PRICING POLICY FOR NEW PRODUCTS

A new product pricing strategy will depend largely on whether a company's product or service is the first of its kind on the market.

Totally new products create problems with pricing as there is no information on which to base the price.

If the product is the first of its kind, there will be no competition yet, and the company, for a time at least, will be a monopolist. Monopolists have more influence over price and are able to set a price at which they think they can maximise their profits. A monopolist's price is likely to be higher, and his profits bigger, than a company operating in a competitive market.

There are two basic strategies:
1. Penetration pricing.
2. Market skimming.
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If the new product being launched by a company is following a competitor's product on to the market, the pricing strategy will be constrained by what the competitor is already doing.

The strategies available here are:
1. Penetration pricing.
2. Average or going rate pricing.
3. Discount pricing.
4. Premium pricing.


(1) Penetration Pricing

Market penetration – a policy of low prices when a product is initially launched in order to obtain a high penetration into the market i.e. to gain rapid acceptance of the product.

The circumstances that favour a penetration policy are as follows:
• If the firm wishes to discourage competitors from entering into the market.
• If the firm wishes to shorten the initial period of the product's life cycle in order to enter the growth and maturity stages as quickly as possible.
• If there are significant economies of scale to be achieved from high-volume output, and so a quick penetration into the market is desirable in order to gain those unit cost reductions.
• If demand is highly elastic and so would respond well to low prices.
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For penetration pricing to be effective, the total market in which the firm is operating must be substantial, and the anticipated market share significant.


(2) Market Skimming

Market skimming involves high prices and high promotion costs when the product is launched to obtain sales.

Market skimming is an attempt to exploit those sections of the market that are relatively insensitive to price changes. Initially high prices may be charged to take advantage of the novelty appeal of a new product when demand is initially inelastic.

Conditions suitable for a market skimming policy are:
• Where the product is new and different, so that customers are prepared to pay high prices so as to be ‘one-up’ on other people who do not own one.
• Where the strength of demand and the sensitivity of demand to price are unknown. It is much easier to lower prices than to increase them. From a psychological point of view it is far better to begin with a high price, which can then be lowered if the demand for the product appears to be more price sensitive than at first thought.
• Where high prices in the early stages of a product's life might generate high initial cash flows. A firm with a liquidity problem may prefer market skimming for this reason.
• Where products have a short life cycle, and so need to recover their development costs and make a profit quickly.

With high prices being charged potential competitors will be tempted to enter the market. For skimming to be sustained, one or more significant barriers to entry must be present to deter these potential competitors. Examples include patent protection, prohibitively high capital investment, or unusually strong brand loyalty.

A skimming policy offers a safeguard against unexpected future increases in costs, or a large fall in demand after the novelty appeal has declined. Once the market becomes saturated the price can be reduced to attract that part of the market that has not been exploited.


(3) Average or Going-rate Pricing

In a competitive market, where there are many suppliers of homogeneous products, and the new product does not differ (and cannot be differentiated sufficiently by marketing means), in terms of quality or design, from existing products, then the firm has little choice but to charge the 'going-rate'. Departure from this price will lead to losses.


(4) Discount Pricing

Discount pricing is where products are priced lower than the market norm, but are put forward as being of comparable quality.

The aim is that the product will procure a larger share of the market than it might otherwise do, thereby counteracting the reduction in selling price.

However, care must be taken to ensure that potential customers' perceptions of the product are not prejudiced by the lower price. The consumer will often view with suspicion a branded product that is priced at even a small discount to the prevailing market rate.


(5) Premium Pricing

In most situations, the new product will either differ, or be made to appear different, in a way that will justify a premium over competing products thereby covering the additional production or marketing costs.


(6) Differential pricing – exists where it is possible to charge different prices for the same product to different customers. The bases on which price discrimination can operate are as follows:

• by product version
• by time
• by place (geographical location)
• by market segment (type of customer)
• by order size
• by age


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