Definition of 'Pricing Strategies'

Definition: Price is the value that is put to a product or service and is the result of a
complex set of calculations, research and understanding and risk taking ability. A pricing
strategy takes into account segments, ability to pay, market conditions, competitor
actions, trade margins and input costs, amongst others. It is targeted at the defined
customers and against competitors.

There are two major pricing strategies

Penetration pricing vs skimming pricing

strategies
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:

1. Meaning
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.

2. Purpose
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.