169 9 Strategic pricing of new products and services* Rabikar Chatterjee Abstract This chapter organizes and reviews the literature on new product pricing, with a primary focus on normative models that take a dynamic perspective. Such a perspective is essential in the new product context, given the underlying demand- and supply-side dynamics and the need to take a long-term, strategic, view in setting pricing policy. Along with these dynamics, the high levels of uncertainty (for firms and customers alike) make the strategic new product pricing decision par- ticularly complex and challenging. Our review of normative models yields key implications that provide (i) theoretical insights into the drivers of dynamic pricing policy for new products and services, and (ii) directional guidance for new product pricing decisions in practice. However, as abstractions of reality, these normative models are limited as practical tools for new product pricing. On the other hand, the new product pricing tools available are primarily helpful for setting specific (myopic) prices rather than a dynamic long-term pricing policy. Our review and discussion suggest several areas that offer opportunities for future research. 1. Introduction Pricing of new products is an especially challenging decision, given its critical strategic importance and complexity. Contributing to the complexity are the uncertainty faced by the firm on both demand and supply sides, the dynamic (changing) environment and operating conditions, and the need for a long-term decision-making perspective, given that the firm’s pricing decision in the current period is likely to impact future outcomes. Thus this chapter focuses primarily on new product pricing strategies that take a long- term perspective and recognize the dynamics driven by demand- and supply-side condi- tions over the extended time horizon. Past reviews of new product pricing models include Kalish (1988). Monroe and Della Bitta (1978), Rao (1984, 1993) and Gijsbrechts (1993) cover new product pricing as part of their broader reviews of pricing. Also relevant are the reviews of new product diffu- sion models incorporating price and/or other marketing mix elements by Kalish and Sen (1986) and Bass et al. (2000). This chapter provides a selective and updated review and synthesis of strategic new product pricing models, focusing primarily on analytical models, but also describing relevant empirical research. 1.1 Dynamic pricing of new products: skimming versus penetration Dean’s ([1950] 1976) seminal article identifies new product pricing policy as ‘the choice between (1) a policy of high initial prices that skim the cream of demand [skimming] and (2) a policy of low prices from the outset serving as an active agent for market penetration [penetration pricing]’ (p. 145). The rationale for these two extreme strategies lays the foun- dation for our subsequent review. As we shall see, some of the policy prescriptions call for * Comments and suggestions from Vithala R. Rao, Jehoshua Eliashberg and an anonymous reviewer are gratefully acknowledged.