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Price Skimming

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Business Studies

Pricing decisions are decisions to be made about the price of a product or service. It is an important element of the marketing mix and is determined by taking into account multiple factors such as production costs, competitor price, customer’s willingness to pay, market conditions, brand image, and product quality. Let's examine how price skimming works in the marketing context.

Importance of price skimming

Pricing decisions allow the company to achieve its financial goals and maintain its position in the market. In addition, they can help to maintain price consistency among products within a company's portfolio as well as fight off competition.

In marketing, the optimal price is one that is close to maximum customer willingness to pay, which balances between price floor (the point below which the company incurs losses) and price ceiling (the point where there is no demand for the product).

To determine the optimal price, companies often employ various strategies and tactics, two of which are price skimming and price penetration. Price skimming strategy will be discussed in this article.

Strategies of price skimming

Price skimming is the strategy of setting a high price at the product’s launch, then lowering it when the demand declines and the market becomes saturated.

This strategy works well in the innovative space where there’s a high demand from the early adopters and the demand is inelastic (the change in the price doesn't strongly affect the demand).

Many iPhones lovers are willing to stand in long lines to purchase the latest iPhone as it launches, even though they know the price will drop a few months later.

The opposite of skimming pricing is penetration pricing, where the price is low at first, then increases over time.

How does price skimming work?

Price skimming is used during the introduction stage of a product, when there's a lot of demand and little competition. It often targets early adopters who are willing to pay high prices for high-quality and unique products. As sales drop, marketers can lower the price to attract more price-sensitive buyers. This allows the company to maximise its profits in the short term while still earning an income when the trend dies out.

The main objective of price skimming is to capture the consumer surplus and exploit its monopolistic position before the competitors enter.

Figure 1 below describes how the process works:

Price skimming diagram, StudySmarterFigure 1. Price skimming. StudySmarter

The company starts at the skimming price P1 which allows it to earn the revenue of A and B. As the price drops, the company can still earn an extra profit - Part C.

Price skimming strategies work best when:

  • There are enough prospective buyers for the product or service.
  • Competitors are yet to enter the market.
  • The demand is inelastic (the demand doesn't change significantly with the change in price).
  • The products are of high quality.

Examples of price skimming

Apple is a great example of a price-skimming brand. The company releases a new product with a premium price, then drops it a few months later to open the door for other buyers. Apple early adopters are aware of the cost but are willing to pay for it anyway due to the cutting-edge technology.

But there's a twist to Apple's price skimming strategy as well. In some cases, the company maintains and defines the price of its product by adding significant value to future iterations.

The price of the MacBook Air hasn't changed much over the years. It was released in 2019 at a base price of US$1,099 (with a discount of $100). In 2021, the price was cut down to $999. Apple justifies this by installing its M1 chip in the latest version that runs faster and has longer battery life.

Price skimming advantages

There are many benefits for a company to adopt price skimming:

High returns on investment

Companies that achieve technological breakthroughs for an in-demand product can set a relatively high price during the introduction stage. Since there’s no competitor around, they’re most likely to earn a lucrative return which not only covers the initial costs of investment but also funds future projects.

Apple launched its first iPhone at US$599. As the sleekest touch screen device ever produced, the iPhone quickly gathered attention and won the company massive income. iPhones also become Apple’s signature product, making up over half of the company’s total revenues.

Prestigious brand image

Many people associate price with quality and status. By pricing the product at a higher end, you can build a prestigious brand image to attract status-conscious consumers. On the other hand, a lower price can give the impression of your product being poorly made or inferior.

A Gucci bag priced at $1,000 better reflects the image of a luxury than if it were sold for $100. The price also ensures that only a small percentage of the population can own the bag, retaining its exclusivity.

Profit maximization

Price skimming differentiates the super fans and early adopters from price-sensitive customers. This allows you to:

  • Gain valuable insights about the market demand. If the early sales are positive, that means your product has a high demand. You should continue making the product to maximise the potential profit.
  • Determine the price point for profit maximization. Setting different prices allow you to the maximum willingness to pay by customers from different segments. With this, you can come up with a pricing strategy to maximize future profits.

Feedback and free promotion from early adopters

Early adopters are your first 'testers' and can offer you valuable feedback to improve the product before reaching a wider customer base. In addition, they may become brand evangelists and provide word-of-mouth marketing campaigns for your business. This means no promotion charge on your side.

Price skimming disadvantages

However, price skimming isn't without its disadvantages. Here are three consequences marketers need to look out for when adopting it.

Not a long-term strategy

Price skimming is most effective when the product is new. Since the market is not saturated and there’s little or no competition around, you can take advantage of the monopolistic position to maximise profit. When more companies enter, it’ll be harder to compete if your price remains high. Moreover, if you keep the price high for too long, a lot of price-sensitive customers will turn to cheaper competitors. This in the long run may lower your overall market share.

Only works if the demand is inelastic

Price skimming only works when the demand for a company's product is inelastic. If the product's demand is elastic, the change in the price will have a more significant impact on the quantity demanded. On the other hand, an inelastic demand reflects a small change in the quantity demanded regardless of the price. Having an inelastic demand means that you can set different prices but still have customers at each price point.

High returns attract competition

Since the firm earns high-profit margins, this may entice other companies to enter the market and sell similar products at lower prices. In the long run, this phases out the competitiveness of the original product. The company must reduce its price to continue earning profits.

Price Skimming - Key takeaways

  • Pricing decisions are decisions to be made regarding the price of a product or service that a company provides.
  • The main objective of pricing decisions is to achieve financial goals while sustaining the company's positioning in the market.
  • Skimming pricing strategy is the technique of setting a high price at the product’s launch, then lowering it when the demand declines and the market becomes saturated.
  • Price skimming is used during the introduction stage of a product when demand is high and there is little or no competition. Later on, the price drops to attract more price-sensitive customers.
  • The idea is to maximise the short-term profits while still earning good revenue when the trend cools down. Price skimming advantages include generating high returns on investment, creating a prestigious brand image, earning profits from different customer segments, and having early adopters test the product.
  • Price skimming may not work well as a long-term strategy and attract a lot of competitors due to high-profit margins. It’s also not effective if the product’s demand curve is elastic.

Price Skimming

Pricing decisions are decisions to be made regarding the price of a product or service that a company provides. The objective is to achieve financial goals while sustaining the company's positioning in the market. It also helps maintain price consistency among products within the company, and fight off competition. Marketers determine the price of a product based on the production costs, competitor price, and customer’s willingness to pay.

Skimming pricing strategy is the technique of setting a high price at the product’s launch, then lowering it when the demand declines and the market becomes saturated. Apple is a great example of a price-skimming brand. The company releases a new product with a premium price, then drops it a few months later to open the door for other buyers. Apple early adopters are aware of the cost but are willing to pay for it anyway due to the cutting-edge technology. 

Pricing decisions are important as they allow the company to achieve its financial goals and sustain its position in the market. It also helps maintain price consistency among products within the company as well as fighting off competition. 

Pricing decisions are made by three parties: the production team, the marketing team, and top executives of the company. The production team considers the production costs and product strategies whereas the marketing team and company's executive examine how likely the product will be successful in the marketplace. 

Final Price Skimming Quiz

Question

What are pricing decisions?

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Answer

Pricing decisions are decisions to be made regarding the price of a product or service that a company provides

Show question

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What factors influence pricing decisions?

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Answer

  • Production costs
  • Competitor price
  • Customer’s willingness to pay
  • Market conditions
  • Brand image
  • Product quality.

Show question

Question

What is price skimming? 


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Answer

Price skimming is the technique of setting a high price at the product’s launch, then lowering it when the demand drops and the market becomes saturated.

Show question

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Brands adopt the price skimming method to...

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capture consumer surplus and exploit its monopolistic position before competitors enter.

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What type of product works well with a price skimming strategy? 


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Products with an inelastic demand curve.

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At which stage of the product life cycle is the price skimming method often adopted?

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The introduction stage

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Price skimming strategies work best when...

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Products are of low quality

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What are some advantages of price skimming?

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  • High returns on investment.
  • Prestigious brand image.
  • Revenues from different customer segments.
  • Testing and free promotion from early adopters.

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Why is price skimming not a long-term strategy?

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Answer

When other companies enter, it’s harder to compete if your price remains high. Keeping the price high for too long also alienates price-sensitive customers. 

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What are the disadvantages of the skimming pricing strategy?

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Not a long-term strategy

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The opposite strategy of price skimming is...

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Price penetration

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Give examples of products with an inelastic demand curve. 

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electricity, medicines, gas

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Price skimming differentiates super fans and early adopters from price-sensitive customers.

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True

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By pricing the product at a higher end, you can build a ... brand image to attract ... consumers.

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Answer

prestigious, status-conscious

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If the early sales are positive, that means your product has a ... demand, and you should continue producing more of that product to ... profit. 

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Answer

high, maximise

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What does word-of-mouth marketing mean?

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Word-of-mouth marketing is free promotion given by customers who are satisfied with your product or service. 

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Pricing skimming is most effective when the product...

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is new

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Why does price skimming attract competition?

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Answer

Price skimming allows companies to sell products at a higher profit margin. This may entice other firms to enter and sell similar products. 

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What is the key idea of price skimming?

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Answer

The key idea of price skimming is to maximise the short-term profits while still earning good revenue when the trend cools down.

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What is not an advantage of price skimming? 

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Answer

High returns attract competition

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Pricing decisions allow the company to achieve its... and maintain its position in the market. 

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Answer

financial goals 

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What is the optimal price?

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Answer

 The optimal price is one that is close to maximum customer willingness to pay which balances between price floor and price ceiling. 

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Price floor is the point below which the company incurs losses. 

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Answer

True

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The optimal price balances between... and...

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price floor, price ceiling

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Give an example of an area where price skimming is often adopted. 

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Answer

An innovative space such as technology. Examples: smartphones, softwares 

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