So you’ve got a great new idea for a product and you’ve secured financing to manufacture it. You have identified a target market and created advertising to build awareness. Your potential customers are anxious to buy the new product because it solves a long-standing problem for them.
Everything is great and even though the product development effort hasn’t been perfectly smooth, it has gone well. But now you’re facing a very tough decision. What is the price of the new product? In fact, how do you even decide how to set the price?
New Product Development Professionals (NPDP) and Certified Professional Engineering Managers (CPEM) are both faced with pricing decisions of existing and new products. The price of a product may shift during its life cycle based on competitive positions and maturity of the product. In all cases, a company normally targets a price high enough to make a profit and to recover any investment in design, development, manufacturing, and marketing. A common pricing strategy is based on two elements: the price itself and perceived product quality.
Premium Pricing
Premium pricing can be achieved when the product has a high price commiserate with a high quality good or service. Most companies strive for premium pricing because it typically yields the highest, long-term profits. The product is perceived to be a luxury item and consumers willingly pay more for the product because of its uniqueness. Premium pricing validates a competitive advantage.
An example of a premium product is a Porsche. The car brand is unique and perceived to be a luxury item. A Porsche will cost more than a Lexus but it is expected to perform better (and faster!). In addition, the brand itself conveys status and infers a “premium” label to its owner. A Porsche commands a high price yet is a high quality product, valued by consumers.
Penetration Pricing
Penetration pricing is a model often used when a new product is first launched (e.g. during the introduction stage of the product life cycle). A penetration price signifies high quality ye the product price is actually set at a low level in order to gain market share. Using a penetration price is normally a short-term strategy used by a firm to establish the product category and gain customers.
A company may deploy penetration pricing for a new-to-the-world product to ensure it gains market traction. The low price is not sustainable as the product needs to earn a profit and is manufactured as a premium product. Firms risk, however, that consumers will become accustomed to the low price and that subsequent price hikes are not feasible. New competitors also may be able to manufacture the product at a lower cost with a financial model that can support the lower price established in the marketplace.
One way to introduce a new product with a penetration price is through the use of sale promotions. Coupons and discounts will encourage first-time buyers to purchase the new product while the company can set the actual price for the product at its long-range target price. Vista Print encourages business card purchases through sales promotions for new customers as demonstrated by television ads providing a special discount code for first-time buyers. Established customers then pay a higher price that is consistent with the product quality (e.g. premium pricing).
Price Skimming
An alternative to penetration pricing for a new product is price skimming. This pricing strategy sets a high price for a common or lower quality product. As an introductory strategy, skimming allows a firm to capture significant profits while there is no other active competition in the market. Consumers have been waiting so long for a product solution that they are willing to pay a high price for any promising product. Companies benefit from the high demand and low competition in such a situation.
Of course, skimming is a short-term strategy as the high price is not sustainable. When competitors begin entering the market (as they surely will), the price will drop as supply and demand balance. Moreover, competitors will take advantage of “fast follower” market strategies to improve the quality of the initial product.
Years ago, I purchased a special GPS as a gift for my husband’s birthday. It was a very new model and interacted with National Park maps so you could track hiking or mountain biking on the park trails. It was waterproof and shatterproof. The GPS conveniently operated on 4AA batteries (no need for an electric outlet if you’re staying in a tent) and cost around $600. There were no other competing products at the time that offered the resolution or ruggedness of the device.
Yet, within a couple of years, smaller GPS devised with Wi-Fi connectivity were marketed. These new devices had similar (or better) resolution and were waterproof enough in a typical rainstorm. Competition dropped the prices to the $100 range quickly. And, of course, today our cell phone have full, built-in GPS capability, including downloadable maps of National Park trails. The company that manufactured the $600 GPS was not able to maintain a price skimming model for long.
Economy Pricing
Economy pricing is exactly what the term implies – a lower price for a “no frills” product. Normally, you will see
products with economy prices in a mature market with lots of competition and as a product becomes commoditized. Manufacturers make a profit by keeping production and marketing costs low.
Products with economy pricing may co-exist in a market with premium products. The two products, though in the same category, will serve different customers. A value-minded customer may purchase a generic or store-brand product while other consumers will not take the risk of sacrificing brand quality. For example, the local supermarket offers bran cereal flakes with raisins at a lower price than Kellogg’s Raisin Bran. A mom with teenage boys may choose the store brand to save money on her weekly grocery bill while a senior citizen will select the higher priced, brand name cereal to be guaranteed a minimum and consistent quality standard.
Pricing Strategies
Every company must be aware of the prices charged for their products. If the firm sells directly to consumers, the company will set the price. If a firm sells to distributors and wholesalers, then they will need to set a minimum expected retail price. Prices reflect perceived product quality and must be set at an appropriate level so that the company makes a profit over the long-run.
However, a firm may establish different prices for products at different stages within the product’s life cycle. Introductory pricing schemes may vary significantly from a mature or declining product. Common introductory pricing strategies include price skimming and penetration pricing. Price skimming is utilized when there are few competitors and a company can charge a high price for a product that may be of low quality or offers few features. This strategy is not sustainable as competitors entering the market will cause the price to decline and competing products will offer higher quality and more features to gain market share.
Penetration pricing is also used as an introductory pricing strategy. Here the product is priced lower than expected for the product category or market perception of the product category. The intent is to establish brand awareness and market share so that the company will retain customers after subsequent price increases. Organizations are often willing to sacrifice short-term profits for longer term brand loyalty.
Ultimately a company wants its products to move into premium pricing. Premium pricing strategies reflect a high price for a product perceived as unique and high value by its target customers. Premium pricing is often realized during growth and maturity of a product category. Companies can maintain high profit margins under a premium pricing model but are subject to disruption by a lower cost competitor who may take advantage of new technologies to lower manufacturing costs.
Finally, products in the maturity phase may price products in the economy pricing category. Economy pricing reflects a lower price for a “no frills” product that has low-cost manufacturing and marketing expenses. These products offer a quality level desired by a group of customers who desire few features. Products with economy pricing attract a different buyer than premium brands and may co-exist with higher end products during the maturity and decline phases of the product life cycle. Commodities are products with economy pricing as demand and supply are matched so that customers choose their purchase based on price more than brand reputation (a substitute for quality).
NPDPs and CPEMs must be familiar with pricing models, especially their linkage to the product life cycle. Companies must also be cognizant of pricing in order to attract new customers, maintain profitability, and to respond to competition. To learn more about strategy and product pricing, please join us for certification training in New Product Development Professional (NPDP). Workshops are available in an affordable self-study course format or in customized face-to-face training sessions. Contact me at info@simple-pdh.com or 281-280-8717 for information on new product development training or professional management coaching. At Simple-PDH, we want to make it simple for you to study, learn, and earn and maintain your professional certifications.
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