What is skimming or penetration pricing strategy?

While preparing to enter the market with a new product, management must decide whether to adopt a skimming or penetration pricing strategy.
(a) Skimming pricing: It is a policy of high prices during the early period of a product’s existence. This can be synchronised with high promotional expenditure and in the later years the prices can be gradually reduced. 

The reasons for following such a policy are : 

(i) Inelastic demand: The demand is likely to be inelastic in the earlier stages till the product is established in the market.
(ii) Sales boost: The charge of high price in the initial periods serves to skim the cream of the market that is relatively insensitive to price. The gradual reduction in price in the later year will tend to increase the sales.
(iii) Assured profit: This method is preferred in the beginning because in the initial periods when the demand for the product is not known the price covers the initial cost of production.
(iv) Cost revenue matching: High initial capital outlays, needed for manufacture, results in high cost of production. Added to this, the manufacturer has to incur huge promotional activities resulting in increased costs. High initial prices will be able to finance the cost of production particularly when uncertainties block the usual sources of capital.

(b) Penetration pricing :
  It is opposite to skimming price. The low price policy is introduced for the sake of long-term survival and profitability and hence it has to receive careful consideration before implementation Penetrating pricing, means a pricing suitable for penetrating mass market as quickly as possible through lower price offers. This method is also used for pricing a new product. In order to popularise a new product penetrating pricing policy is used initially. The company may not earn profit by resorting to this policy during the initial stage. Later on, the price may be increased as and when the demand picks up. The use of this policy by the existing concerns will discourage the new concerns to enter the market. This pricing policy is
also known as “stay-out-pricing”.
The three circumstances in which penetrating pricing policy can be adopted are as under:
(i) Elastic demand: When demand of the product is elastic to price. In other words, the demand of the product increases when price is low.
(ii) Mass production: When there are substantial savings on large scale production. Here increase in demand is sustained by the adoption of low pricing policy.
(iii) Frighten competition: When there is threat of competition. The prices fixed at a low level act as an entry barrier to the prospective competitors.
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