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.
This blog gives you an overview about price skimming and its working. Let’s dive in!
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.
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 rivaled PS3 with their simpler approach to gaming and increased compatibility.
Price skimming strategy is something that helps 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.
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:
When the context surrounding product launches is favorable to your company, price skimming is most effective. While some of the most notable examples of successful price skimming involve hardware rather than SaaS, the technology adoption life cycle makes it a more than viable pricing strategy for SaaS companies. This is especially true for SaaS companies with high-end primary market targets and a penchant for cutting enterprise-grade deals.Having cutting-edge technology is a powerful social currency. If your product generates positive word of mouth, these early adopters can not only generate a large amount of revenue for you but also become a significant source of recurring revenue.
Price skimming can be an expensive waste if your product has immediate competition or if your product isn’t appealing to the upper echelons of the market. Similarly, if your product is not sufficiently distinct to elicit a positive word-of-mouth reaction, you may not reap the full benefits of a skimming strategy. Finally, if we are dealing with an inelastic demand curve, price changes will not produce any results. Price cutting without high quality and brand image can stymie rather than help your progress. Include skimming in your pricing strategy only if you have enough repeat customers to generate reliable word of mouth and assurance that you cannot be easily undercut.
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:
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
|Price Skimming||Prestige Pricing|
|a pricing strategy in which the producer sets a high introductory price to attract buyers who have a strong desire for the product and the resources to purchase it, and then gradually lowers the price to attract buyers in the next and subsequent layers of the market.||Prestige pricing is a marketing strategy in which companies charge a higher price for a product in order to persuade customers that the product is of higher quality.|
|The objective is to skim the market||The objective is to maximise profit in areas where customers are willing to pay more, where there are no substitutes for the product, and where there are no substitutes for the product.|
|Its price inelastic||Its price elastic|
|Low profit margins||High profit margins|
|High level of competition||Raises barrier for new entries in the market|
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.
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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.
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.
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.
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.
Rice skimming is also a form of price discrimination, which is the practice of selling the same product at different prices to different groups of customers. This strategy is illegal in some cases, but the actual conditions that define illegal price discrimination are shady to say the least.
Skim pricing is the inverse of penetration pricing, which involves pricing newly launched products low in order to build a large customer base from the start.
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