Definition
Price skimming is a pricing strategy used by businesses, primarily during the launch of a new product. It involves setting a high price initially and gradually lowering it over time as the product moves through its lifecycle. This strategy aims to maximize revenue from early adopters who are willing to pay more before targeting more price-sensitive consumers.
Key Takeaways
- Price Skimming is a pricing strategy in which a marketer sets a relatively high initial price for a product or service at first, then lowers the price over time. It is effective in maximizing profit in market introduction phase.
- Price skimming is often used when a new type of product or service is being launched. The aim is to “skim” off customers who are willing to pay more to have the product or service earlier. Early adopters, such as technology enthusiasts, are less sensitive to price and eager to pay a premium for the latest product or service.
- After the highest-priced segment is saturated, prices are gradually lowered to capture lower-price market segments. This enables the company to maximize its profits layer by layer. However, this strategy also depends on the nature of the product, market demand, and the competitive landscape.
Importance
Price skimming is a crucial financial strategy often used by companies during the launch of a new product.
It involves setting high prices for new products initially to ‘skim’ off the maximum revenue layer by layer from the market.
The motive is to recover the research and development costs quickly, create a perception of exclusivity and high quality about the product, and cater to less price-sensitive segments in the initial phase.
As market competition increases over time, the price is gradually lowered to attract price-sensitive customers.
Therefore, price skimming is important because it not only allows companies to maximize profits in the product introduction phase, but also helps manage customer demand effectively over the product’s lifecycle.
Explanation
The primary purpose of price skimming is to maximize profits, particularly during the initial phase of product launch. Companies that have recently introduced a unique or innovative product or service frequently utilize this pricing strategy in order to exploit the high demand and comparatively lower supply.
Since the product or service in question is relatively novel and competition at this stage is minimal or non-existent, customers are often willing to pay a premium to be among the first to own it. Essentially, this strategy allows the company to “skim” the top layer of the consumer market where demand is less price-sensitive.
Moreover, price skimming is used to recover the high costs associated with research and development (R&D), marketing, and product launch more swiftly. This is especially prevalent in sectors such as technology or pharmaceuticals where investments in R&D can be substantial.
Also, by starting with a high price, companies get the opportunity to slowly decrease the price over time in response to decreasing demand or increasing competition, thereby managing to capture different segments of the market with varying price sensitivity levels.
Examples of Price Skimming
Apple Inc: Apple is known for its price skimming strategy, most noticeably with their iPhone product range. When a new iPhone model is first launched, the prices are quite high compared to other smartphones in the market. These high prices appeal to tech enthusiasts and Apple loyalists willing to pay a premium for the latest product. As time goes by, Apple lowers the price of the older models upon the release of new ones, allowing another segment of consumers who are more price conscious to purchase the product.
Sony’s PlayStation Console: Sony also uses a price skimming strategy, especially with its PlayStation consoles. When a new version of the console is released, it is often priced quite high, targeting avid gamers who are willing to pay more. Over the life cycle of the console, Sony reduces the price, allowing the product to become more accessible to a wider audience.
Pharmaceutical Industry: In the pharmaceutical industry, a new drug that has exclusive patent protection is often priced very high initially. These drugs are especially expensive since they have monopoly protection and offer distinct advantages over existing treatments. Some patients and providers will pay these high prices to avail of the benefits. However, once the drug’s patent expires and generic versions enter the market, the price of the original drug usually drops significantly.
FAQs about Price Skimming
1. What is price skimming?
Price skimming is a pricing strategy wherein a product or service is initially sold at a high price, and then gradually lowered over time. This is usually done to recover the costs associated with development, typically in the early stages of a product lifecycle.
2. In what situations is price skimming used?
Price skimming is often used when a new, innovative, or unique product or service enters the market. The high initial price can create the perception of quality and exclusivity.
3. What are the benefits of price skimming?
Price skimming can allow companies to maximize their profits on early adopters before dropping prices to attract more price-sensitive consumers. It also helps businesses recover their development costs quickly.
4. What are the pitfalls of price skimming?
If not implemented carefully, price skimming can lead to negative consumer perception. It can also quickly lose effectiveness if competitors introduce similar products at lower prices.
5. Can price skimming be used in any industry?
While price skimming can be seen in various sectors, it is most successful in technology, luxury goods, and pharmaceutical industries. However, the success formula highly depends on the market situation and the product itself.
Related Entrepreneurship Terms
- Market Segmentation
- Pricing Strategy
- Product Life Cycle
- Demand Elasticity
- Competitive Market Analysis
Sources for More Information
- Investopedia – A comprehensive source for learning about financial concepts, strategies or terms like Price Skimming.
- The Balance – A personal finance website that can provide insight into various finance terms including Price Skimming.
- Harvard Business Review (HBR) – This provides a deep dive into many business concepts, including pricing strategies such as Price Skimming.
- Boundless – An educational resource that covers many topics, including business and finance terms like Price Skimming.
