price-skimming

Price Skimming And Why It Matters In Business

Price skimming is primarily used to maximize profits when a new product or service is released. Price skimming is a product pricing strategy where a company charges the highest initial price a customer is willing to pay and then lowers the price over time.

Understanding price skimming

The strategy is most effective for a company with first-mover status.

By generating maximum profit in the shortest time possible, the company can quickly recover its sunk costs before competition and pricing pressures increase.

Price skimming is sometimes described as riding down the demand curve as the business seeks to capture consumer surplus early in the product life cycle to exploit its first-mover position.

The product is initially offered at a high price targeting consumers with the desire or required funds to purchase it. 

As demand and the novelty of the product decreases, the price is lowered to capture consumers with the next highest level of desire and purchasing ability.

This process may be repeated multiple times until the pricing levels off at a base price. In theory, the business “skims off” the top of each level since it charges the maximum price consumers in each level are willing to pay.

Price skimming is closely related to the diffusion of innovation, a theory explaining the rate at which a new product spreads through a social system.

Initially, price skimming targets the innovators – a group of risk-taking consumers who want first access to a product no matter the price.

Examples of price skimming

Price skimming can be seen in any scenario with one or more of the following characteristics:

  • The presence of a target audience willing to buy the product at a higher price – the so-called innovators of the diffusion of innovation theory.
  • A general belief among consumers that a higher price is associated with higher quality.
  • A general belief that higher prices do not attract significant competition.
  • A view that lowering the price would have a minor effect on increasing sales volume and reducing unit costs.

Real-world examples of price skimming in action include:

  • Smartphones – when Samsung releases a new smartphone, the company sets a higher price when initial demand is high and then progressively lowers the price as hype begins to wane. 
  • Sports apparel – Nike also employs a similar strategy when it releases a range of new or limited edition shoes. Where Samsung relies on exclusivity and innovation to attract premium buyers, Nike relies more on brand equity. 
  • Gaming consoles – Sony is well known for releasing its PlayStation line of gaming consoles at a high price and progressively lowering it over time. In fact, the company sold more PlayStation 4 consoles in the third and fourth years after release than it did in the first two years.

Advantages and disadvantages of price skimming

Advantages

  • Return on investment – higher price points in conjunction with lower supply help a business recoup its costs and deliver a superior ROI. This is particularly beneficial for companies that invest heavily in research and development.
  • Brand image – innovators who gain early access to a new product are not just gaining access to the product itself. There is often novelty, prestige, and superiority involved with owning a new product. This causes consumers to associate positive feelings or emotions with certain brands.

Disadvantages

  • Alienation of consumers – unfortunately, emotions can also damage a brand. This occurs when innovators see that a product they paid top dollar for is being offered to the masses for a discounted price. Aside from the obvious financial disadvantage, the innovator loses some degree of exclusivity as the product they bought becomes more mainstream.
  • Not applicable to all industries or companies – for whatever reason, some businesses will simply not have the ability to implement price skimming. Luxury goods manufacturers could not progressively discount their products for fear of having their range seen as lower quality by consumers.

Key takeaways

  • Price skimming is a product pricing strategy for businesses with the first-mover status that want to target consumers willing to pay a high price for a product. The price is then progressively lowered over time to target new customer segments.
  • Price skimming is employed by companies such as Nike, Sony, and Samsung, among others. The presence of consumers willing to pay a high price for early access is critical to the success of each company’s strategy.
  • Price skimming delivers a superior ROI and increases brand equity. However, it can alienate first adopters and does not apply to some industries or businesses.
pricing-strategies
A pricing strategy or model helps companies find the pricing formula in fit with their business models. Thus aligning the customer needs with the product type while trying to enable profitability for the company. A good pricing strategy aligns the customer with the company’s long-term financial sustainability to build a solid business model.

Read Next: Pricing Strategies, Dynamic Pricing, Is First Mover Advantage a Myth?

Read Next: Pricing Strategy.

Connected Business Concepts

Revenue Modeling

revenue-model-patterns
Revenue model patterns are a way for companies to monetize their business models. A revenue model pattern is a crucial building block of a business model because it informs how the company will generate short-term financial resources to invest back into the business. Thus, the way a company makes money will also influence its overall business model.

Pricing Strategies

pricing-strategies
A pricing strategy or model helps companies find the pricing formula in fit with their business models. Thus aligning the customer needs with the product type while trying to enable profitability for the company. A good pricing strategy aligns the customer with the company’s long term financial sustainability to build a solid business model.

Dynamic Pricing

static-vs-dynamic-pricing

Price Sensitivity

price-sensitivity
Price sensitivity can be explained using the price elasticity of demand, a concept in economics that measures the variation in product demand as the price of the product itself varies. In consumer behavior, price sensitivity describes and measures fluctuations in product demand as the price of that product changes.

Price Elasticity

price-elasticity
Price elasticity measures the responsiveness of the quantity demanded or supplied of a good to a change in its price. It can be described as elastic, where consumers are responsive to price changes, or inelastic, where consumers are less responsive to price changes. Price elasticity, therefore, is a measure of how consumers react to the price of products and services.

Premium Pricing

premium-pricing-strategy
The premium pricing strategy involves a company setting a price for its products that exceeds similar products offered by competitors.

Price Skimming

price-skimming
Price skimming is primarily used to maximize profits when a new product or service is released. Price skimming is a product pricing strategy where a company charges the highest initial price a customer is willing to pay and then lowers the price over time.

Productized Services

productized-services
Productized services are services that are sold with clearly defined parameters and pricing. In short, that is about taking any product and transforming it into a service. This trend has been strong as the subscription-based economy developed.

Menu Costs

menu-costs
Menu costs describe any cost that a business must absorb when it decides to change its prices. The term itself references restaurants that must incur the cost of reprinting their menus every time they want to increase the price of an item. In an economic context, menu costs are expenses that are incurred whenever a business decides to change its prices.

Price Floor

price-floor
A price floor is a control placed on a good, service, or commodity to stop its price from falling below a certain limit. Therefore, a price floor is the lowest legal price a good, service, or commodity can sell for in the market. One of the best-known examples of a price floor is the minimum wage, a control set by the government to ensure employees receive an income that affords them a basic standard of living.

Predatory Pricing

predatory-pricing
Predatory pricing is the act of setting prices low to eliminate competition. Industry dominant firms use predatory pricing to undercut the prices of their competitors to the point where they are making a loss in the short term. Predatory prices help incumbents keep a monopolistic position, by forcing new entrants out of the market.

Price Ceiling

price-ceiling
A price ceiling is a price control or limit on how high a price can be charged for a product, service, or commodity. Price ceilings are limits imposed on the price of a product, service, or commodity to protect consumers from prohibitively expensive items. These limits are usually imposed by the government but can also be set in the resale price maintenance (RPM) agreement between a product manufacturer and its distributors. 

Bye-Now Effect

bye-now-effect
The bye-now effect describes the tendency for consumers to think of the word “buy” when they read the word “bye”. In a study that tracked diners at a name-your-own-price restaurant, each diner was asked to read one of two phrases before ordering their meal. The first phrase, “so long”, resulted in diners paying an average of $32 per meal. But when diners recited the phrase “bye bye” before ordering, the average price per meal rose to $45.

Anchoring Effect

anchoring-effect
The anchoring effect describes the human tendency to rely on an initial piece of information (the “anchor”) to make subsequent judgments or decisions. Price anchoring, then, is the process of establishing a price point that customers can reference when making a buying decision.

Pricing Setter

price-setter
A price maker is a player who sets the price, independently from what the market does. The price setter is the firm with the influence, market power, and differentiation to be able to set the price for the whole market, thus charging more and yet still driving substantial sales without losing market shares.

Economies of Scale

economies-of-scale
In Economics, Economies of Scale is a theory for which, as companies grow, they gain cost advantages. More precisely, companies manage to benefit from these cost advantages as they grow, due to increased efficiency in production. Thus, as companies scale and increase production, a subsequent decrease in the costs associated with it will help the organization scale further.

Diseconomies of Scale

diseconomies-of-scale
In Economics, a Diseconomy of Scale happens when a company has grown so large that its costs per unit will start to increase. Thus, losing the benefits of scale. That can happen due to several factors arising as a company scales. From coordination issues to management inefficiencies and lack of proper communication flows.

Network Effects

network-effects
network effect is a phenomenon in which as more people or users join a platform, the more the value of the service offered by the platform improves for those joining afterward.

Negative Network Effects

negative-network-effects
In a negative network effect as the network grows in usage or scale, the value of the platform might shrink. In platform business models network effects help the platform become more valuable for the next user joining. In negative network effects (congestion or pollution) reduce the value of the platform for the next user joining. 

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