As we’ve laboured through various types of pricing strategies in previous posts, we have addressed Cost Based, Competitor Based, and Customer Based strategies. Some would say these major segmentations cover all types of pricing actions, but I’ve added Market or Brand Based strategies as a fourth segmentation.
Certainly markets are made up of customers, but sometimes we make decisions at a different level. For example, we might undertake a broader marketing strategy such as market build, where the objective is to expand the entire market by increasing end user consumption. An example of a market build campaign, as reported in a recent issue of Ad Age, would be the move to overcome negative perceptions of frozen food amongst US consumers. In this instance, the US frozen food industry is working to (re)build the frozen food market, and while a variety of tactics will be employed, pricing will need to take into consideration the broader market approach.
At the brand level, sometimes pricing decisions are based on specific situations without much consideration to cost, competition, or customers. Price skimming (see below) is an example of this.
Similar to Customer Based Pricing, the seller makes pricing and other marketing decisions based on a clear understanding of their market and the position of their brand within that space. Here are some examples of Market or Brand Based pricing strategies.
Penetration Pricing Strategy
Penetration pricing is a strategy designed to gain rapid trial and capture market share by offering deep discounts during introduction. These deep discounts usually result in prices significantly below competitive offerings, and potentially below cost. Since this pricing model is not sustainable over time, once market share and customer acquisition objectives have been addressed, price will increase.
One example of penetration pricing would be the launch of Lays’ Stax potato chips. In this example, which now dates back many years, the new Stax brand had limited differentiation versus the defending market leader, Pringles. In certain markets the launch price of Stax was $0.69; pricing rose to $1/ unit a few months after launch.
Penetration pricing is also commonly used by Internet phone companies such as Comwave in Canada, where the first 6 months are free with a 3 year contract.
Pros and Cons of a Penetration Pricing Strategy
Penetration pricing can quickly establish a presence for a new product, building share and a user base. It may also discourage competition from entering a market based on low margins, at least initially.
Penetration pricing represents an investment, paid through reduced margin, on the company’s behalf. It’s therefore appropriate to evaluate this price investment versus establishing a market presence by investing in other tactics such as advertising or non-price promotion. Also, since this strategy attracts price conscious consumers, customer retention may prove challenging when the time comes to move the price up. Once a higher price is established, incentives such as promotional discounts or coupons may be required to keep customers from switching brands.
Price Skimming Strategy
Another often used pricing strategy during the product launch phase is Price Skimming. This strategy early in the product life cycle leverages the initial strength of the product to generate high margins at first, with prices and margins declining as time progresses. The initial strength of the product may be driven by technology or some other product characteristic, potentially enhanced by brand power.
Price skimming is particularly evident in the technology arena with examples including the introduction of high definition televisions and personal electronics. For example, Apple has used price skimming as an effective strategy to profit from early adopters during the launch of the iPhone and iPad. As early adopters are satisfied, the price is lowered. Apple has also used a hybrid of price skimming by launching new variants of the iPad (mini; 2) with new features. This allowed the company to continue price skimming with the new products, while reducing the price to (more) competitive levels on older versions.
Pros and Cons of a Price Skimming Strategy
Of course, the over-riding positive associated with skimming is profitability. It allows a company to cover its development and launch costs more quickly, sometimes before competition arrives on the scene and drives pricing downward. And competition will come, pushed on by the high margins being enjoyed by the price skimmer.
Price skimming is the opposite of penetration pricing, so it attracts those customers willing to pay an early adopter ‘tax’. Since premium purchasers are traditionally a smaller market segment, unit sales volume may be low, resulting in cost impacts due to limited production runs and slower inventory turns. Moreover, since the company has chosen to basically limit sales volume, it leaves a larger share of market available for competition to address. Competition will address that opportunity, and inevitable price decreases will occur. When that happens some early purchasers may feel cheated and alienated, which could negatively impact the price skimmers brand perception.
The above illustrates two very different pricing strategies for market entry. While each has pros and cons, the first is volume and share oriented, and the second has a profit focus. If you were in launch mode with a first to market product, which would you consider for your company, and why? It certainly isn’t a black or white decision.