Price skimming is a price setting strategy that a firm can employ when launching a product or service for the first time. By following this price skimming method and capturing the extra profit a firm is able to recoup its sunk costs quicker as well as profit off of a higher price in the market before new competition enters and lowers the market price. It has become a relatively common practice for managers in new and growing market, introducing prices high and dropping them over time.
Price skimming is sometimes referred to as riding down the demand curve. The objective of a price skimming strategy is to capture the consumer surplus early in the product life cycle in order to exploit a monopolistic position or the low price sensitivity of innovators.
Therefore, the skimming strategy gets its name from skimming successive layers of “cream,” or customer segments, as prices are lowered over time.
Pricing Strategies: Price Skimming
How price skimming works
Effective price skimming often takes advantage of high consumer interest when releasing a new product. Charging early adopters a premium increases the profit margin on all units sold upon initial release. As sales at the higher rate slow, a company begins a series of one or more downward adjustments to the price.
This can expand the potential customer base to reach those who would not pay the initial price but who are interested in using the products. By offering lower rates, the company targets reaching each consumer as soon as they offer a price that meets that consumers willingness to spend, maximizing total sales value.
What is price skimming?
Price skimming is a sales technique in which a company charges high prices for a product upon release, and then gradually lowers the price of the product as time passes. The goal of price skimming is to maximize sales prices for products by offering consumers the opportunity to get the products before others by paying a higher price, while still offering a more affordable option in the future for those who dont purchase immediately. When properly executed, this allows a company to generate sales over an extended period, extracting the highest price possible from each group of consumers.
Disadvantages of price skimming
When making a business decision, such as choosing a pricing method, its important to consider potential negatives with the positives to make a more informed decision. Potential disadvantages of using price skimming include:
It requires a low-elasticity market
Elasticity is a term that represents how likely the demand for your product is to change based on the price you ask. In a market with low elasticity, charging higher prices is less likely to diminish interest in your product, allowing you to initiate the price skimming method and gain the benefits it provides over a period of time.
If your market research shows that there is highly elastic demand for your products, price skimming may not suit it well. By charging a higher price, theres the potential for you to reduce interest from the market. This can cause a situation where the increased profits generated by early adopters dont adequately cancel out the lost sales from diminished interest.
Selling fewer units
Using a price skimming approach may mean fewer total units sold for a product. While some consumers will decide to purchase at a higher price and others may wait until the price drop reaches their acceptable range, some in the latter group may also change their mind before your price falls enough for them to buy. When deciding on price skimming, its important to weigh this possibility against the increased profits generated by the higher prices to determine which is an ideal option.
Potential consumer backlash
Consumers facing a price skimming approach may offer backlash to the pricing plan. This may occur in the initial phases, with some consumers responding negatively to the high prices charged at release. This may present itself in fewer sales, a negative impact on your company or your products brands and a loss of customer loyalty.
Another area of potential concern when using a price skimming approach is the reaction from early adopters when you lower the price. A price drop that occurs too steeply or too quickly may upset those who purchased at a higher rate, and this can affect future sales.
Waning demand can impact profits
When releasing a product that has high demand, if it doesnt maintain those high levels of interest throughout its lifespan, then price skimming may affect the profitability of the product run. A skimming approach wouldnt suit a product thats likely to have a short period of intense cultural interest, though. Using it may cause you to miss sales for those who may have paid a lower price initially but who are no longer interested by the time the price reaches their range.
Advantages of price skimming
Price skimming can be an effective pricing technique when properly executed for a product that is well situated for its application. Some benefits provided by using price skimming include:
High return on investment
Price skimming has the potential to improve your return on investment when releasing a product. Selling at a high rate to early adopters allows the company to increase the profit margin for the initial units while demand is high. Because some consumers will pay a premium to be the first people to own a product or to not have to wait for the benefits it provides, a company can charge more to those buyers.
When the company moves the product into its series of price decreases, this can have the effect of increasing the total number of units sold as the product enters more consumers acceptable price range. When using a price skimming structure, this has the potential to allow you to increase the average profit per unit sold comparable to selling at a lower price, while selling more total units than if they only charged the initial high price.
Maintaining consumer interest
Lowering the price of a product may be an effective way to keep consumer interest in the products high. When launching a product using a price skimming approach, there are likely to be groups of consumers interested in the product the company is selling while feeling that the asking price is too high. As you lower your prices, this attracts the interest of those in this category. This may allow you to generate a steady stream of sales, with each price drop helping to rejuvenate the market for the product.
Early adopter testing
When releasing a product using a price skimming method, youre likely to sell fewer units than if you launched at a lower market price. This can provide the opportunity for you to move your products to market for practical use without reaching their full market yet. A smaller release can allow for those early adopters to serve as unofficial testers of the product as well, potentially identifying concerns that didnt arise during product testing. This can be a strong benefit to technological products, where it may be more difficult to identify all potential issues through internal testing.
Although its beneficial to use the smaller release that a price skimming technique may offer to improve a product, its important to consider the experience of the early adopters as well. Besides completing thorough internal testing to identify and solve as many problems as possible before release, it may be beneficial to have high-quality customer service available in the event of unforeseen issues for early adopters. This allows a company to fix problems early while maintaining positive experiences for those who purchased before the fix.
Establishing a premium brand
Using a price skimming approach for product releases can help you establish branding for your company or for your product as a premium offering. By charging a higher price at release, you tell consumers that your products are also of high quality. Earning a reputation as a premium product manufacturer may allow you to charge higher prices for current and future products.
When to use price skimming
Before choosing a price skimming approach to pricing your products, its beneficial to consider whether you satisfy the conditions which make it more likely to be helpful. Top reasons to use price skimming include:
If theres minimal risk of undercutting competitors
Choosing price skimming in a competitive market where your competitors offer products a consumer could reasonably use in place of your own may not be an ideal setting. When releasing a product at an increased price tag initially while facing similar competitors, it creates an opportunity for your competition to charge a lower price and satisfy those interested in your product but who cant afford it. Without similar competitors, you can charge a higher initial price without fears of competition claiming a significant portion of your potential customers.
When theres high consumer demand for your product
Price skimming is a technique that generally works best for products with high levels of interest. Significant consumer interest in your product generates the potential for more competitive shoppers willing to spend higher amounts to get their own copy of the product. This allows you to set your price high, then slowly taper it over time to meet new demand levels as they diminish when customers make their purchase and remove themselves from the market.
If your product has exhibited a long-lasting value
When deciding if price skimming suits your product, consider its enduring value. Because price skimming relies on decreasing prices over time, it often requires a significant period of consumer interest to carry out the full production plan. If you believe your product is likely to remain attractive to consumers over an extended period in which you can apply a price skimming plan, it may be an effective way to maximize your profits.
Example of price skimming
Heres an example of a company using price skimming:
A video game console manufacturer is preparing to announce its latest console release. Console cycles between releases at the company typically last for approximately five years, with fans remaining interested in the consoles throughout the entire period and throughout much of the next editions release schedule, creating long-term interest in the product. Consumers maintain high demand levels for each new console released by the manufacturer, and while there are competitive consoles on the market, brand loyalty and gamers who purchase multiple consoles reduce the impact of competition on a potential moderate price skimming approach.
The company announces that its new console retails for $400 for the base version, with potential upgrades increasing the price by up to $200 per unit. The company maintains the price for the first two years of sales, before initiating a series of price drops over the remaining years in the console cycle until the company has reduced prices by half when their next console is ready for release.
Through this process, the company sells to its most ardent fans upon release and in its first years at full price, maximizing profits for each unit sold. As the console ages and fans think about the development of the next generation of consoles, the company removes $50 from the price as needed to maintain sales throughout the length of the consoles release schedule and into the release schedule of its successor.
What is the meaning of price skimming?
What is price skimming give an example?
What stage is price skimming?
What is an advantage of price skimming?
Price skimming provides higher up-front sales figures to cover research and development costs. You’ll potentially see higher returns on your investment by maintaining interest for longer. You can segment your customer base with different marketing strategies at each price level.