Penetration Pricing versus Price Skimming: Advantages and Disadvantages
Often when companies launch a new product, pricing is a big challenge before them. Every company wants its product to be successful but while gaining market share amid fierce competition can make it challenging, the key to success often lies in how you price the product. Several times, companies do not have a better choice than to price their products lower than the competitors to gain market share faster. It is mostly the case when the product is not new to the market or when the level of competition is very high. Many times sellers introduce a product or service at a very low price but as an introductory offer mainly and the price rises gradually. Based upon market conditions, level of demand and consumer demographics, pricing strategies that companies use can vary. Quality is also an important factor related to pricing. Products with higher quality often sell at higher prices. Based upon the level of competition, product quality, demand, and other factors companies can decide whether to use Price Skimming or penetration pricing when launching a new product.
Penetration pricing is also seen as a marketing strategy whose main aim is to lure customers away from competing products and brands by offering a product/service at lower prices. Usually, this pricing is utilized during the introductory phase and prices rise gradually as the product gains market share. On the one hand, this strategy is aimed at growing the awareness regarding the product and brand through unusually lower prices and on the other, it aims to help the product penetrate the market and grow customer base. If used correctly, penetration pricing can be a great marketing strategy and help gain market share faster. However, the key thing is to retain market share and the acquired customers. For example, a newly launched online video streaming service entices customers to purchase a subscription by giving the first month free.
Such companies are also successful at retaining a large percentage of the customers they gain if their services are reasonably priced and the benefits included in the subscription are as good or better than the competitors. Otherwise, the customers would switch back to the competitor once the introductory benefits are utilized. For example, a customer may switch back from Netflix to Hulu or Hotstar once the free one month subscription period is over.
There are other risks associated with penetration pricing as well. The competitor might lower the prices of its services or introduce a new class of services at lower prices to prevent customers from switching. This could also result in a price war and lead to lower price margins for both the players and this situation could continue for an extended period of time. While penetration pricing can be useful in specific situations, the key thing is to use it carefully and in a manner that does not ignite a price war. So, apart from quality, differentiating the product or service from your competitor can also be helpful at retaining the customers you gain. As you gain market share and sales grow, you could maintain lower prices and still enjoy high profits.
Advantages of Penetration Pricing:
- Faster growth in market share and customer base.
- Low prices can help grow demand faster.
- Lower competitive pressure since price-sensitive customers will switch from competitors.
- Growth in brand awareness which can otherwise take a large marketing budget.
Disadvantages of Penetration Pricing:
- It can lead to price wars in certain situations.
- Risks to product and brand image since lower pricing can give rise to the perception of inferior quality.
- Lower or no profit margins in the introductory phase.
Price skimming is the opposite of penetration pricing and must be utilized carefully or the chances of failure are high. Companies that utilize this strategy are either sure of their product’s quality or the product is unique/highly differentiated. Mostly they use this strategy when they are introducing a product that is absolutely new to the market and they know soon competitors will enter the market and make cheaper substitutes available.
In the case of price skimming, a company sets a higher price for its product. The main aim behind setting a high price is that while sooner or later the prices will drop, the profits it will earn in the initial stage will offset the price drop later. Any competitor trying to introduce a competing product or to enter the industry will use this price as a reference price.
Over time, the prices of smartphones have continued to reduce. This is also an example of price skimming. A smartphone that you buy today could be priced double or even treble some five years ago. While the number of features in these smartphones has continued to improve, prices have continued to decline since the number of brands making smartphones has grown.
For a company that intends to use price skimming, it must be careful about its product quality and unique position. If the product can be easily imitated, competitors might enter the market soon and that could affect the prices fast leading to losses for the original company. Apart from quality, a strong brand image also helps sustain the benefits of price skimming. The strategy is most suited for innovative products or for luxury goods where early adopters are less price-sensitive and will pay higher prices.
Advantages of Price Skimming:
- Product image and differentiation (higher prices are related to higher quality and early adopters are willing to pay a higher price.)
- Strong Profit margins make up for the price decline in the later stage.
- Highly suited for high-quality/ innovative products or products with a small market niche and low competition.
Disadvantages of Price Skimming:
- Lowering prices later can affect brand image and profit margins.
- Competitors could enter the market with cheaper substitutes quicker than the company’s expectations leading to lower demand and loss.
- Demand will be lower due to setting higher introductory prices.
- Requires a heavy focus on product quality and customer satisfaction for sustaining sales and growing demand.
|APA||Pratap, A. (2020, February 18). Penetration versus Skimming: Pricing a new product. . Retrieved February 18, 2020, from https://notesmatic.com/2020/02/penetration-versus-skimming-pricing-a-new-product/|
|MLA||Pratap, Abhijeet. Penetration versus Skimming: Pricing a New Product. . 18 Feb. 2020, notesmatic.com/2020/02/penetration-versus-skimming-pricing-a-new-product/. Accessed 18 Feb. 2020.|
- The Principles of Contract Law and their Application to Businesses
- 10 Secrets Every Law Student Should Know
- Types of competitor dealings with antitrust risks
- 10 Apps To Monitor Your Employees’ Performance
- How does the US Supreme Court determine if a collaboration between competitors is illegal?
- Mergers and premerger notifications in the United States