Skimming and penetration: two opposite ways to price a launch

1. Price skimming launches the product high and then steps the price down in stages, taking the largest profit per unit from the buyers who are least willing to wait.
   1. Use it when the product is genuinely new, because the first buyers have nothing to compare it with and judge the price against how much they want it, which is how a games console can sell at £999 and then £599 a year later.
   2. The risk is that a fat margin advertises the market, so rivals copy the product, the business is forced to cut faster than planned, and the early customers who paid full price feel overcharged.
2. Price penetration launches below the going rate to buy customers quickly, then lifts the price once people are in the habit of buying and switching feels like effort.
   1. Use it when rivals are already established, because a new name gives a shopper no reason to move unless the price does, and volume is what makes a fixed cost such as rent affordable per unit.
   2. The risk is that the low price has to be paid for, so start-up costs are recovered slowly, and customers recruited by cheapness are the first to leave when the price rises.

Pricing from costs, from rivals and from the shopper's head

1. Cost-plus pricing builds the price from the inside out: work out what one unit costs to make, add a set mark-up, and that sum is the price.
   1. It suits a business whose unit cost is easy to pin down, such as a bakery costing flour, labour and packaging per loaf, or a plumber quoting a job before starting it.
   2. The risk is that nobody outside the business is consulted, so the price can land above what shoppers will pay and sales stall, or below what they would have paid and profit is given away for nothing.
2. Competitive pricing starts from the going rate and holds the price level with it, which keeps a business in the running where two products are near enough identical that a shopper will switch over pennies.
   1. The risk is that rivals now set your margin, so when Aldi or Lidl cut a headline line, Tesco either follows and earns less per item or holds firm and loses the trolley, and the business has to defend itself on range, service or convenience instead.
3. Loss leader pricing sells one line below what it cost the business, accepting the loss because the shopper who came in for that line fills the rest of the basket at a normal margin.
   1. The risk is the cherry-picker who buys the cheap line and nothing else, so it works only where one item alone is not worth the trip, which is why a supermarket can run it on milk and a single-product market stall cannot run it at all.
4. Psychological pricing stops the price just short of a round number so the shopper anchors on the first figure, and £9.99 is filed away as nine pounds rather than ten.
   1. The risk is that the gain is thin and the trick is well known, so it shifts a decision only where prices are scanned quickly, and a clean rounded price signals quality better on a premium product such as a pair of Dr Martens boots.

The six strategies side by side

This table sets each strategy against what it means and the situation it is built for.

1. Skimming and penetration are the only two rows that describe a launch, and they answer the same question in opposite directions, so a scenario about a new product is usually asking you to pick between those two and defend the choice.
2. Cost-plus is the safest row and the least responsive, because it is the only one that never looks at a rival or a customer, so a business using it can be the last to discover that shoppers would happily have paid more.
3. The loss leader row depends entirely on what else is bought, so it is a strategy about the whole basket rather than the product, and it collapses the moment customers can take the bargain and leave.
4. What decides which row a particular business picks, including its costs, its rivals and where the product sits in its life cycle, is the subject of the next guide.