Skimming & Penetration Pricing Strategies that are crucial for marketers
The difference between these two pricing strategies prove themselves to be an important part of the marketing mix. They will enable marketers to make better decisions when pricing new offerings. Following these guidelines is a sure fire way to make sure you're on the right path!
When a business is introducing a new product or service to the market the two best practices for pricing strategies are price skimming and penetration pricing strategies. These strategies will allow a firm to price their products or services at a sweet spot for their customer willingness to pay (WTP), or allow the firm to launch into a leading business in the market depending on a differentiating set of criteria.
Price Skimming Strategy
The price skimming strategy works best when a new product or service is being introduced to a market. This strategy suggests that the price of the offering should be set high initially and decrease incrementally over a period of time in order to speak to consumers at different levels of WTP. As seen in ‘Strategic Marketing Problems’ here is set criteria to consider before deciding to use this pricing strategy.
1. Demand is likely to be price inelastic.
As price changes, demand is unlikely to be heavily influenced. This means a higher price will consist of relatively similar demand.
2. There are different price-market segments, thereby appealing first to buyers who have a higher range of acceptable prices.
As the price over a period of time customers with a lower range of acceptable prices may start to purchase the businesses products or services.
3. The offering is unique enough to be protected from competition by a patent, copyright, or trade secret.
When a business is unique enough to be protected it is considered to be proprietary. This means you can set a high initial price and it will be difficult for competitors to enter the market or undercut you (if possible).
4. Production or marketing costs are unknown.
This question may arise during the planning phase of a new venture where an entrepreneur is unsure of the production costs for manufacturing, selling, warehousing and other production costs along with the potential costs of marketing efforts. Although this is criteria to be considered when setting an initial price it is strongly suggested for entrepreneurs to do have some estimate of these possible costs before starting a new venture.
5. A capacity constraint in producing the product or providing the service exists.
A capacity constraint deals with the capabilities of the business itself. A business should consider its’ ability to mass-produce products; or its’ ability to provide its’ proprietary services. By understanding the constraints on means of production a firm can compare it with a break-even analysis in order to gain better insights as to how they should set an initial price.
6. An organization wants to generate funds quickly to recover its investment or finance other developmental efforts.
If an organization is looking to replenish their investment quickly to use the cash for other developmental efforts a price skimming strategy will be effective as long as it meets criteria number one. When using the price skimming strategy a firm will set a high initial price which will generate higher total revenue.
7. There is a realistic perceived value in the product or service.
Customers tend to associate lower prices with lower quality this can usually mark death for a business. With a high initial price and proprietary offering the offering tends to have a higher perceived value. However, it wouldn’t be a wise decision to go off of this criterion alone. Usually, businesses will run surveys, focus groups, and collect qualitative data to determine how a customer perceives the offering.
If an offering meets these criteria a price skimming strategy may be the best pricing choice. For example, Apple Inc. has been using a price skimming strategy for its’ Apple iPhones. When a new model is released it has a high initial price; however, as time passes and new models come out the price of the previous model drops incrementally. This strategy allows Apple to collect higher total revenue when a model is first released and allows them to reach new customers who have lower acceptable buying rates, over a period of time.
Price Penetration Strategy
The price skimming strategy uses a high initial price on the one hand and on the other price penetration strategy uses a low initial price. Price penetration strategy should be considered if the business meets these criteria as shown in ‘Strategic Marketing Problems’.
1. Demand is likely to be price elastic in the target market segments at which the product or service is aimed.
As price changes quantity demanded is likely to shift. If price increases quantity demanded is expected to do the same and vice versa.
2. The offering is not unique or protected by patents, copyrights, or trade secrets.
For example, companies like Wish.com sell generic items in which they are not proprietary in any way, shape, or form.
3. Competitors are expected to enter the market quickly.
Competitors can quickly and easily enter the market and possibly undercut your offering.
4. There are no distinct and separate price-market segments.
The target market has no defined willingness to buy points for the offering as it usually has little to no perceived value.
5. There is a possibility of large savings in production and marketing costs if a large sales volume can be generated.
Manufacturers usually offer their products at lesser costs when buyers order larger quantities. This can result in huge savings as long as the retailer has the right amount of customers.
6. The organization’s major objective is to obtain a large market share.
When an organization's main objective is to obtain a large market share they often operate with KPI’s such as cost per acquisition (CPA). As long as their customers generate (even small) returns on investment (ROI).
A great example of a company that uses the price penetration strategy is Wish.com. They offer generic products at extremely low costs. However, Wish.com has generated a huge customer base and have seen over a billion dollars in sales. With their extremely low prices, they were able to grow quickly and the results of their growth have been seen through their marketing efforts.