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What Is Price Skimming?
Price skimming is a pricing strategy in which a company starts by charging the highest price that customers will pay. Over time, the company lowers the price to reach different types of customers. Initially, the high price targets early adopters willing to pay more for a new product. As these early customers are satisfied and competitors enter the market, the company reduces prices to attract more price-sensitive consumers.
“Price skimming” originates from “skimming” layers, like removing successive layers of cream from the top of milk. Unlike penetration pricing, which starts with a low price to attract a large customer base quickly, price skimming leverages initial high prices to maximize early profits before adjusting to more competitive levels.
Key Takeaways
- Price skimming is a product pricing strategy by which a firm charges the highest initial price that customers will pay. Over time, the price is lowered to attract more price-sensitive customer segments.
- The strategy focuses on capturing early adopters willing to pay a premium for being the first to own the product. As demand from early adopters is satisfied and competition increases, prices are adjusted to appeal to more price-sensitive consumers.
- Unlike penetration pricing, which introduces a product at a low price to quickly gain market share, price skimming starts high to maximize initial profits before gradually lowering prices.
- This approach also differs from cost-plus pricing, in which a store takes the cost of the product and adds a profit margin to determine the final price.
Investopedia / Sydney Saporito
How Price Skimming Works
Price skimming is often used when a new product type enters the market. The goal is to gather as much revenue as possible while high consumer demand and competition haven’t entered the market.
This approach works well for products with a high perceived value or innovative features, where early adopters are less sensitive to price. Initially targeting these consumers, companies can recover their investment quickly and generate significant early profits. Once the market becomes more saturated with competitors, lowering the price helps capture a broader audience and maintain market share.
Key factors for effective price skimming include understanding the product’s life cycle, projected demand, and the competitive landscape. High demand allows for higher initial prices, while increased competition necessitates price adjustments.
Skimming can encourage the entry of competitors since other firms will notice the artificially high margins available in the product, they will quickly enter.
This approach contrasts with the penetration pricing model, which focuses on releasing a lower-priced product to grab as much market share as possible. This technique is generally better suited for lower-cost items, such as basic household supplies, where price may be a driving factor in most customers’ production selections.
Firms often use price skimming to recover development costs and in situations where:
- Enough prospective customers are willing to buy the product at a high price.
- The high price doesn’t attract competitors.
- Lowering the price would have only a minor effect on increasing sales volume and reducing unit costs.
- The high price is interpreted as a sign of high quality.
For new products, like innovative home technology, a high initial price can signal quality and exclusivity. This attracts early adopters willing to spend more and can generate valuable word-of-mouth marketing.
Price Skimming Example
One of the most common examples of price skimming is the launch of Apple’s iPhone. When Apple introduces a new iPhone model, it tends to set a high initial price to target early adopters willing to pay a premium for the latest technology. However, as demand from this segment is met and newer iPhone models are released, Apple gradually lowers the price of the older models to attract more price-sensitive customers.
This strategy allows Apple to maximize early revenue from a new product and gradually expand its market reach without alienating different customer segments. By lowering prices over time, Apple can remain competitive and continues to generate sales throughout the product’s life cycle.
Price skimming carries a timing risk; customers may switch to cheaper alternatives if the price reduction occurs too late. This could lead to lost sales and reduced revenue as competitors capture more price-sensitive customers. However, there’s also the risk of dropping prices too early. For example, when Apple reduced the price of its iPhone by a third after only two months on the market, loyal buyers complained, forcing CEO Steve Jobs to apologize and offer a partial rebate.
Price Skimming Limits
Generally, the price skimming model is best used for a short time, allowing the early adopter market to become saturated but not alienating price-conscious buyers over the long term. If the price isn’t reduced promptly, consumers may turn to cheaper competitors, resulting in lost sales and revenue.
Price skimming may also be less effective for any competitor’s follow-up products. For example, once the initial market of early adopters has purchased the latest gaming console, other buyers may not purchase a competing product at a higher price without significant improvements over the original.
What is the Meaning of Price Skimming?
Price skimming is a strategy where a company introduces a new or innovative product at a high price to maximize revenue from customers willing to pay a premium. Once the demand from these early adopters is met, the company gradually reduces the price to attract more price-sensitive buyers. This method helps maximize profits in the early stages of the product’s life cycle and assists in recovering development costs.
Is Price Skimming Illegal?
No, price skimming isn’t illegal. However, if not executed correctly, it can cost a company a buyer’s trust. The key to the strategy is to price the product right at launch and then time the price reduction appropriately. When done correctly, it can maximize revenue without alienating customers.
What Types of Businesses Use Price Skimming?
Price skimming is commonly used by businesses in industries where products have high initial development costs and significant consumer interest. This includes technology companies like Apple and Samsung, which use this strategy for new smartphone and gadget launches, as well as high-end fashion brands and automobile makers.
The Bottom Line
Price skimming sets high initial prices for new, innovative products to target early adopters, then lowers prices over time to attract more budget-conscious buyers. This approach maximizes early profits and helps recover development costs, as seen with Apple’s iPhone. However, timing is critical; for example, delaying price cuts can drive customers to competitors.
Though effective, price skimming works best for highly innovation products or products with a high perceived value. It’s less successful for follow-up competitor products because the early adopter market may already be saturated.
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