Price skimming is a price determination strategy whereby firms initially charge a higher price for a product and subsequently lower it. Experts believe price skimming tends to capitalise on the demand for products that are a luxury rather than a necessity. Businesses will try to lower the price of their products over time to maintain their competitive advantage and reach the major portion of a market.
Consider the more expensive smartphone range offered by Apple Inc. The company initially launched the iPhone 12 at a base price of Rs.79,900 (as of 2020). However, after the launch of the iPhone 13, the base price for an iPhone 12 dropped down to Rs. 65,900, which was at par with some of the newly-launched products of the competitors. Thus, when consumers grew more familiar with the iPhone 12 range, they bought it at a price that was less than the initial price.
Price skimming means creating a niche customer base depending on demand and high value. Thus, Apple could judge their product placement by selling it at an exorbitant price that would set it apart. However, price skimming is applicable when a well-established brand introduces a revolutionary product.
How Does Price Skimming Work?
Price skimming assumes that demand exists for the revolutionary product released at a higher price. When new products are launched into the market, the lack of competition and the brand’s goodwill creates a sense of individuality that brands want their consumers to have.
Thus, a mature market automatically makes room for newly released products and looks forward to discounts. Firms assume their customers have the purchasing power and the willingness to own such products with cutting-edge technologies.
Price skimming could enable firms to make high profits by capturing the consumer surplus. It is important to note that the pricing structure aims to maximise a product’s life cycle without damaging its brand reputation.
Example of Price Skimming Strategy
Here’s a price skimming example to highlight its potential effectiveness. The initial launch price of Sony’s PlayStation 3 was around Rs. 45,000, with its principal rival XBOX 360 selling its product at an initially lower price. However, PlayStation 3’s price gradually dropped to Rs. 25,000 when XBOX rivalled PS3 with their simpler approach to gaming and increased compatibility.
Similarly, Panasonic released the world’s first mirrorless camera, G1, at an initial price of Rs. 70,000. Putting price skimming to the test, they posed serious competition with their breakthrough technology while competing with other camera giants like Nikon, Canon, and Fujifilm.
Price skimming strategy could help firms to widen their market reach and make more profits. The ‘skimmed’ price tests the patience of consumers, and brands get the opportunity to realise the product’s value. Customers tend to pay a premium price for such products because of their inconsistent demand.
The skimming pricing strategy involves proper product positioning, thereby reaching the correct audience. Despite the presence of numerous smartphone brands, Apple maintains its position by setting high initial prices for its products. During the product’s early life cycle, Apple aims to capture the consumer surplus, thereby maximising its profits.
Competition eventually forces firms to adopt this pricing strategy to lower their prices and compete with other firms. Therefore, brands use this strategy to target early buyers and use various product differentiation techniques to get ahead in the competition.
What are the Uses of Price Skimming Strategy?
In terms of pricing strategy, price skimming is the opposite of the penetration pricing model for newly launched products. Instead of introducing products at a lower price, firms using price skimming effectively judge consumer perception and launch their products with a higher than usual markup.
Here are the reasons why this strategy is useful:
Before using this strategy, firms ensure that sufficient potential customers are willing to purchase new products at a higher price. This strategy helps to garner a loyal customer base.
The price strategy is set in a way such that it does not enable competitors to follow it immediately.
The eventual lowering of prices in a price skimming strategy does not affect the sales value effectively. It also has a lower effect on per unit manufacturing cost.
Since a high price represents a high quality, lowering prices in a price skimming strategy takes longer to implement.
What are the Advantages of Price Skimming?
Price skimming strategies assist firms in investing more in research and development. In a competitive market environment, firms spend most on researching their products to create a market, thus justifying the high price. Some advantages of using price skimming strategies are as follows:
Return on Investment: High-tech industries tend to spend enormous amounts on research and development. With the launch of their products at higher prices, they also recover their promotional and marketing expenses invested. The high short-term profits help firms to justify the technological breakthroughs and the corresponding high prices.
Maintaining Brand Image: Since high quality is an important requisite for launching new products, firms target customers who wish to stand out from the crowd. Apple iPhone, for example, has a separate market that caters to customers’ desire to own a premium product. Serving status-conscious consumers helps to maintain brand image.
Market Segmentation and Product Placement: Price skimming strategies help segment the customer base, thereby earning profits from more consumers when firms lower the price. With the introduction of Lumix G1, Panasonic effectively created a separate market base that was later exploited by all other camera manufacturers. As more consumers adopt this new technology, Panasonic could attract more price-sensitive consumers, thereby expanding their base.
Product Testing: Status-conscious consumers provide a base for testing new products and providing valuable feedback. Gradually, the superior brand perception attracts more customers when the prices are lowered.
What are the Disadvantages of Price Skimming?
Despite the advantages, a price skimming strategy can also backfire and cause a fall in the customer base. Following are some disadvantages of price skimming.
Frustration of the Early Buyers: Let’s take the example of an iPhone 12 initially launched at Rs. 79,900. Its current price has significantly decreased from what it was initially. This price drop may frustrate buyers and may force them not to fall prey to its strategy again.
Fall in the Customer Base: Price skimming strategies can backfire when firms keep using them for all their product launches. This may eventually deter potential buyers and cause a fall in the firm’s customer base even when they lower the price at a later stage.
Correct Implementation is a Necessity: To enable price skimming strategies, firms must have symmetric knowledge of customer demand and the price elasticity of their products. Thus, factors like customer sentiment and brand perception are important while placing the product.
Evaluation of Price Skimming
Many firms use a price skimming strategy in combination with competitive strategies to achieve basic business objectives. Price skimming advantages and disadvantages are subject to several factors, including brand perception. For example, a brand with a much lower customer base than Apple cannot utilise such strategies unless its product stands out.
Almost every revolutionary technology product like smart TV, electric vehicles and smartphones is released with a price skimming pricing model. However, firms can limit their growth and revenue generation if their products are not effective enough to make a change. Products that face tough competition are therefore not launched with such strategies.
Is Price Skimming Right for Your Business?
The three basic components of price skimming are recurring profitability, brand status and market anticipation. Skimming price models can thus allow firms to enjoy higher profit margins and sponsor their research.
However, the price skimming strategy could be unviable in a crowded market. Companies that launch products too quickly with exorbitant prices can lose their customer base to other competitors in the market. Although price skimming is legal, consumers can term it unethical, which has the potential to stain a brand’s reputation.
On the other hand, it’s an effective pricing strategy that companies can use if they are confident about their customer base and innovative products.
Technology and innovation are two crucial indicators for adopting price skimming. Although this strategy can eventually decrease a firm’s volume growth, it is effectively a potentially stable approach to recovering sunk costs and market segmentation. This strategy is especially useful for brands that wish to leverage their brand value while launching new products.
Q1. How can price skimming help manufacturers?
Ans. Unlike penetration pricing, price skimming involves launching products at an initial high price and gradually lowering it. It helps manufacturers generate high short-term profits and attract a loyal customer base. This could lead to new product launches in the future, which is advantageous for manufacturers.
Q2. What are the limitations of price skimming?
Ans. The price skimming strategy works till early adoption saturates. Thus, this strategy is best suited for the short term, whereby firms can recover their research expenses and marketing costs. Additionally, brands that use this strategy are required to launch innovative products to maintain their competitive advantage.
Q3. What does a successful price skimming strategy involve?
Ans. Firms indulging in price skimming must have a loyal customer base without immediate competition. A successful price skimming involves high pricing to signal higher quality, thus resulting in higher sales volume. In addition, assessing the products of the competitors also ensures the successful implementation of this strategy.
Q4. What are the brands that use the price skimming technique?
Ans. Technology giants like Samsung, Apple, and Sony use this technique to launch highly innovative products for their loyal customer base. By adopting this strategy, they also tend to reach a larger market after the initial launch period fizzles down.
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This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information, and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
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