New USC Marshall Study Challenges Marketing Strategy Assumptions

Finds Most Firms do not Stick to One Strategy for Pricing New Products

March 12, 2015

Like #thedress, marketers do not see things one way or another when it comes to new products. A new study by Gerard Tellis, professor of marketing at the USC Marshall School of Business, and colleagues finds that contrary to assumptions on how marketers work, most firms rarely use a skimming or penetration strategy to price new products as experts recommend. The study, called “Skimming or Penetration? Strategic Dynamic Pricing for New Products,” looked at the market for digital cameras for its sample.

The research, which was conducted by Tellis, Martin Spann, professor at Ludwig-Maximilians-University Munich (Germany) and Marc Fischer, professor at the University of Cologne (Germany), will be published in Marketing Science.

Strategists have long recommended that marketers use either a skimming or a penetration strategy for pricing new products. A skimming strategy involves charging a price much above costs in order to exploit demand for the new product that offers improvements in quality or features. “This strategy basically attempts to skim consumer surplus,” said Spann. On the other hand, a penetration strategy involves selling at a low price, even below costs, in order to gain a large chunk of the market and achieve economies of scale. “This strategy sells low on the hope of driving down costs and reaping a profit in the future,” said Fischer

Marketers had long assumed that firms adopted either one of these two strategies for pricing new products.

In contrast, the authors found that manufacturers of digital cameras adopt penetration and skimming strategies, for roughly a small 20 percent of new products. However, for 60 percent of new products, firms use a straightforward competitive or market pricing strategy. The authors obtained these results from an analysis of dynamic pricing strategies in a highly complex branded market, consisting of 663 products under 79 brand names of digital cameras in a large European country. They developed a method to classify dynamic pricing strategies and analyze the choice and correlates of observed pricing paths in the introduction and early growth phase of this market.

Tellis explained: “Market conditions are so restrictive that they limit strategic pricing. Some competitors would undercut the skimming price limiting margins while others would match the penetration price preventing economies of scale.” Thus, despite experts’ recommendations, skimming or penetration are not practiced much.

The authors find that firms exhibit various dynamic pricing strategies simultaneously over a portfolio of products. The choice of strategy is associated with market, firm and brand characteristics. “Market-pricing and penetration strategies occur more often after the takeoff of the market and under increased competitive intensity,” said Fischer.

“Market pricing is also more likely to be adopted by late entrants, whereas firms that have established a reputation in the market rather adopt a skimming strategy,” said Tellis. “Penetration strategies occur more often if firms have larger cumulated sales.”

The authors concluded that firms seem to follow a portfolio approach in their choice of pricing strategy, with various products in their product line launched at various times and probably targeted at various consumer segments. “In this case, the application of penetration pricing for some products can exploit economies of scale and experience that may cross-subsidize costs for the skimming strategy for other products,” said Spann. ”Related, price skimming for some products exploits margin that can complement the low margin from price penetration for other products.”

Marketing managers in other markets can apply the method developed in this study to analyze the prevalence and use of pricing strategies in their respective market. They need only to adapt variables such as product features to the specific characteristics of their market.

The authors of this study are members of ISMS, INFORMS Society for Marketing Science. ISMS is a group of scholars focused on describing, explaining and predicting market phenomena at the interface of firms and consumers.