Solution:

Pricing a New Product:

• Pricing policy in respect of a new product depends on whether or not close substitutes are available.

• Depending on whether or not close substitutes are available, in pricing a new product, generally, two kinds of pricing strategies are suggested, viz., (i) price skimming, and (ii) price penetration.

Price Skimming:-

• It is a pricing strategy in which a marketer sets a relatively high price for a product or service at first, then lowers the price over time.

• It is a temporal version of price discrimination/yield management. It allows the firm to recover its sunk costs quickly before competition steps in and lowers the market price. Price skimming is sometimes referred to as riding down the demand curve.

• The objective of a The price skimming strategy is to capture the consumer surplus.

• If this is done successfully, then theoretically no customer will pay less for the product than the maximum they are willing to pay. In practice, it is almost impossible for a firm to capture this entire surplus.

• The initial high price would generally be accompanied by heavy sales promoting expenditure.

• This policy succeeds for the following reasons. First, in the initial stage of the introduction of the product, demand is relatively inelastic because of consumers' desire for distinctiveness in the consumption of a new product.

• Second, cross-elasticity is usually very low for lack of a close substitute. Third, step-by-step skimming of consumers' surplus available at the lower segments of the demand curve.

Penetration Pricing:-

• It is the pricing technique of setting a relatively low initial entry price, often lower than the eventual market price, to attract new customers.

• The strategy works on the expectation that customers will switch to the new brand because of the lower price. Penetration pricing is most commonly associated with a marketing objective of increasing market share or sales volume, rather than making a profit in the short term.

• The success of the penetration price policy requires the existence of the following conditions. First, the short-run demand for the product should have elasticity greater than unity.

• It helps in capturing the market at lower prices. Second, economies of large-scale production are available to the firm with the increase in sales. Otherwise, an increase in production would increase costs which might reduce the competitiveness of the price.

• Third, the product should have a high cross-elasticity with rival products for the an initially lower price to be effective.

• Finally, the product, by nature should be such that it can be easily accepted and adopted by the consumers.