Price Skimming
A pricing strategy where the company prices the launched product at a higher price bandwidth and gradually lowers it over time
What is Price Skimming?
Price skimming is a pricing strategy where the company prices the launched product at a higher price bandwidth and gradually lowers it over time. The price is set high for those customers who are inelastic to pricing and willing to pay an added premium.
The company here targets two sets of customers. The first set of customers includes those indifferent to the product's pricing, and the second set consists of price-sensitive ones.
Therefore, 'skimming' refers to creaming one set of customers for profits before moving to another.
This strategy is vastly different from penetration pricing. In penetration pricing, the company prices its products at the lowest price possible to capture as much target market as possible. It wants to infiltrate and acquire as much customer base as it can.
This skimming allows the company to earn as much revenue as possible during the initial stages of the product's shelf life. Then, when the company decides to reduce the prices, it taps the market of conscious buyers who then get acquitted to the product's taste and become part of early adopters.
If the company runs late in reducing the prices, the competitors enter the market and provide cheaper alternatives to potential customers leading to a loss of sales and revenue.
Key Takeaways
- Price skimming is a strategy where a product is initially priced high and gradually lowered over time.
- It targets price-insensitive customers willing to pay a premium.
- This approach maximizes initial revenue and attracts early adopters as prices decrease.
- Its advantages include high ROI, brand building, market segmentation, and valuable feedback from early adopters.
Rationale Behind Price Skimming
Companies feed off the enthusiasm of customers who purchase the new products introduced in the market.
These businesses enjoy a competitive edge over their peers by differentiating the product in terms of features offered or the expected quality to be served, which puts them in an advantageous position to charge premium prices.
The perfect example one can witness of a brand that follows price skimming is that of Apple. Every year Apple launches an overly priced iPhone, and people still stand in the queue for hours to get their hands on them.
They can pull this high pricing without losing the customer base because of how they have shaped their brand perception in the eyes of the customer. It has established itself as a credible and high-quality product brand. It markets its products creatively and creates hype around them, making the price work in its favor.
Brands Examples using Price Skimming
Let us take some real world examples of a few brands that are using this technique:
1. Samsung
Samsung uses this strategy, especially for its mobile phones. In the same way, Apple differentiates its products through marketing, Samsung has followed a similar formula.
It prices its segments of phones that are considered a luxury at the topmost level and gradually lower it over time when a new model is launched in the market.
2. Sony Playstation
The gaming industry is a lucrative field, and the next-generation console always gathers its audience to pay a higher price point to buy it. As soon as its competitors launch their products, they lower their prices.
3. Netflix
Netflix is a major streaming platform that launched itself by providing high-quality content at high prices. People often complain about the high subscription charges but are not ready to let go of good media content.
Netflix used its product differentiation to acquire premium customers. Once it acquired the top segment, it gradually increased its prices to attract customers who wanted more affordable prices.
4. Starbucks
Starbucks has transformed the coffee industry with its premium products. One can find a store almost everywhere due to its global presence.
Due to its high pricing, it often introduces new and seasonal flavors of coffee and tea at a lower price or discount to encourage new customers to try them. Once the customers are accustomed to it, they introduce premium prices.
Advantages of Price Skimming
A few of the advantages are:
1. The company gets a high return on investment
Price skimming allows companies to recover their costs for research and development, marketing, and distribution within a short period. Products and services with short shelf life benefit from this.
Reaping the benefits in a shorter period is more appealing as ascertaining success in the future is uncertain.
2. Builds brand image
Customers perceive high prices with high quality. This strategy allows the company to build a better brand image for its products. Users are attracted to the differentiation created by marketing, become loyal to it, and purchase its products every time it launches.
3. Segments the market into two types
The pricing and the differentiation method can segment the target market. Where one segment is sensitive to the price and the other is not. This segmentation allows the company to serve and tap the market accordingly and reap the benefits.
With the first segment, who are not price-sensitive and loyal to the brand, the company bags-in huge profit. With price-sensitive customers, the company attempts to lure them into the first segment by offering them utility at lower prices.
4. Early Adopters provide feedback
The first segments of the target market are called early adopters. These people purchase products and provide feedback on them. This feedback provides the market with much-needed information to attract conscious buyers.
Disadvantages of Price Skimming
A few of the disadvantages are:
1. Works only in the presence of less elastic demand
Price skimming is only for those products whose demand changes proportionately less as compared to prices, i.e., who have less elasticity to demand. Therefore, products with elastic demand won't do well in the market with this pricing strategy.
2. Early adopters may lose their loyalty due to decreased prices
Loyal customers of a product may react negatively to the company reducing profit and putting the company's reputation at risk. As a result, the customers can no longer feel the need to be associated with the company and shift to substitutes.
3. Quality doesn't justify the price
The product's quality will not match to justify the high price point, which can lead to negative utility and loss of future sales.
The companies will have to meet the expectations of the consumers while pricing. Price skimming won't work where customers think the product is a 'rip-off.'
4. Threat of competitors
If the company exists in a dynamic and competitive industry, there's a risk of competition replicating your product and selling at a lower price point. As a result, they can poach many potential customers by introducing a cheaper substitute for the product.
Pricing determines the extent of income the company can earn, keeping the cost of production and the profit margin.
Price Skimming FAQs
The skimming and penetration pricing strategies have similar objectives of gaining market share and earning profits but differ in their application. While skimming works on pricing the products at a higher price band, penetration prices the product at the lower end.
Skimming, therefore, earns maximum profits in a short period but restricts the ability of the company to target other customers in the market.
While penetration pricing, as the name suggests, makes it easier for the company to penetrate the market by targeting all the people and making the product very affordable.
This market divide is captured based on the unequal distribution of income and wealth in a society, making a larger population in the market sensitive to pricing.
In cost plus profit pricing, as the name suggests, the company adds a percentage of profit to the unit cost calculated for the product produced.
This helps the company cover its costs and earn an average profit throughout the product's shelf life. This method of pricing is commonly known as markup pricing.
While on the other hand, price skimming follows no such policy of adding a percentage to the unit cost. It tries to earn maximum profit during this short period and ultimately reduces the price after the products shelves to its last stage.
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