Pricing decisions are subject to an incredibly complex array of environmental and competitive forces. A company sets not a single price, but rather a pricing structure that covers different items in its line. This pricing structure changes over time as products move through their life cycles. The company adjusts product prices to reflect changes in costs and demand and to account for variations in buyers and situations. As the competitive environment changes, the company considers when to initiate price changes and when to respond to them.

This chapter examines the major dynamic pricing strategies available to marketers. In turn, we look at new-product pricing strategies for products in the introductory stage of the product life cycle, product mix pricing strategies for related products in the product mix, price adjustment strategies that account for customer differences and changing situations, and strategies for initiating and responding to price changes.²

Pricing strategies usually change as the product passes through its life cycle. The introductory stage is especially challenging. Companies bringing out a new product face the challenge of setting prices for the first time. They can choose between two broad strategies: market-skimming pricing and market-penetration pricing.

Many companies that invent new products initially set high prices to "skim" revenues layer by layer from the market. Sony frequently uses this strategy, called market-skimming pricing. When Sony introduced the world's first high-definition television (HDTV) to the Japanese market in 1990, the high-tech sets cost $43,000. These televisions were purchased only by customers who could afford to pay a high price for the new technology. Sony rapidly reduced the price over the next several years to attract new buyers. By 1993 a 28-inch HDTV cost a Japanese buyer just over $6,000. In 2001, a Japanese consumer could buy a 40-inch HDTV for about $2,000, a price that many more customers could afford. HDTV sets now sell for about $3,000 in the United States, and "HDTV-ready" sets sell for about $1,500. In this way, Sony skimmed the maximum amount of revenue from the various segments of the market.³

Market skimming makes sense only under certain conditions. First, the product's quality and image must support its higher price, and enough buyers must want the product at that price. Second, the costs of producing a smaller volume cannot be so high that they cancel the advantage of charging more. Finally, competitors should not be able to enter the market easily and undercut the high price.

Rather than setting a high initial price to skim off small but profitable market segments, some companies use market-penetration pricing. They set a low initial price in order to penetrate the market quickly and deeply—to attract a large number of buyers quickly and win a large market share. The high sales volume results in falling costs, allowing the company to cut its price even further. For example, Dell used penetration pricing to enter the personal computer market, selling high-quality computer products through lower-cost direct channels. Its sales soared when IBM, Apple, and other competitors selling through retail stores could not match its prices. Wal-Mart and other discount retailers also use penetration pricing.

Several conditions must be met for this low-price strategy to work. First, the market must be highly price sensitive so that a low price produces more market growth. Second, production and distribution costs must fall as sales volume increases. Finally, the low price must help keep out the competition, and the penetration pricer must maintain its low-price position—otherwise, the price advantage may be only temporary. For example, Dell faced difficult times when IBM and other competitors established their own direct distribution channels. However, through its dedication to low production and distribution costs, Dell has retained its price advantage and established itself as the industry's number one personal computer maker.

Market penetration: Dell used penetration pricing to enter the personal computer market, selling high-quality computer products through lower-cost direct channels.