Pricing Innovative Products

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Pricing a product that is conceptually new is an extremely challenging decision because there is no pricing precedence. There are no existing customers, no known volume and no benchmarks to follow. More than ever, pricing is more art than science.

Basically, you have a choice of three strategies:

  1. skimming
  2. penetration or
  3. value-based pricing strategy.

Often the choice of strategy boils down to whether there are competitive barriers to entry that are not price related (for example, you have a patent or some other protection). If a barrier is in place, you might choose skimming, a common strategy in electronic goods and pharmaceuticals.

Where substitute or alternative products exist, a penetration strategy may be the preferred choice.
 

SKIMMING.

This strategy sets prices high in the introductory stages of the product life cycle and lowers the price during later stages to encourage mass-market penetration.
The marketer may use this model when the following factors apply:

  • When there are few, if any, close substitutes for the product.
  • The Marketer has a strong brand profile.
  • When there are a sufficient number of people willing to pay a premium price for the product.
  • When you need to recover research and development costs (R&D).
  • When you want to earn extra revenue that can be directed into further R & D.
  • When the marketer has competitive barriers to entry in place.

This strategy is commonly used in the launch of new electronic appliance categories, such as the release of the first DVD player. When new entrants follow into the market, you can expect them to enter at a lower price point. If using a skimming model, therefore, you should factor likely competitive behaviour in to your profit objectives.
Skimming strategies can be maintained over a period of time. This requires a business to deploy an aggressive product roadmap so that would-be copycat competitors are always playing catch-up.
 

PENETRATION.

This strategy sets price low at the outset of the product life cycle and uses it as a wedge to enter the market.

The marketer may use this model when the following factors apply:

  • When all segments of the market are sensitive to price, even in the early stages of the product life cycle.
  • When an increase in volume rapidly decreases per unit production, distribution, and promotion costs.
  • When you want to grab as much market share as possible because competitors are likely to enter the market quickly.

If using a penetration model, you are already anticipating competitive reaction and, by pricing low you are using price as a barrier to entry.
 

VALUE-BASED MODEL.

More recently, a new model has emerged. Value-based pricing occurs where the marketer seeks to quantify the benefit that the customer derives from using the product, and uses this quantification as the basis from which to price the product.
For example, a video conferencing product may apply flight costs as the basis for forming the price point. Using a value-based pricing model, the software manufacturer would argue that video conferencing means that executives can avoid flying to attend interstate meetings, and that saves both time and expenses. Or, a pharmaceutical company may argue that their drug avoids expensive surgery and lengthy recovery times.
The model enables profit to be maximized and may make it difficult for competitors to take business from a marketer solely based on price. To be successful, the marketer needs to have an extensive knowledge of how the customer measures value.
 

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