The two most commonly used pricing methods for new products are: penetration pricing and price skimming.
Penetration pricing sets an initial low price to entice buyers and enter the market quickly. Prices are then increased as market share builds up.
Price skimming sets a high initial price to recover costs as soon as possible. Prices are then gradually lowered to target a greater market share and reap more profits. This is common in gadgets or other technological products where repeat order is not common.
Have you ever seen a new product advertising with a low "introductory price of $1.99"? This is a classic example of penetration pricing method.
Penetration pricing involves setting low prices with the intention of quickly introducing a new product to the market.
Penetration pricing aims to attract customers away from competitors by offering lower prices initially. Once the product has been accepted and has established its brand in the market, prices may be increased to yield greater margins.
Price skimming involves setting high initial prices to recover costs and make huge profits in the early stages of the product's life cycle. It is very common in technological markets and for companies with established brands (Apple iPhones, gaming consoles such as Sony Playstation and Microsoft X-box, etc.).
Once the upper class market has been served, the price is lowered to cater to a larger target market. Those who were not able to afford the product during its initial offering will be able to buy it after subsequent price adjustments. This results in a larger market share hence continuous sales.
Penetration pricing gets the new product diffused into the market quickly. Buyers are enticed by low prices. However, when prices are set very low, it results in low profit per unit. This, nonetheless, may be compensated by higher volume of sales.
Penetration pricing can also help the business establish market dominance. By setting low prices, possible entrants will be discouraged in entering the market. Current competitors may also be forced to leave if they cannot keep up with low prices.
On the downside, setting substantially low prices might cause customers to question the quality of the product. Also, once prices are increased, buyers may not be willing to make repeat purchases anymore.
The main advantage of price skimming is higher profits in the early stages of the product's life cycle. This is common in technological markets where repeat purchase is uncommon.
Research and developments costs in technological markets are high. These costs are recovered early on by setting high selling prices. Also, customers often associate high prices with good quality.
A business that adopts price skimming limits its sales. Because of high initial price, sales volume is restricted. Also, when the price is dropped later on, customers might not be as excited as when the product was first released.