# Why do companies launch products at much higher prices, only to reduce the price drastically after a few months?

I see this to be a prevalent trend - companies too often launch products at much higher prices than they know is gonna lead to good sales numbers, only to reduce the price drastically after a few months. And by the time they do so, they lose any competitive advantage they might have had, and thus can't "recover" any more as far as product sales are concerned.

Let's take a concrete example - the Razer Phone 2. They knew people didn't know much about the brand when it was launched, as Razer is new into making phones. Thus, it only made sense to have launched it for something more reasonable, like $600 perhaps. But no, they launched it for \$800-850. And of course, it didn't sell well. And now after 2-3 months, its price is \$500. But it lost traction - all the excitement that was there when it was first launched about its gaming capabilities is not so fresh in people's minds anymore. Moreover, there are other products at competitive prices that are more value for money. Why couldn't they have launched it for \$600 in the first place?

Another example - Blackberry. They were all but practically dead after a few years of not catching on the Android train. Then they decided to adopt Android a couple years back, and launched a phone (I can't remember its name). It was a good product, but again, they priced it ridiculously high for a company coming back from dead, and making a first product with a new technology for them. Of course it didn't sell well. But had they launched for half the price, I strongly think the phone would have sold well. I know I for one would have bought that phone, but for around \$400 - not for \$750.

Is the reason greed or over-optimism? Surely that can't be right? Don't they want to sell more products, and thus get more profits?

P.S. I am not a finance student or economics student. Just a layman trying to understand why so many companies go for seemingly stupid product pricing.

• This is typical economic 101 , price seeking process. Because the market have more than few player. Do take note that, phone manufacturer now have something call "call plan bundles" to promote their expensive phone. – mootmoot May 23 at 13:25
• @mootmoot I mean, if companies go up to the point of extinction by following this supposedly 101 "rule", it's not a good rule, is it? I understand price seeking; I think if a company like Blackberry tries to make an Android phone, they should launch it at maybe 10-15% profit max, if they don't wanna take the risk of dying. And then if it did well, then maybe look at 20-25% profit for the next iteration of the product, etc. That's what I meant - I understand launching something for $500 when it should cost$400. But launching it for $700-800? I feel that's insane and stupid. – Kristada673 May 23 at 13:30 • Not everyone is Apple, which able to stick to their launch price. Most manufacturer simply use launch price as "suggested retail price" to give the dealer a margin to push their product. In addition, the price are also mean to create some sort of "quality" illusions. – mootmoot May 23 at 13:34 • Apple is an outlier; they've always sold their products at 200-300% profit. Maybe that margin has reduced in the most recent iPhones; either way, I don't think Apple is relevant in this discussion, as we are taking about much lesser margins here - about companies deciding to go for 10-15% margins to be safe, or be greedy and go for 50% margins and lose sales in the process. – Kristada673 May 23 at 13:40 • We need to first establish if the premise of this question is even true. And perhaps it is true of the one specific product of phones (the only two examples that have been given -- with no sources cited -- are the Razer 2 and Blackberry phones). But is it more generally true of all products, as is suggested by the title of the question? – Kenny LJ May 24 at 7:25 ## 4 Answers Two very general reasons are: 1) High prices at the beginning target "early adopters" - people that have a higher "willingness to pay" for a new product just to have it first. Early adopters know that they pay more, and they 're ok with it. 2) As regards consumer reaction, it is much better to reduce prices than to increase prices. So sometimes prices are set high to "feel" the market response and then adjust accordingly. Note: these are very general and "universal" reasons for the phenomenon. The degree to which are qualified in each special case, market, country, etc its a matter of examination. Also, in some circumstances other strategic considerations may lead to the opposite action: start very low to "sweep the market" (price self-subsidy) in order to drive competitors out/increase market share, and then start increasing prices when market has become "captive" to a degree. I want to flesh out the answers from Alecos Papadopoulos and Bill Clark to make sure it's clear why a firm might want to reduce prices over time—known as intertemporal price discrimination. Suppose there are two groups of potential customers: enthusiasts (who love the product) and laymen (who aren't very interested in the product). Enthusiasts are willing to pay \$800; laymen are only willing to pay \$600. Suppose there are 100 consumers in each group. Uniform price What would happen if the firm sets a single price, $$p$$, that doesn't vary over time? If $$p$$ is low enough then both groups of consumer are willing to buy, so the seller would earn $$200p$$. The highest such price is $$p=600$$, so the seller would earn $$600\times200=120,000$$. Alternatively, the seller could choose a higher price such that the enthusiasts would still be willing to buy, but the laymen would not. The seller then serves only 100 consumers and the highest such price is $$p=800$$ The most the seller could make would therefore be $$800\times 100=80,000$$. Conclusion so far: if the firm were to set a single constant price, the best price would be a fairly low one (\$600) to serve the whole market.

Intertemporal discrimination

Notice that if the firm sets a price of \$600 then it is leaving money on the table because the enthusiasts would have been willing to pay more. This means that the firm might be able to do better by changing its price over time. Suppose the firm sets two prices: in year one the price is $$p_1=800$$ and in year two the price is $$p_2=600$$. The laymen certainly won't buy in year one because the price is too high. But if the enthusiasts buy in year one and the laymen buy in year two then the firm earns $$(100\times 800)+(100\times 600)=140,000$$. This is higher than the maximum achievable with a uniform price (120,000). Intertemporal price discrimination allows the firm to earn more than even the best uniform price because it allows the firm to charge a high price to those willling to pay a lot and a lower price to those willing to pay less. There's a major but here: for the intertemporal discrimination scheme to work, the enthusiasts have to buy in year one. But if they are smart and figure out that the price will be reduced in the future, why don't they just wait until they can buy at a lower price (this issue is known as the Coase Conjecture). There are various possible answers, but one that often seems quite plausible is simply that people are impatient. So long as enthusiasts are at least a little bit impatient, they would rather buy at a high price now than wait for a price cut that might not come for months. Then, if the firm can commit not to cut its price immediately it will be able to sell to enthusiasts at a higher price by exploiting their unwillingness to wait. You can read about other ways out of the Coase conjecture here. Lastly, I picked a simple example with (only) two types of consumer and known willingness to pay to keep things simple. But this idea is remarkably general. In addition to (intertemporal) price discrimination, there's a parallel process of ramping up production. Especially with tech products, they can have bugs at the beginning, even with all the precautions during design/prototyping. So a massive launch at high production volume is more risky. (Lower production volume also implies higher unit price; see economies of scale.) If you look how chipmakers tier their products, they almost always launch a flagship first, which usually high price and small market, then the tech "trickles down" to a more mass-market product (that usually has lower specs than the flagship). But as this mass-market product takes hold it also lowers the appeal of the flagship somewhat. So it is a more complicated process if you consider the company's entire product range than just a single (flagship) product. For the first issue; I could locate some (fairly cited) "seminal" literature; but there's a lot of it out there--the topic has been massively researched: • Stokey, Nancy L. 1979. "Intertemporal Price Discrimination." Quarterly Journal of Economics 94:355-71. This paper covers both the basic case of heterogeneous consumers and the case when production unit cost falls over time, but it doesn't cover stuff like incomplete information or self-competition from alternative products. As an aside, even temporary ("sales"/discount) low prices are related to the same issue of intertemporal price discrimination; see • Sobel, J., 1984. "The timing of sales." The Review of Economic Studies 51, 353–368. Another fairly cited theoretical paper is • Besanko, D. & Winston, W. (1990), "Optimal Pricing Skimming by a Monopolist Facing Rational Consumers", Management Science 36(5), 555-567 It assumes that the producer doesn't know apriori the value that consumers attach to a product and that consumers anticipate future price drops, so there's an iterated game being played in which the producer discovers the prices that consumers are willing to pay. This model also leads to an optimal strategy of decreasing price over time, but with lesser profits for the producer than in more simplistic models. Since I couldn't find an applied paper on actual devices (insofar), from an 2004/2006 applied paper on console video-games, which formulated a model inspired from actual strategies of producers, in which competition is apparently not much of a concern due to apparently weak substitutability of video game titles, and in which the unit production cost doesn't really change over time, but capturing the price premium from "hardcore" games is important. The model this paper uses is a more elaborate version of the Besanko & Winston model, but here is their empirical justification for applying such a model: All video-games exhibit consistent patterns of price cutting from their times of introduction. Our interviews with managers in the industry revealed that much of the motivation for this price cutting arises from the desire to sell to the segment of high valuation “hardcore gamers” initially, and to cut prices over time to sell to the “mass market”. This closely parallels the price discrimination incentive. On the cost-side, production of video-games is characterized by a constant marginal cost structure. Marginal costs correspond to royalty fees paid by the game manufacturer to the hardware console manufacturer (i.e. Sony), and also the costs of producing and packaging each CD-ROM title, both of which were constant over the time-period of the data. Hence, falling marginal costs are unlikely to be an issue in pricing over time. Further, competition from other games is also unlikely to be driving force behind falling prices. Given the large number of games in the market (over 600 for the Sony Playstation alone), and the fairly unique characteristics of each game, we find video-games to be weak substitutes for each other. The observed price data also reveal that the rates at which prices fall are not explained by competitive conditions in the market, a feature corroborated by managers in the industry. Hence, this industry forms an almost ideal setting to study the value of intertemporal price discrimination policies in practice. Given the features of our empirical application, we work with a monopolistic model of pricing that ignores competitive considerations. [...] We learned that the typical rules-of-thumb used for pricing share many similarities to our model. First, estimates are used to assess the evolution in the size of the potential market. Our interviews also revealed that managers revise game-prices periodically, cutting prices if sales are low, and keeping prices high if realized sales are high. We interpret this heuristic as indicating that the total sales of the game is an important state variable for the firm’s pricing decision. This is roughly consistent with the model since the theoretical state variables, the segment sizes, are a function of cumulative sales of the game until that time period. The model assumes that managers know the distribution of consumer types and can, therefore, translate the observed sales of the game into segment sizes, which form the “payoff relevant” state variables for the pricing decision. Managers are also aware that high willingness-to-pay “hardcore gamers” sustain initial high prices, which have to be lowered once the game becomes “main-stream”. This adherers to the notion of price discrimination over time. As a reviewer pointed out, this heuristic thumb-rule for price cutting is also consistent with managers cutting prices to reflect lower valuations of consumers for older games. To the extent that such “novelty” effects are common across segments, these are captured by our model via the game-specific shocks to utility [...]. A relevant question here is whether it is the retailer, rather than the manufacturer (as in our model), that is initiating the observed price-cuts in the data. For instance, it could be that wholesale prices from the manufacturer are constant, and the retailer is cutting prices over time due to reasons unrelated to intertemporal price discrimination. For example, falling retail prices could arise from retailers rapidly clearing inventory of low-selling games to free up shelf-space for new releases. Our interviews with managers in the industry however, indicated that game manufacturers do periodically initiate cuts to wholesales prices, which are mostly passed through to consumers by retailers. Further, we found that the industry typically implements excess inventory return policies within the manufacturer-retailer channel, whereby retailers can return unsold stocks of games back to the manufacturer, making retail price-cutting to clear inventory a less compelling explanation. Nevertheless, in the absence of retail-level inventory data, we are unable to rule out this explanation completely. Devices however aren't as unsubstituitable as video games. There exist fairly sophisticated models (based on optimal stopping) of demand segmentation; e.g. I found an analysis of the PC printer market from this perspective, which assumes that the prices fall exogenously (from the consumer perspective). But apparently the problem gets fiendishly complicated when such consumer models (i.e. with partially substitutable products along multiple dimensions) have to be combined with (iterated) supply-side price models; insofar I haven't found a paper that analyzes supply and pricing in the context of more complex demand models like this... According to a 2005 review by Ryzin and Talluri (which summarizes the theoretical works I mentioned above in more technical terms, so it's a good read in that respect) there was not much research on dynamic price models for multiple (competing) products; they only point out to one such (2004) paper on airfare pricing (by the same authors), in which the competing products are different classes (economy vs business). Also, airfares generally see a different intertemporal price discrimination pattern (relative to durable goods) with the price for a given airfare generally increasing over time due to business customers making last minute reservations/decisions. They also mentioned that multiple-product models are apparently very sensitive to the substitution function, so difficult to generalize. There was also no specific research mentioned on dynamic pricing oligopoly models, but an opinion piece was cited that such models might not even be too useful since the rational-behavior expectation might not hold for (a small number of) competitors; so monopoly models were the staple of dynamic pricing research up to that date. I haven't found a more recent review insofar. The 1972 Coase conjecture (negative result), which Ubiquitous highlighted can indeed be consider seminal in the sense that it spurred the research on actual dynamic pricing models that do allow for the price discrimination that is often seen in practice; e.g. one book said The seminal work on inter-temporal sales is Coase (1972) which demonstrates that, given a durable product with an infinite number of selling opportunities over time, a monopolist will eventually decrease a product’s price to its marginal cost because consumers will anticipate this decrease and will wait for discounts (the famous Coase conjecture). Numerous papers that followed laid out conditions in which the Coase conjecture may not hold (Stokey 1979, Besanko and Winston 1990, and DeGraba 1995). The first two of these I've already mentioned above. The DeGraba paper is about the producer creating an artificial shortage in the first period. This strategy is also considered relevant to the consumer electronics and related (e.g. gaming) industries; the DeGraba paper exemplified it with some console videogames shortage at launch. In the (simplest) DeGraba model of buying frenzy, with a limited total number of potential customers (n): the monopolist wants to sell to customers when they are uninformed, because all uninformed customers have the same valuation for the good (equal to the common expected valuation). Thus, a single price could capture all of this willingness to pay from n - 1 customers. Once customers become informed they no longer have homogeneous valuations, so the potential to capture all of this surplus with a single price vanishes. More recent works on buying frenzies exemplify them with Apple products (at launch). More generally the reason for the frenzy (for a rational consumer and in a dynamic [at least two-period] pricing model) is buying frenzies occur when customers are sufficiently uncertain about their valuations of the product and when they discount the future sufficiently but not excessively. [...] such frenzies can have a significantly positive effect on firm profits and partially recover the loss due to non-commitment to future prices. [...] If customers are relatively informed about the product and do not value the waiting option, the firm does not have any incentives to ration demand. Buying frenzies are more likely to occur when customers are initially uncertain about their preferences for the product and benefit from waiting to learn their preferences. Such uncertainty is more likely with respect to an innovative product that will match the needs of some customers but not others which may explain why frenzies are common for new electronic products (e.g., the iPhone) than for similar, “me too” products (e.g., Android phones) that are released later. It is therefore reasonable to assume that customers have more uncertainty about new products than about knockoffs produced later. There also some alternative behavioral-economics models for buying frenzies, which don't assume full rationality from the consumer. One of these, Papanastasiou et al. observes that scarcity strategies appear to be employed even when prices are fixed and availability in the long-term is ample In their Bayesian-learning model (of consumers) [induced] product scarcity may act as an effective substitute for dynamic pricing, allowing the firm to approximate dynamic-pricing outcomes while charging a fixed price So it seems controversial that [producer induced] buying frenzies are (always) related to later price drops... which is why I left this issue for the end. It’s a form of price discrimination. Early adopters are willing to pay more, and so the product is launched at a higher price to capture that value. If they launched at the lower price, then early adopters would be paying a lower price than they’d otherwise be willing to pay. • My point is, clearly this has not worked for some companies as evidenced by their dwindling sales numbers. Then why keep doing that? Also, it wouldn't seem stupid if they keep the price only$100-150 more than what it should be; but when they price a product $300-400 more than it should be, it seems inexplicable. That's what I meant. – Kristada673 May 23 at 15:23 • I'm sure it's working just fine for the companies that do that. The profit from selling a product for (say) \$850 vs. \$600 almost certainly makes up for the lower volume, especially when you consider they're not going to lose all the potential sales at the lower price by delaying. Every \$850 sale probably offsets several lost \$600 sales. Companies wouldn't keep doing this if it weren't a more profitable way. – Bill Clark May 23 at 17:48