Price skimming is a pricing strategy that entails pricing a product or service at a high price when it first enters the market in order to ‘skim’ portions of the market ready to pay the higher price. A company’s pricing will then be gradually reduced in order to access increasingly price-sensitive consumers and to line with rivals that have entered the market during this period.
Price skimming is most commonly used by brands attempting to separate themselves from competitors by framing their offering as the ‘leader’ in terms of quality, customer happiness, popularity, and so, on.
Price skimming, like any other pricing approach, comes with risks, and organizations must undertake extensive pricing research before opting to apply it. This is due to the fact that time is of the essence when it comes to price skimming, making proper preparation critical to its success.
Read on to learn more about the price skimming strategy, how it works and when to use it.
What is Price Skimming?
Price skimming means charging a high price when a product first enters the market in order to benefit from those willing to pay more, while gradually dropping the price to reach the remaining markets.
How Does Price Skimming Work?
Price skimming is one of the most difficult pricing tactics that a company may employ due to its dependency on timing. Businesses must understand each stage of the price skimming cycle in order to improve their product’s prospects of maximizing profit and remaining competitive in the market when new items enter the market.
Price skimming works best for new items since the main objective is to grab as much profit as possible while prices are at their peak. Given that demand has a big influence on pricing, firms should guarantee that the product is in high demand, with a large section of the market prepared to pay the initial price. The existence or absence of alternatives frequently impacts demand; for example, the fewer competitors a new product has, the more likely it will be successful with a price skimming approach.
As a result, price skimming is common in the electronics business; new technologies develop on a regular basis, leaving room for unique items. Leading companies create a buzz around these advancements by introducing the latest items at exorbitant rates that tech-savvy consumers are prepared to pay. These companies then cut their pricing in preparation for cheaper ‘copy-cat’ items from competitors to enter the market. It’s critical to understand that such pricing movements aren’t reflexive or accidental, but rather part of a well-executed price skimming strategy that correctly matches its pricing changes with the market.
Because it is unavoidable that customer demand and willingness to pay dwindle over time, it is critical that firms plan their price skimming tactics carefully and efficiently to assure maximum profit for the longest feasible time. Choosing the optimal time is critical to getting this strategy right – too soon and a business will miss out on profit from those willing to pay a higher price, too late and the price-sensitive will turn to cheaper alternatives that have become available, and others will simply have lost interest at this stage.
Keep in mind that price skimming is based on time, exclusivity, and demand. Businesses must modify their tactics to these characteristics or risk falling behind the competition.
Advantages of Price Skimming:
- Increased Return on Investment
Charging the highest initial price at the introduction of an innovative product, particularly in high-tech sectors, might assist your firm in recouping R&D and advertising costs. Companies such as Apple gain from large short-term earnings at the debut of a product, and the initial higher pricing are justified by the technical achievements they produce.
The bottom line is that if you put all of your cash flow and resources into developing a gadget or service that no competition can equal, you should be able to charge higher pricing during the launch to recoup the majority of your investment and, hopefully, finance future advancements.
- It aids in the creation and maintenance of your brand’s image
Price-skimming can also give the impression that a product is a high-quality “must-have” for early adopters who can’t live without the latest tech gadgets. Higher costs at the start of a product’s life cycle allow you to create a premium brand image that attracts status-conscious buyers. Furthermore, when rivals enter the market, you’ll have the breathing room you need to cut your rates. In some circumstances, a lower starting price at the outset might create consumer price sensitivity, making subsequent rate increases unfeasible without losing sales.
- It divides the market into segments
Price skimming, as previously noted, is an excellent strategy to segment your consumer base, possibly allowing you to collect the most possible profits from different categories of customers as you lower the price. Starting with a larger price will not dissuade early adopters, and as you drop the price over time, you will attract more price-sensitive customers. You may capture part of that consumer surplus and increase revenue by changing product pricing depending on the product demand curve and the maximum price customers are prepared to pay.
- Early Adopters Aid in the Testing of New Products
One advantage of early adopter consumers is that they serve as test subjects for new items. Those status-conscious customers who buy your new product first can give vital feedback and assist you in ironing out the wrinkles before the next update and, hopefully, a larger user base. Early adopters who enjoy your product may function as brand ambassadors, creating a sense of quality through word of mouth in addition to being useful testers. This free offer will entice new clients to purchase the goods when the price is lowered.
Disadvantages of Price-Skimming
- It is only effective if your demand curve is inelastic
Price skimming may be a realistic strategy for a company like Apple, but only when demand does not fluctuate drastically when prices change. If your product’s demand curve is typically elastic, which means that price adjustments have a stronger influence on product demand, then starting with high pricing might substantially hinder your sales volume. Any company’s objective is to make a product as inelastic as possible, but not everyone sells tech goods or services that are innovative enough to look vital to consumers.
- In a crowded market, this is a poor strategy
Before determining your rates in any business, it is critical to measure client values and research the competitors (and their market share). If you already have a lot of rivals, chances are your demand curve is quite elastic, and excessive prices during your product launch will drive buyers away. In an already crowded market, price skimming is not a realistic tactic. If you want to preserve a competitive advantage, you should avoid skimming unless your product has remarkable new features that no one can match.
- Price-skimming Entices Competitors
Perhaps your product is innovative enough to generate a new market, but as demonstrated by the launches of the iPhone and iPad, competitors such as Samsung and Microsoft are waiting around the corner. High pricing at the start of a new product’s life cycle will entice rivals to enter the market, and the inelasticity of a demand curve is nearly always lowered over time owing to the emergence of competitive replacements. Price skimming might also limit the rate of adoption by your potential consumers, allowing your competitors more time to duplicate and improve on your product before you’ve profited on the desire for innovation.
- It may make your Early adopters angry
Remember those brand evangelists who were the first to buy your product? They might just as well be the source of your biggest PR catastrophe. If costs decrease too drastically or too soon after the first product introduction, your early users will feel cheated. This sort of pushback was encountered by Apple in 2007, when the firm cut the price of the iPhone by $200 just two months after its release. The phone’s fast 33 percent price decrease from $599 to $399 may have helped stimulate demand, but some early adopters were understandably disappointed.
To avoid clients at the top of your demand curve feeling duped, utilize price skimming regularly and avoid rushed or blatantly evident price drops. Price skimming is also known as price discrimination, which is the practice of selling the same product at different rates to various groups of customers. In certain situations, this tactic is unlawful, but the precise requirements that constitute illegal pricing discrimination are, to put it mildly, dubious.
Some Examples of a Price Skimming Strategy
Plenty of famous products are prime instances of price skimming. Electronic devices, such as the Apple iPhone, frequently use a price-skimming strategy during the first launch period. Then, once competitors launch competing goods, such as the Samsung Galaxy, the price of the product reduces to maintain the product’s competitive edge.
Every year, Apple introduces new iPhone models, and the costs of the newer iPhones are quite high, in fact, considerably higher than the competition.
Meanwhile, the previous year’s lineup receives a price reduction because it’s no longer deemed cutting-edge technology.
Apple is able to do so because of the following:
- There will undoubtedly be sufficient demand for the latest technology.
- Its brand image will not be harmed as a result of this.
- It helps them position themselves as a higher-end brand.
Sony’s PlayStation 5 is a more contemporary example of price gouging. Because it has little competition, this next-generation console has a substantially higher price tag. However, when more rivals launch competing systems or the early adopter demand is satisfied, prices will reduce, as we have seen with past generations of the PlayStation product line.
We can also take, for example, Sony’s PlayStation 3 console, which was first released at a $599 price point since it had little competition and was expected to sell because Sony’s prior platform, the PlayStation 2, was a tremendous success. While the PS2 was priced modestly, Sony understood there would be a large number of prospective purchasers for the PS3 and hence set a higher initial launch price. The PS3’s pricing was gradually reduced with each passing year, eventually reaching $299 during the year before it was discontinued.
In summary, price skimming can be a highly effective pricing strategy to optimize profits – if the product, market and competitive environment provide suitable conditions. Therefore, before implementing this or any other strategy, you must do a thorough examination of the market in which you want to implement the strategy. Then, consider all available pricing strategies and choose the strategy that best fits the environment you operate in.