Price Skimming: What is it? Advantages and Disadvantages
Price skimming is one of many pricing strategies that companies use to increase their profits by setting a high price and
gradually lowering it.
This strategy starts with setting the highest price that some customers find acceptable, and then the price slowly begins to decrease in order to increase sales.
This pricing strategy is also known as cream skimming. This means that the company gets more consumer surplus as it lowers the price on the demand curve.
How does price skimming work?
Price skimming allows a company to sell its product or service at a very high price and slowly lower the price until a desired long-term price is reached.
The cream skimming strategy is used when the product is unique or highly desirable, so it is usually used in new markets or when the product is of great value.
Price skimming examples.
Using price skimming can be observed when new models of Apple phones appear. When the iPhone enters the market, its functionality is so attractive to users that they are willing to overpay for the product. By offering the product at a higher price first, Apple can profit more from this interested segment of society before adjusting the price to true market equilibrium for more sales.
Well-known clothing brands regularly set high prices for new collections and then lower them. In this way, they first target their fans, who want to be the first to purchase clothes, and the price is not an obstacle. Another category of society expects a price reduction and does not understand the point of overpaying if, for example, in a week, clothes can be purchased at a lower price.
In this case, there are two separate categories of buyers for the product, and by moving from high to low price, the company can get the most out of each.
Having figured out how price skimming works and having dealt with examples, we can move on to the advantages and disadvantages of this strategy in the market.
Advantages of price skimming.
1. High return on investment.
Setting the highest initial price when an innovative product is released helps your company recoup the costs of research and development, as well as advertising. Companies like Apple benefit from large short-term profits when introducing a product, and high prices are justified by the technological breakthroughs achieved.
2. Reaching different consumer segments.
When you launch a product using a price-skimming strategy, there are groups of consumers interested in the product for whom the price is too high. When you lower your prices, it attracts the interest of customers in that category. This can allow you to create a steady stream of sales, with each price reduction helping to interest new categories of consumers.
3. Building your brand image.
Higher prices early in the product lifecycle allow you to create a brand image that really appeals to the category of consumers for whom status is important. Earning a reputation for producing premium products will allow you to set high prices for current and future products or services.
Disadvantages of price skimming.
1. Reduced sales.
Using a price skimming strategy can lead to a decrease in the total number of units sold. High prices can slow down the speed of decision-making by your potential customers, giving your competitors a better chance. While choosing a pricing strategy, it is important to be aware of the possibility of such a phenomenon in order to safeguard your business from loss.
2. Negative customer reaction to price changes.
If prices drop too much or too quickly after the initial product launch, some customers will feel they have overpaid significantly. Apple faced such backlash in 2007 when the company cut the price of the iPhone by $200 just two months after it was introduced. The rapid drop in prices helped boost demand, but some customers were, of course, upset. This reaction can lead to a further decrease in sales of new products, negative evaluation of your company and loss of customer loyalty.
3. Limited implementation of the strategy.
This is not the best strategy in a crowded market. If you already have many competitors, your demand curve is likely to be quite elastic, and high prices at product launches will cause customers to choose another company. Such a strategy is not viable in an already engaged market. If your product does not contain special features that no one else can compete with, it is best to choose a different strategy.
As you can see, using price skimming involves certain advantages and disadvantages. Does this type of strategy make sense for your business? The answer depends on the level of innovation your company has, your target audience, and the competition in the marketplace.