Pricing of new products is a very important decision to make, however, very complex process. According to Vithala R. Rao, complexity is brought about by uncertainty from both the demand and supply sides, changing environment and operations condition, and the need of a long-term decision given that the current set price will influence future results.
He discussed 3 strategies price skimming, penetration pricing and experience curve pricing.
Price skimming is pricing technique where business sets the highest possible initial price that customers will pay for a product then it lowers the price to gain more customers. This price strategy is applicable where there are enough potential buyers willing to pay for a high price and interpret the high price as high quality, competition is not attracted to the industry due to high prices, and finally, lowering the price will have a minor effect on increasing sales volume and reducing cost per unit.
Penetration pricing is a technique where the initial price is set relatively low with the main aim of increasing market share and sales volume. In a competitive market, the business uses the penetration technique with the intention of encouraging potential customers to switch to the product.
Penetration pricing catches competitors off-guard especially on products entering a market with relatively little product differentiation and the demand for the product is price elastic (Tutor2u, 2016). However, it encouraged word of mouth endorsement and business pay attention on minimizing unit cost to increase efficiency. Low prices in the market can create a barrier to entry of other potential business willing to get in the industry, however, increasing price will be difficult.
Experience curve pricing is a technique found in highly competitive markets, where customers are price sensitive and there is a high experience effect of the industry. Producers with the most experience benefits from having lower costs than the rivals have. They apply experience curve pricing because they are able to be price aggressive and decrease the price of the commodity below the existing market price. Competitors who are not able to match up the low set prices quit the market while the producer taps into the new market. Low prices also encourages new customers to join and enhance the producer achieve economies of scale.