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?

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Published by

Gennaro Cuofano

Gennaro is the creator of FourWeekMBA which reached over a million business students, executives, and aspiring entrepreneurs in 2020 alone | He is also Head of Business Development for a high-tech startup, which he helped grow at double-digit rate | Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy | Visit The FourWeekMBA BizSchool | Or Get The FourWeekMBA Flagship Book "100+ Business Models"