Economic - Penetration Pricing

Penetration Pricing As mentioned earlier, a highly elastic demand curve is likely to greet any undifferentiated new brand launched on to an existing product market. If substantial offsetting economies of scale can be expected at higher levels of production volume, a firm may deliberately set a particularly low price in order to 'penetrate' the market and quickly secure a large enough share of it to guarantee the necessary reductions in unit cost. Obviously, for penetration prices to be effective, the total market in which the firm is operating must be substantial, and the anticipated market share significant. However, the company must not lose sight of the role of product quality in this equation - success will be a function of the ability to produce sufficient units of the desired quality standard. This is particularly relevant in high technology industries, where difficulties in the supply of raw materials may be experienced. The search for market dominance, as opposed to the desire for a substantial market share, might lead a large firm with very considerable excess productive capacity to take penetration pricing one stage further. Instead of merely settling for the satisficing benefits of lower unit costs, as spare production capacity is taken up through the stimulus of the penetration price, the company reduces the initial price still further as its costs fall. The aim would be to dominate the market at the stage at which the whole of the firm's productive capacity is being utilized. Effectively, the strategy is to trade-off high early losses against what ultimately should be the lowest production costs in the market and the dominant share of it - with all that is implied by that in terms of future price manoeuvrability. Buy-Response Curves In an established market, a modest investment in consumer research should yield valuable information concerning the elasticity of demand for existing brands. The construction of a buy-response curve, to be used in conjunction with the strategic considerations outlined in the preceding paragraphs, can help a newcomer to select an appropriate price with which to enter the market. Buy-response curves are based on the work of Stoetzel (1954), who suggested that consumers associate with any given article a certain price range, rather than a single price. The data for the curve are obtained by establishing the top and bottom prices that individuals would be willing to pay for a particular product. For each price within this range, a cumulative distribution of the numbers giving it as their upper or lower limit is calculated. By subtracting from the lower limit cumulative distribution at a particular price the upper limit cumulative distribution of the price immediately below it, one can determine a buyresponse percentage for the former price, which can be plotted on a graph. By obtaining details of the last prices actually paid for the product by the sample members, and plotting this against the buy-response curve, it is possible to see whether the existing brands on the market are under- or over-priced. In Figure 11.9, it can be seen that the distribution of actual prices is well to the left of the buy-response curve, indicating that the public would be willing to pay considerably more than the prices being charged currently for existing brands; a distribution to the right would have signified that existing brands were overpriced. The strategic value to management of such analyses of consumer response is obvious.