Price Skimming

Samsung is one of the most proficient companies in price skimming. You may have noticed that Samsung drops the prices of its phones almost 2 to 3 months after their launch. This strategy allows Samsung to quickly catch the initial buzz around the product and recover its investments. This eventual price decrease is known as price skimming. In this comprehensive article, we'll dive into the definition of price skimming, its advantages and disadvantages, and examples of companies successfully implementing it. 

Price Skimming Price Skimming

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Table of contents

    Price Skimming Definition

    Price skimming, also known as skim pricing, is a pricing strategy where a company charges a high price for a new product or service, to maximise revenue from customers who are willing to pay a premium for the novelty. The company then gradually lowers the price over time to attract more price-sensitive customers and increase overall sales.

    Price skimming is a pricing strategy used by companies to charge a high initial price for a new product and then gradually lower the price to attract more price-sensitive customers and increase overall sales volume.

    Price skimming aims to 'skim' customers willing to pay a premium price for a product. 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). Once the initial excitement disappears, the company reduces the product's price and targets price-conscious buyers. Companies may also reduce prices when competitors launch similar products at a lower price.

    One important point to note here is that price skimming is a pricing strategy used for products in the initial stage of the product life cycle.

    Let's say a tech company is releasing a new smartphone. They know that early adopters are willing to pay top dollar for the latest features and technology, so they set the price at $1,200 when the phone is first released. As time goes on, they gradually lower the price to attract more budget-conscious customers who may not have been willing to pay the initial high price. After a few months, the price drops to $1,000, and then a year later it drops to $800. By using price skimming, the company is able to maximize revenue and capture market share from both types of customers.

    Premium Pricing vs. Price Skimming

    Now that you understand the basic idea of price skimming, you might have thought, "Isn't price skimming just premium pricing?". Although the two sound quite similar, price skimming is a different approach to premium pricing.

    Premium pricing involves keeping the price of one (or more) of your goods or services higher than competitors.

    Using premium pricing, the company tactically sets the high price to attract buyers to its products. Due to the higher pricing, the company hopes customers view its product as higher quality than a competitor's substitute product. Premium pricing is founded on the idea of manipulating customer perceptions based on pricing. On the other hand, price skimming is a strategy whereby the price of the product is only high when it is introduced to the market. After the product reaches its saturation phase or if new product developments are introduced, the company will decrease the product's price.

    Market Skimming Pricing

    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 - customers willing to pay high prices for high-quality, unique products. As sales drop, marketers can lower prices to attract more price-sensitive buyers. This allows the company to maximize 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 market position before competitors enter.

    Figure 2 below describes how the process works.

    Price Skimming Market skimming pricing graph StudySmarterFig. 1. Price Skimming

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

    Market Skimming Policy

    The market skimming policy works best when the following statements apply.2

    1. There are enough prospective buyers for the product or service - Price skimming targets highly motivated buyers who are price insensitive. These buyers want to buy the product for better technology or prestige. A business cannot use price skimming if no such customer group exists.
    2. Competitors are yet to enter the market - Many competitors will be tempted to enter the market if high demand is observed, even at high skimming prices. However, technological advancements and production costs often act as barriers to entry into the market.
    3. Demand is inelastic The demand doesn't change significantly when the price changes.
    4. The products are of high quality/ premium brand image - A high initial price often communicates the high quality of the product. If a brand is considered premium and is launching a new product, the increased costs are often associated with a premium brand image.
    5. Low unit costs - Brands that use price skimming do not (usually) mass-produce goods. These brands often have a limit on production capacity. Even though production capacity is low, brands must ensure that producing a small volume does not cost them much. If production costs increase, profit from skimming decreases.

    Price skimming may not work with brands that produce affordable, essential daily goods.

    Nike, a well-known sports shoe and clothing brand, uses price skimming while launching limited edition shoes. But Primark, the affordable clothing brand, will use price penetration when introducing new clothing designs.

    The Swiss watchmaker Rolex can use price skimming as the unit cost of producing a small volume is almost the same as manufacturing higher volumes. On the other hand, bread companies like Kingsmill and Warburtons take advantage of economies of scale and cannot produce smaller quantities for low prices.

    Price Skimming Strategy

    Companies use price skimming strategy for innovative products. While implementing price skimming, marketers must understand how customers view their products. Assessing the market will help companies understand customer segments and decide on pricing.

    For example, innovators and early adopters will buy new technological products first. These two customer groups are price insensitive.

    Once the demand from these groups is satisfied, prices are decreased to serve the remaining price-sensitive customers. The theory that governs this difference is called diffusion of innovation theory. Table 1 outlines the characteristics of different consumers based on the diffusion of innovation theory.

    Customer group title

    Characteristics

    Overall percentage

    Innovators

    Technology enthusiasts

    2.5%

    Early Adopters

    Visionaries

    13.5%

    Early Majority

    Pragmatics

    34%

    Late majority

    Conservatives

    34%

    Laggards

    Skeptics

    16%

    Table 1. Group of customers as per diffusion of innovation theory. Source: Canadian Journal of Nursing Informatics3

    Another important consideration is the lifetime of the product. In sectors like telecommunications and automobiles, there are regular new technological advancements. Hence, such sectors see rapid changes in product developments. New improvements make old products or old versions of the same products obsolete. Therefore, companies only have the option to recover costs and earn profit at the beginning of the product life cycle. For these products, price skimming may be the only option.

    All products have a life cycle. A business may decide to continue producing the same product or to update the product. In any case, the company must know how that particular product will exit the market. Will the product be replaced by an updated version or vanish from the market? The business should consider an exit strategy as the product's life cycle determines profits.

    Price Skimming Advantages and Disadvantages

    Established brands with loyal customers implement price skimming. Here are some of the advantages and disadvantages of this pricing strategy.

    Price Skimming AdvantagesPrice Skimming Disadvantages
    • Helps maximize profits
    • Brings benefits of dynamic pricing
    • Allows Real-time monitoring
    • Helps in market segmenting
    • Provide quick returns
    • Creates excitement about the product
    • Might have negative effects on brand
    • Creates opportunity for competitors to penetrate the market
    • Does not work well with products with elastic demand
    • Can be used only for the short term

    Read on to learn details of the advantages and disadvantages of the price skimming strategy.

    Advantages of Price Skimming

    Advantages of price skimming include:

    • Maximize profits: As price skimming introduces products at a high price, the company has a high profit margin in the initial period. Once prices are reduced, the company still earns profits. Therefore, profits are maximized during the entire sales period.
    • Dynamic pricing: Brands can adjust prices according to market conditions and the initial response from customers. Hence, price skimming provides the benefits of a dynamic pricing strategy.
    • Real-time monitoring: Price skimming targets innovators and early adopters at launch. These groups provide active feedback about the product and its positioning. Businesses can then use the input to enhance future products.
    • Right target customer: Price skimming helps brands segment markets into distinct customer groups. It helps maintain inventory and test how different groups react to pricing.
    • Quick returns: 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 that covers the initial costs of investment. Price skimming reduces the time required for the recovery of sunk costs. It provides quick returns from the market.
    • Creates excitement about the product: High prices attract customer attention. The attention can turn into word-of-mouth and create buzz around the product. The built-up excitement may help the product sells faster.

    Disadvantages of Price Skimming

    Price skimming has many downsides if a company fails to use the strategy correctly:

    • Negative effects on brand: A brand that uses extreme price skimming may face customer disappointment. Customers who buy products at a high price may feel cheated after prices are lowered. Consumers may see these brands as manipulative and opportunistic.
    • Opportunity for competitors to penetrate the market: 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.
    • Product should have inelastic demand: 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 slight change in the quantity demanded regardless of the price. Inelastic demand means the business can set different prices but still have customers at each price point.
    • Only for the short term: Price skimming is most effective when the product is new. Since the market is not saturated and there's little or no competition, the business can take advantage of its market position to maximize profit. Competing will be more challenging when more companies enter if the price remains high. Moreover, if the business keeps its prices high for too long, price-sensitive customers may turn to cheaper competitors. This, in the long run, may lower the overall market share.

    Price Skimming Examples

    Price Skimming Person driving a Tesla car StudySmarterFig. 2. Tesla Car Example

    Tesla Price Skimming Example

    Tesla is considered a leader in new pure electric vehicles. Tesla employs a similar pricing strategy in most countries, including China. Here are the pricing strategy steps that Tesla uses:

    Step 1. Launch luxury sports cars and target high-income groups.

    Step 2. Develop luxury electric family cars following a standard pricing strategy similar to competitors.

    Step 3. Create the most cost-effective models to meet the needs of most people.

    This strategy starts with price skimming and then adopts price penetration. Here is how Tesla reduced the prices of its Model 3 cars.

    Date

    Cost (Yuan)

    August 2019

    363,900

    November 2019

    355,800

    April 2020

    291,800

    October 2020

    269,700

    July 2021

    235,900 (subsidised)

    Table 2. Cost of Tesla Model 3 in China. Source: ICSSED 20224

    Hence, we can conclude that Tesla implemented a price skimming strategy and reduced prices by approximately 36%. The leading cause of the price decrease is a reduction in manufacturing costs. But a step-by-step drop in prices shows a price skimming strategy.

    Apple Price Skimming Example

    Apple is known for using price skimming as a launch strategy for its iPhone line of products. Upon each new model's release, the price is set high, and as the product's lifecycle progresses, the price decreases.

    iPhone prices are excellent examples of Apple's price skimming strategy. When iPhone 11 was launched in 2019, it was priced at $749, which gradually reduced to $649 after a year. This strategy allowed Apple to target early adopters and enthusiasts willing to pay a premium for the latest technology, while also catering to customers looking for a more affordable option over time.

    YeariPhone 11 128GB Price
    2019$749
    2020$649
    2022$590

    Price Skimming - Key takeaways

    • Price skimming is a pricing strategy used by companies to charge a high initial price for a new product and then gradually lower the price to attract more price-sensitive customers and increase overall sales volume.
    • The following factors are necessary for price skimming to be successful:
      • Availability of buyers who are willing to pay high prices
      • Premium brand image
      • Low unit costs for producing small volumes
      • Entry barriers
    • A competitor using penetration pricing can damage the effectiveness of price skimming.


    References

    1. Katerina Polenovich-Price Skimming on a Successful Marketing Strategy-Academia
    2. Dolgui, Alexandre, and Jean-Marie Proth. Pricing strategies and models. Annual Reviews in Control. 2010.
    3. Kaminski, June. Diffusion of innovation theory. Canadian Journal of Nursing Informatics. 2011.
    4. Zhou, Yi. Research on Influencing Factors of Tesla Pricing Strategy. In 2022 7th International Conference on Social Sciences and Economic Development (ICSSED 2022), pp. 107-114. Atlantis Press, 2022.
    Frequently Asked Questions about Price Skimming

    What is price skimming in marketing?

    When a company introduces a product at a high price and then gradually drops the price over time, it is pursuing a price-skimming strategy. Price skimming, also known as skim pricing, is a pricing strategy where a company charges a high price for a new product or service, to maximise revenue from customers who are willing to pay a premium for the novelty. The company then gradually lowers the price over time to attract more price-sensitive customers and increase overall sales.

    What is a price skimming strategy?

    A price skimming strategy aims to 'skim' customers willing to pay a premium price for a product. 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). Once the initial excitement disappears, the company reduces the product's price and targets price-conscious buyers. Companies may also reduce prices when competitors launch similar products at a lower price.

    What is an example of price skimming?

    An example of a price skimming strategy can be observed through Apple's iPhones. 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's early adopters are aware of the cost but are willing to pay for it anyway due to the cutting-edge technology. 

    How does price skimming work?

    Price skimming involves charging a relatively high price for a short time when a new, innovative, or much-improved product is launched onto a market. The company then lowers the product's price when demand declines and the market becomes saturated.

    What are the advantages and disadvantages of price skimming?

    Some of the advantages of price skimming include profit maximization, quick returns, real-time monitoring, and creating word-of-mouth. The disadvantages of price skimming include its short-term nature, the opportunity for competitors to enter the market, and possible negative effects on the brand.

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