Price Skimming

Last Updated :

-

Blog Author :

WallStreetMojo Team

Edited by :

Raisa Ali

Reviewed by :

Dheeraj Vaidya, CFA, FRM

Table Of Contents

arrow

Price Skimming Definition

Price skimming refers to a pricing strategy where the producers sell new, innovative, or improvised products or services at a high price for a short period targeting high-end customers and subsequently, reduces the price to tap remaining market segments.

The strategy focussing on consumers who are early adopters or with high discretionary income is well utilized by different industries, mainly technology and fashion, where less-price sensitive customers are prevalent. Such customers are influenced by brand value, technological advancements, high quality, enthusiasm for the latest editions, etc.

Table of contents
  • Price skimming is a strategy where a product or service is priced above the market price, reflecting its uniqueness and influencing factors like technological utility, quality, and innovation.
  • It is suitable for new, innovative, or improvised products and services.
  • Brands are pricing their innovative and latest model very high at its initial phase and reducing its price to capture different market segments after a period when the demand for that model declines is an example. 
  • The strategy helps to earn a high short-term profit, which is beneficial in recovering sunk costs.

How Does Price Skimming Strategy Work?

Price skimming strategy optimizes a firm's profit when entering a new or growing market with a novel product or service, ensuring quality and customer satisfaction. There is likely to be little competition and high demand for it. So, it is easy to charge buyers a price that is usually higher than the market price.

Price Skimming

The strategy works by segmenting the market. The scenario can be imagined as an array of layers where customers with similar price sensitivity or desire constitute a layer. As demand from a layer saturates, the strategy skims off the layer and moves to lower layers by decreasing the price to make it affordable for customers in a target layer. It is done repeatedly until the law of demand and supply then governs the price of the product or service. The process enumerates different prices and corresponding demand, making the product flow through the demand curve.

Price Skimming Examples

Manufacturers can enjoy setting a high price for a short period in a market segment where the demand for the product or service is inelastic. Also, if a product emerges with revolutionary features and abnormal pricing, there will be a lot of hype, and the brand will become a buzzword. Let's take the example of Apple Inc., a developer of hardware products like iPhone and Macintosh computers.

Like most of Apple's products when they launched the iPad, they designed the marketing strategy in such a way to portray an innovative, luxurious, high-quality image appealing to the masses. The important part is that they applied price skimming in this new stage of the PLC (Product Life Cycle). The relatively high price of the iPad made people believe that something was unique about the offering and created an emergency to own the product. Apple's successful marketing strategy reflected when within a period less than two months after the launch, Apple sold 2 million iPads. However, whenever Apple launched new versions of the iPad, the price of the old versions dropped to a new level.

Let's look into another example from the fashion industry. While introducing limited edition products, Nike uses a market-skimming strategy. When they bring a new design to the market, it is evident that they are pricey. Nike uses this method to extract profit from early adopters who desire the product and spend discretionary income. Ultimately, Nike decreases the price of new products after being on the market for a while.

Advantages and Disadvantages

The advantages of price skimming are that it allows firms to recover sunk costs such as the high price of research and development. In addition, skimming the price periodically until it meets the supply-demand point ensures that the manufacturer makes as much money as possible from various target markets. In cases where research and development have been long and complex, it may take long for competitors to catch up, so the seller has time to make as much as possible from the market. Generally, adopting skimming strategy benefits in the following ways:

  • Recover sunk cost
  • Segments the market
  • Reaches break-even using minimum sales
  • Retailers can get a higher margin

Price skimming also has some obvious disadvantages. The biggest of these is that it is a viable tactic only for a few companies who invest so much in research and development that it becomes difficult for competitors to produce goods or services which imitate their products. Otherwise, competitors may develop cheaper (and sometimes better) products and services similar to what they offer. We can enumerate the disadvantages as follows:

  • Suitable only when the product follow the inelastic demand curve
  • Attract more competitors and can turn inelastic nature into elastic
  • Sometimes customers may wait until the price drops

A market-skimming strategy is not usually viable in a market that has already been established and is busy. In such an environment, one would have to manufacture products that highly outdo the competition.

Frequently Asked Questions (FAQs)

Explain price skimming meaning?

The strategy intends to extract maximum profit by selling a product or service at a very high price, in contrast to the prevailing competitive price in the market. The strategy first targets high-end customers. When it gets saturated, the suppliers will reduce the price and target the next layer of more price-sensitive customers than early adopters.

What is an example of price skimming or market-skimming?

When introducing a new product, the luxury brand, specifically in the fashion industry, is priced very high, targeting the fashion enthusiast or brand lovers. Over time, the target market will saturate, other competitors will introduce similar products, and the brand will develop a new product. All this points to the product getting outdated and less pricy than before.

What companies use price skimming?

The market-skimming strategy is primarily seen in industries such as technology, where the frequent introduction of innovative products occurs.