In this chapter we have examined the pricing of new products, meaning products that are radically different from what has gone before, rather than existing products that have simply been changed or improved. We noted that it is particularly difficult to collect reliable estimates of market demand for such products, because of the lack of consumer awareness of the product and its usefulness. The innovating firm will search for information on the demand for the product initially, if it expects the value of this information to exceed the search cost. Given the high failure rate of new products, the value of information might be expected to be relatively high, and thus search activity should be seriously considered. Test marketing the new product in a limited area is a typical solution to this problem.
Price skimming will be the preferred pricing strategy if the firm’s time horizon falls within the short run, if the demand for the new product will not extend beyond the short run, or if the barriers to entry are insurmountable. In these cases the skimming price will be the short-run profit-maximizing price. A skimming price is also indicated if the product is of the experience or credence type, since post-entry profit will be higher, and a higher initial price may favorably influence perceptions of the product’s quality. The limit price to prevent the entry of a high-cost entrant may be viewed as a skimming price, since it will involve a relatively high markup over the innovating firm’s (relatively low) unit costs.
Penetration pricing is appropriate when the innovating firm’s time horizon falls beyond the short run and its EPV of profit is maximized by setting a relatively low price. This price may be the sales-maximizing price (subject to a minimum profit con-
straint) if the firm can tolerate entry of some firms and expects to earn greater profits in future periods through repeat sales of the item and sales of goods that are complementary to it. If the EPV of profit is maximized by preventing entry and potential entrants would have little or no production cost disadvantages after entering, then the penetration price is the limit price. Search goods are more likely to be candidates for penetration pricing than are experience and credence goods, other things being equal.
After entry occurs, the resulting oligopoly may adopt low-cost price leadership if that is appropriate, or the innovating firm might initially be a dominant firm price leader. Barometric price leadership, conscious parallelism, and independent pricing along ceteris paribus demand curves are also possible. The latter is more likely initially while the market is still immature, and some form of price leadership is more likely as the market attains maturity. We expect the price level to decline initially because of reductions in cost that result from learning effects and economies of plant size, as well as because of reduced demand for each firm that results from the entry of new firms at a rate faster than the rate of growth of the market demand. It is possible that prices would rise over time as a result of the inability of firms to enter as fast as the market grows, where there are few or no gains from learning or economies of plant size.
The innovating firm benefits from “first-mover” advantages, which are the initial monopoly profits and an ongoing unit-cost advantage which others will find difficult to overcome. Entrants may have a steeper learning curve because they may avoid some of the pitfalls and dead ends that the innovator encountered. This statement probably is particularly true for “search” products because these products are easier to evaluate and may therefore be easier to emulate. The innovating firm faces the risk that the new product will fail to be a market success and has typically incurred high developmental costs that may not be recouped if the new product is a failure.