example, so-called “premium products” (including relatively simple products, such as cappuccino compared to regular coffee with cream) have a price differential that is not explained by the cost of production. Some economists have argued that this is a form of price discrimination exercised by providing a means for consumers to reveal their willingness to pay.

There are two conditions that must be met if a price differentiation scheme is to work. First, the firm must be able to identify market segments by their price elasticity of demand. Second, the firm must be able to enforce the scheme. For example, airlines routinely engage in price differentiation by charging high prices for customers with relatively inelastic demand (business travelers) and discount prices for tourists who have relatively elastic demand. The airlines enforce the scheme by making the tickets non-transferable, thus preventing a tourist from buying a ticket at a discounted price and selling it to a business traveler (arbitrage). Airlines must also prevent business travelers from directly buying discount tickets. Airlines accomplish this by imposing advance ticketing requirements or minimum stay conditions that would be difficult for the average business traveler to meet.

Psychological Pricing

Psychological pricing or price ending is a marketing practice based on the theory that certain prices have a psychological impact.

Learning Objectives

Apply the discipline of psychology to pricing

Key Takeaways

Key Points

  • Psychology is an academic and applied discipline that involves the scientific study of mental functions and behaviors.
  • While psychological knowledge is often applied to the assessment and treatment of mental health problems, it is also directed towards understanding and solving problems in many different spheres of human activity.
  • Psychological pricing can be used to increase the perceived value of a product as well.

Key Terms

  • psychological pricing: Psychological pricing or price ending is a marketing practice based on the theory that certain prices have a psychological impact.

Psychological

Psychology is an academic and applied discipline that involves the scientific study of mental functions and behaviors. Psychology has the immediate goal of understanding individuals and groups by both establishing general principles and researching specific cases and, by many accounts, ultimately aims to benefit society. In this field, a professional practitioner or researcher is called a psychologist, and can be classified as a social, behavioral, or cognitive scientist. Psychologists attempt to understand the role of mental functions in individual and social behavior, while also exploring the physiological and neurobiological processes that underlie certain cognitive functions and behaviors.

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Stop & Shop Price Cruncher: A British Stop & Shop ad from the 1994 holiday season, informing consumers what they would save on the purchase of each item.

While psychological knowledge is often applied to the assessment and treatment of mental health problems, it is also directed towards understanding and solving problems in many different spheres of human activity. The majority of psychologists are involved in some kind of therapeutic role, practicing in clinical, counseling, or school settings. Many do scientific research on a wide range of topics related to mental processes and behavior, and typically work in university psychology departments or teach in other academic settings (e.g., medical schools or hospitals). Some are employed in industrial and organizational settings, or in other areas such as human development and aging, sports, health, and the media, as well as in forensic investigation and other aspects of law.

Psychological pricing or price ending is a marketing practice based on the theory that certain prices have a psychological impact. The retail prices are often expressed as odd prices: a little less than a round number, such as $19.99 or £2.98. The theory is that this drives demand greater than would be expected if consumers were perfectly rational.

Psychological pricing can be used to the perceived value of a product up as well. By charging $350 for designer jeans, retailers are at times able to create more demand for the product than if they were priced at $19.99 for example.

Product Line

Product lining is the marketing strategy of offering several related products for sale as individual units.

Learning Objectives

Explain the strategies of creating a product line

Key Takeaways

Key Points

  • Line extensions strategies involve adding goods related to the initial product, whose purchase or use is keyed to the product.
  • A line extension strategy should only be considered when the producer is certain that the capability exists to efficiently manufacture a product that compares well with the base product.
  • Line-filling strategies occur when a void in the existing product line has not been filled or a new void has developed due to the activities of competitors or the request of consumers.
  • Line-pruning strategies involve the process of getting rid of products that no longer contribute to company profits.

Key Terms

  • line vulnerability: the percentage of sales or profits that are derived from only a few products in the line.
  • product line: a series of several related goods or services for sale as individual units
  • product mix: the number of different categories and lines of goods or services offered by a company
  • line depth: the number of subcategories a product category has.
  • line consistency: how closely related the products that make up the line are.

Product lining is the marketing strategy of offering several related products for sale as individual units. A product line can comprise related products of various sizes, types, colors, qualities, or prices. Line depth refers to the number of subcategories a category has. Line consistency refers to how closely related the products that make up the line are. Line vulnerability refers to the percentage of sales or profits that are derived from only a few products in the line. The number of different categories of a company is referred to as width of product mix. The total number of products sold in all lines is referred to as length of product mix. If a line of products is sold with the same brand name, this is referred to as family branding.

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Walmart Exterior: Large companies, such as Walmart, often have product lines that cover a wide variety of similar or related needs.

Variables to Consider When Selecting a Product Line Strategy

There are two basic strategies for dealing with whether the company will attempt to carry every conceivable product needed and wanted by the consumer or whether they will carry selected items. The first is a full-line strategy while the second is called a limited line strategy. Few full-line manufacturers attempt to provide items for every conceivable market niche. And few limited-line manufacturers would refuse to add an item if the demand were great enough. Each strategy has its advantages and disadvantages.

Line extensions strategies involve adding goods related to the initial product, whose purchase or use is keyed to the product. For example, a computer company may provide an extensive selection of software to be used with its primary hardware. This strategy not only increases sales volume, it also strengthens the manufacturer’s name association with the owner of the basic equipment and offers dealers a broader line. These added items tend to be similar to existing brands with no innovations. They also have certain risks. Often the company may not have a high level of expertise with either producing or marketing these related products. Excessive costs, inferior products, and the loss of goodwill with distributors and customers are all possible deleterious outcomes.

There is also a strong possibility that such a product decision could create conflict within the channel of distribution. In the computer example just described, this company may have entered the software business over the strong objection of their long-term supplier of software. If their venture into the software business fails, re-establishing a positive relationship with this supplier could be quite difficult. A line extension strategy should only be considered when the producer is certain that the capability exists to efficiently manufacture a product that compares well with the base product. The producer should also be sure of profitable competition in this new market.

Line-filling strategies occur when a void in the existing product line has not been filled or a new void has developed due to the activities of competitors or the request of consumers. Before considering such a strategy, several key questions should be answered:

  • Can the new product support itself?
  • Will it cannibalize existing products?
  • Will existing outlets be willing to stock it?
  • Will competitors fill the gap if we don’t?
  • What will happen if we don’t act?

Assuming a firm decides to fill out its product line further, there are several ways of implementing this decision.

Ways to Implement the Filling Out of a Product Line

  1. Product proliferation: The introduction of new varieties of the initial product or products that are similar.
  2. Brand extension: Strong brand preference allows the company to introduce the related product under the brand umbrella.
  3. Private branding: Producing and distributing a related product under the brand of a distributor or other producers.

In addition to the demand of consumers or pressures from competitors, there are other legitimate reasons to engage in these tactics. First, the additional products may have a greater appeal and serve a greater customer base than did the original product. Second, the additional product or brand can create excitement both for the manufacturer and distributor. Third, shelf space taken by the new product means it cannot be used by competitors. Finally, the danger of the original product becoming outmoded is hedged.

Yet, there is serious risk that must be considered as well. Unless there are markets for the proliferations that will expand the brand’s share, the newer forms will cannibalize the original product and depress profits. Line-pruning strategies involve the process of getting rid of products that no longer contribute to company profits. A simple fact of marketing is that sooner or later a product will decline in demand and require pruning.

Promotions

Promotional pricing means temporarily reducing the price of an established product in order to increase interest in customers.

Learning Objectives

Explain why and how marketers use promotion

Key Takeaways

Key Points

  • Promotion is one of the market mix elements, and a term used frequently in marketing.
  • Fundamentally, however, there are three basic objectives of promotion: to present information to consumers as well as others, to increase demand, and to differentiate a product.
  • Promotional pricing often involves reducing prices to unsustainably low levels. In some cases, products and services may be sold at or below cost.

Key Terms

  • Promotional pricing: The temporary reduction of the price of an established product in order to increase interest in customers.

Promotion is one of the market mix elements, and a term used frequently in marketing. Fundamentally, there are three basic objectives of promotion:

  • To present information to consumers as well as others.
  • To increase demand.
  • To differentiate a product.

There are different ways to promote a product in different areas of media. Promoters use internet advertisement, special events, endorsements, and newspapers to advertise their product. Many times with the purchase of a product there is an incentive like discounts, free items, or a contest. This is to increase the sales of a given product.

Promotional Pricing

Promotional pricing means temporarily reducing the price of an established product in order to increase interest in customers. This is sometimes done because the sales of the product are falling and the firm wants to renew customer’s interest in it. Or perhaps the product has gone out of fashion, and the firm wants to clear their stock (e.g., sales on last season’s clothes).

Promotional pricing often involves reducing prices to unsustainably low levels. In some cases, products and services may be sold at or below cost. A buy-one-get-one-free scheme may even be used. When this is done, interest in goods can be greatly increased, meaning sales are also likely to increase dramatically.

This technique may be used by retailers or producers alike. When it is used by retailers, the goal is generally to attract attention to the business and to attract regular customers. When the technique is used by producers, the goal is generally to attract customers to a product or brand and to encourage brand loyalty.

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Quaker Oats man: A Quaker Oats promotion at a Publix grocery store.