Many companies that invent new products set high initial prices to skim revenues layer by layer from the market. Apple frequently uses this strategy, called market-skimming pricing (or price skimming). With each new generation of Apple iPhone, iPad, or Mac computer, new models start at a high price then work their way down as newer models are introduced. In this way, Apple skims the maximum amount of revenue from the various segments of the market. For example, through smart premium pricing, Apple vacuums up as much as 92 percent of all smartphone profits.2

Market skimming makes sense only under certain conditions. First, the ­product’s quality and image must support its higher price, and enough buyers must want the product at that price. Second, the costs of producing a smaller volume cannot be so high that they cancel the advantage of charging more. Finally, competitors should not be able to enter the market easily and undercut the high price.

Rather than setting a high initial price to skim off small but profitable market segments, some companies use market-penetration pricing. Companies set a low initial price to penetrate the market quickly and deeply—to attract a large number of buyers quickly and win a large market share. The high sales volume results in falling costs, allowing companies to cut their prices even further. For example, AGIT Global used penetration pricing to quickly build demand for its Wavestorm surf boards:3

Before Wavestorm, surfers and would-be surfers typically bought custom-made or high-end surfboards at local surf shops, where entry-level boards typically run $300 to $1,000. AGIT Global had a different idea. With a mission to make surfing more accessible for both adults and children, it began 10 years ago mass-producing good quality soft-foam surfboards and selling them through big-box stores at penetration prices. For example, it sells an entry-level, 8-foot, blue-and-white Wavestorm board at Costco for only $99.99. Thanks to penetration pricing, Wavestorm is now the market leader, selling an estimated five times more boards than the other largest surfboard brands. The inexpensive boards have even become favorites of advanced surfers, who buy them for their friends or children. “Margins are slim at Costco,” says Matt Zilinskas, AGIT’s vice president of sales. “But we pump out volume and get paid on time.”

Several conditions must be met for this low-price strategy to work. First, the market must be highly price sensitive so that a low price produces more market growth. Second, production and distribution costs must decrease as sales volume increases. Finally, the low price must help keep out the competition, and the penetration pricer must maintain its low-price position. Otherwise, the price advantage may be only temporary.