A low penetration price discourages competitors from entering the market

Pricing Strategies and Tactics There is no limit to the number of variations in pricing strategies and tactics. The wide variety of options is exactly what allows entrepreneurs to be so creative with their pricing. This section examines some of the most commonly used tactics under a variety of conditions. Pricing always plays a critical role in a firm’s overall strategy; pricing policies must be compatible with a company’s total marketing plan.

New Product Pricing: Penetration, Skimming, or Sliding

Most entrepreneurs approach setting the price of a new product with a great deal of apprehension because they have no precedent on which to base their decisions. As a result, they often look at the prices their competitors charge and set prices that are slightly lower. If a new product’s price is too high, it is in danger of failing because of low sales volume. However, if its price is too low, the product’s sales revenue might not cover costs. Establishing a price that is too low is far more dangerous than setting one that is too high. Not only does the company forgo revenues and prof-its, but it also limits the product’s perceived value in the eyes of its target customers. “When you build a business around the lowest price, you soon find that there’s always someone else who can offer an even lower one,” says serial entrepreneur Norm Brodsky. “As a result, you are under constant pressure to keep reducing your price. At best, you end up with an unsustainable commodity business that’s no fun to run and an obstacle to achieving the goal of becoming economically self-sufficient.”26 To avoid the trap of setting their prices too low, entrepreneurs should consider the total value that they provide their customers, including intangibles such as additional service, convenience, speed, and others, and set a price that reflects that value.

When pricing any new product, an entrepreneur must satisfy three objectives:

1. Get the product accepted. No matter how unique a product is, its price must be acceptable to a company’s potential customers. The price a company can charge depends, in part, on the type of product it introduces: • Revolutionary products are so new that they transform an industry. Companies that intro-

duce these innovative products usually have the ability to charge prices that are close to the price ceiling although they may have to educate customers about the product’s benefits.

• Evolutionary products involve making enhancements and improvements to products that are already on the market. Companies that introduce these products do not have the ability to charge premium prices unless they can use the enhancements, they have made to differentiate their products from those of competitors. Establishing a price that is too low for an evolutionary product can lead to a price war.

• Me-too products are products that companies introduce just to keep up with competitors. Because they offer customers nothing new or unique, me-too products offer companies the least amount of pricing flexibility. Achieving success with these products means focusing on cost control and targeting the right market segments.

2. Maintain market share as competition grows. If a new product is successful, competitors will enter the market, and a small company must work to expand or at least maintain its market share. Continuously reappraising a product’s price in conjunction with special advertising and promotion techniques helps the company maintain market share.

3. Earn a profit. A small company must establish a price for the new product that is higher than its cost. Entrepreneurs should not introduce a new product at a price below cost because it is much easier to lower the price than to increase it once the product is on the market. Pricing their products too low is a common and often fatal mistake for new businesses; entrepreneurs are tempted to underprice their products and services when they enter a new market to ensure its acceptance.

Entrepreneurs have three basic strategies to choose from in establishing a new product’s price: penetration, skimming, and life cycle pricing.

PENETRATION If a small company introduces a new product into a highly competitive market in which a large number of competitors are competing for acceptance, the product must penetrate the market to be successful. To gain quick acceptance and build market share quickly, some entrepreneurs use a penetration pricing strategy, introducing the product at a low price. Setting the price just above total unit cost allows the business to develop a wedge in the market and quickly achieve a high volume of sales. The resulting low profit margins may discourage other competitors from entering the market with similar products.

A penetration pricing strategy is ideal when introducing relatively low-priced goods into a market in which no elite segment and little opportunity for differentiation exist. This strategy works best when customers’ switching costs (the cost of switching to a lower priced competitor’s product) is high (e.g., video game consoles). Penetration pricing also works when a company’s competitors are locked into high cost structures that result from the channels of distribution they use, labor agreements, or other factors. For instance, since its inception, Southwest Airlines has relied on its lower cost structure to compete with older, “legacy” carriers by emphasizing low prices. For a penetration pricing strategy to be successful, a company should have a cost advantage over its rivals; otherwise, it risks starting a no-win price war.

Entrepreneurs must recognize that a penetration pricing may take time to be effective; until a company achieves customer acceptance for the product, profits are likely to be small. When a young college student launched a carpet cleaning business to help pay for his education, he decided to be the low-cost provider in his area. Although he landed plenty of work for his part-time business, he found that his company generated very little profit after deducting the expenses of doing business. Realizing that his customers would be willing to pay more for quality work, he raised his prices and began earning a reasonable profit.

A danger of a penetration pricing strategy is that it attracts customers who know no brand loyalty. Companies that garner customers by offering low introductory prices must wonder what will become of their customer bases if they increase their prices or if a competitor undercuts their prices. If a penetration pricing strategy succeeds and the product achieves mass-market penetration, sales volume increases, economies of scale result in lower unit cost, and the company earns attractive profits. The objectives of the penetration strategy are to achieve quick acceptance among customers and to generate high sales volume as soon as possible.

SKIMMING Companies often use a skimming pricing strategy to introduce a new product or service into a market with little or no competition or to establish a product or service as unique and superior to those of its competitors. Sometimes a company uses this tactic when introducing a product into a

competitive market that contains an elite group that is willing and able to pay a premium price or when introducing a revolutionary product. A company sets a higher-than-normal price in an effort to quickly recover its initial developmental and promotional costs of the product. The idea is to set a price well above the product’s total unit cost and to promote the product heavily to appeal to the segment of the market that is not sensitive to price. This pricing tactic often reinforces the unique, prestigious image of a company and projects a high-quality image of the product. If a product’s price proves to be too low under a penetration strategy, raising the price can be very difficult. If a company using a skimming strategy sets a price that is too high to generate sufficient volume, it can easily lower the price. Successful skimming strategies require a company to differentiate its products or services from those of competitor to justify the above-average price.

LIFE CYCLE PRICING A variation of the skimming pricing strategy is called life cycle pricing. Using this technique, a small company introduces a product at a high price. Then technological advances, the learning curve effect, and economies of scale enable the company to lower its costs and reduce the product’s price faster than its competitors can. By beating other businesses in a price decline, the company discourages competitors and, over time, becomes a high-volume producer. Blu-Ray players are a prime example of a product introduced at a high price that quickly cascaded downward as companies forged important technological advances and took advantage of economies of scale. When Blu-Ray players were first introduced in 2006, they sold for $800; three years later, they were selling for just $220. Today, shoppers can purchase Blu-Ray players that have more features for less than $100. Life cycle pricing assumes that competition will emerge over time. Even if no competition arises, companies almost always lower the product’s price to attract a larger segment of the market. In a life cycle pricing strategy, the initial high price contributes to the rapid return of start-up or development costs and generates a pool of funds to finance expansion and technological advances.

Pricing Techniques for Established Products and Services

Entrepreneurs have a variety of pricing techniques or tactics available to them to apply to established products and services. Entrepreneurs must examine each of these techniques or tactics to determine their effectiveness under different circumstances and situations.

ODD PRICING Although studies of consumer reactions to prices are mixed and generally inconclusive, many entrepreneurs use the technique known as odd pricing. They set prices that end in odd numbers (frequently 5, 7, or 9) because they believe that an item selling for $12.69 appears to be much cheaper than an item selling for $13.00. Psychological techniques such as odd pricing are designed to appeal to certain customer interests, but research on their effectiveness is mixed. Some studies show no benefits from using odd pricing, but others have concluded that the technique can produce significant increases in sales. Omitting the “$” symbol from prices may help, too. Researchers at Cornell University have discovered that restaurants that list menu prices without the “$” symbol (“12”) achieved higher sales on average than those whose menu prices were written in script (“twelve dollars”) or included the “$” symbol (“$12”).

PRICE LINING Price lining or tiered pricing is a technique that greatly simplifies the pricing decision. Under this system, an entrepreneur sells a product in several different price tiers or price lines. Each category of merchandise contains items that are similar in appearance, quality, cost, performance, or

other features. Many lined products appear in sets of three—good, better, and best—at prices designed to satisfy different market segments’ needs and incomes. Apple uses price lining for many of its products, including the iPad Mini, which it introduced at prices of $329 (16 GB), $429 (32 GB), and $529 (64 GB). Price lining can boost a store’s sales because it makes goods available to a wide range of shoppers, simplifies the purchase decision for customers, and allows them to keep their purchases within their budgets.