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What Is Price Skimming
Price skimming is a pricing strategy where a company first charges the highest possible price for a product or service and gradually reduces its price over time.
Typically, price skimming is effective in markets with few competitors, or a new innovative product is released.
At first, customers are willing to pay a higher price to get the goods.
However, as market demand is satisfied and competitors enter the market, the company will gradually start reducing its price to continue attracting new clients who are more price sensitive.
The reason why it’s called price skimming is in reference to the “skimming of milk” where successive layers of cream can be accessed.
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Why Use Price Skimming Strategy
Price skimming is an effective pricing strategy when there’s a strong market demand for a product or service and there are few organizations that can effectively meet the demand.
Typically, when a new innovative product is released in the market, companies will use a price skimming strategy to demand the highest possible price for their product taking advantage of high demand and low competition.
This type of pricing strategy works best in environments where there is a high demand for a product and service, there’s little competition, and customers are willing to pay a high price.
For example, a company producing a new innovative smartphone may initially release the product a very high prices knowing there’s a strong demand.
However, as the market demand is satisfied and competitors enter the market for the same product, the company will lower its prices to attract customers that are more price sensitive.
When Is Price Skimming Effective
Price skimming is a type of pricing strategy that must be used with care.
Not every company can choose to charge very high prices and hope that customers will continue buying from it without finding an alternative solution.
However, there are certain conditions that make price skimming more effective.
First, your market should not yet be crowded with competitors.
If you are releasing an innovative product or entering a market with few competitors, then you’ll know that customers will not have any other choice but to buy from you even at high prices.
Second, you should have something unique about your product.
Most of the time, innovative products like smartphones, high-tech products, and other innovative products can command a high price as they are highly desirable.
Third, the market has the capacity to pay for the high prices charged and is willing to pay for your products and services at a significant premium.
Finally, the demand curve for the product should be inelastic which means that the demand for your product will stay substantially the same even if you were to reduce your price.
Price Skimming Advantages
The main advantage of price skimming is that a company can charge a much higher initial price for its product.
By charging a higher initial price, the company is able to pay for its development and production costs quickly.
As such, the company’s profit margin will be maximized without compromising sales volume.
Another advantage that comes with price skimming is that since the company sets a high initial price, it provides the company with positive brand equity as the market will perceive the goods as premium and of high quality.
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Price Skimming Disadvantages
Although price skimming has clear advantages, you should also be mindful of its disadvantages.
The first disadvantage is that a company sets an initial price so high that it ends up alienating its customers.
In other words, even though there’s a demand in the market, they will perceive the product as too expensive and opt for a more affordable solution offered by the competitors.
Another disadvantage of price skimming is that you can only command higher prices for a short period of time.
If you maintain your price too high and miscalculate what the market can absorb, you end up hurting your overall sales and profitability.
In addition, when you charge a high price for the initial release of the product, your clients will have a much higher expectation of quality.
You can hurt your brand if you cannot deliver the quality customers expect at the price you command.
Charging high prices can also mean that it may be more difficult to charge for subsequent product improvements unless there’s a significant enhancement or improvement over the prior version.
Otherwise, customers will keep their original product for longer without upgrading to the next version or product.
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Price Skimming vs Penetration Pricing
What is the difference between price skimming and penetration pricing?
In essence, price skimming is when an organization charges a high initial price when selling its products and services and then starts lowering its price over time.
The company’s objective is to charge the highest possible price per unit and generate the highest profit margin.
On the other hand, penetration pricing is a pricing strategy where a company will charge a price that is lower than that of its competitors at first and eventually raises the price to market levels.
Penetration pricing’s main objective is to increase market share and not profits.
On the flip side, price skimming maximizes profit without necessarily focusing on market share.
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Price Skimming FAQ
What does price skimming mean in business?
“Price skimming” is a type of strategy where you are looking to sell your products and services at the highest possible price at first and gradually lower prices over time.
You’re essentially “skimming” each layer of the market by capturing the clients willing to pay the highest for your goods and services.
Then you lower the prices a bit to capture another layer of customers who are a little more price sensitive but still willing to pay a high price.
The prices are reduced until the market reaches an equilibrium.
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Why do companies use price skimming strategies?
Companies adopting price skimming strategies primarily focus on maximizing profits by taking advantage of high consumer demand and low competition.
First movers and companies launching innovative products typically adopt this strategy as they tend to have a highly desired product and few competitors in the market.
What are the pros and cons of price skimming?
Price skimming is beneficial as it allows the market to perceive a company’s products of high quality, the company can more quickly pay off its development costs, generate higher returns, and benefit the entire vertical supply chain.
On the other hand, price skimming can deter customers from buying due to the high prices, reduce the company’s total sales volume, will not be an efficient strategy long-term, and can compromise customer loyalty.
Takeaways
So there you have it folks!
What is price skimming?
In a nutshell, price skimming is a type of pricing strategy where a company will charge a high initial price and then slowly lower its prices over time.
This type of strategy is typically pursued by first movers when they release a new product to the market without facing significant competition.
The main benefit is that you can generate high profit margins at first to pay for your product development and production cost more rapidly.
Then, as competitors enter the market, you can slowly reduce your price as you have already amortized your production costs to a certain extent.
Now that you know what price skimming means and how it works, good luck with your research!
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