Initial Price Decisions Can Have a Big Impact on a Product's Future

Whether to use price skimming or penetration pricing for an initial product launch can set a company up for either success or failure.

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by Ethan Hausmann

Every company that launches a new product wants to be successful. The question they need to answer is "by what measure?" Are they a success if they make a bunch of money initially? Or if the company controls the majority of the market? How a business answers this question determines the best pricing strategy to use.

What are some pricing strategies
There are two primary initial pricing strategies--price skimming and penetration pricing. Price skimming is where a company offers a high initial price in an attempt to recoup research and development costs. Once all of the costs have been recouped, then the price drops down to average market levels.

Another option is penetration pricing. This is where a company offers an artificially low price, often at or below cost, in order to capture market share. Usually the business initially loses money due to advertising costs and other overhead. The idea is to corner the market on this new product. Once you have a significant market share, then you can raise your prices to average market levels.

Pros and cons
The advantage of price skimming is the goal of recouping money quickly. Research and development can be very expensive and even lead to cash flow issues for a company. A high price often equates to a high profit margin, too. That cash can really assist a company to become strong.

Of course this only works if people are willing to pay the high price. Usually the majority of people can't afford a high-priced new item. Advertising must highlight the features of the new product to entice new customers. You must determine the highest possible price to recoup costs quickly, without turning off people to actually buying the product.

Penetration pricing has opposite considerations. Having such a low initial price can easily entice people to buy a product. This leads to capturing a large amount of market share. Once market share is firmly established, then prices can gradually rise to typical market levels.

Beware though. People are very resistant to price hikes. A company that uses penetration pricing might find it difficult to successfully raise their prices once customers become accustomed to the artificially low prices.

Which strategy to use?
Both pricing strategies can prove successful if executed correctly. The key is to do your research beforehand.

If there are large costs or hassles to switching products, then penetration pricing often works best. The users become hooked on your specific brand and are less willing to jump ship, even when prices rise.

If a market is already saturated and gaining market share is not possible, then high pricing leads to high profits. You need to compete on features, not price.

Doing your due diligence before product launch will put you ahead of the curve. Know your audience, your competition, and your industry. Initial pricing is important, don't neglect it.