Product pricing is an essential part of any online business strategy. How you price your product will determine your sales, profit margins, and sometimes even the customer’s perception of quality.
Pricing strategies determine many of the key objectives of your online company, including marketing position, brand positioning, and revenue objectives. Price skimming is one of several pricing strategies that businesses can choose from.
Properly timed and managed, a price skimming strategy can earn an online business owner above-average income margins. It is, however, not without risks and is not suitable for many business models.
So, What is a Price Skimming Strategy?
Price skimming is a strategy most often used by technological companies for new product launches. The launch typically comes with some hype as it usually involves products with breakthrough features. Under these conditions, the seller has a competitive advantage that it can use to charge early buyers a much higher price.
Apple is a prime example of a business that successfully uses price skimming. Apple launches new products such as iPad or iPhone at a premium price. Early buyers are happy to pay the price despite knowing that the price will come down in a few months.
Price skimming is the practice of charging high prices when the product is launched and reducing the cost over time as demand decreases. The aim of the price skimming model is to make as much revenue as quickly as possible.
Price skimming enables a higher return on investments, enhances the brand, and improves product appeal. It also allows the brand to target specific market segments.
The price skimming model allows the founding company to recoup some of the research and development costs before competitors enter the market with similar products. Additional competition will always drive market prices downwards, so timing is key.
As the demand for the newly launched product grows, the company can ramp up production. When economies of scale come into play, the manufacturing costs drop. Reduced input costs make it easier to lower the price.
How Price Skimming Works
The practice of price skimming is possible because people who want new and innovative products drive market demand. Known as early adopters, these people are not priced sensitive. They are willing to pay higher prices when new products hit the market.
As time passes, prices will drop to include more price-sensitive customers. Incremental price reductions ensure that market demand for the product doesn’t falter. The term price skimming refers to the way the changing prices skims off various market segments. It starts with the early adopters and eventually reaches the most price-sensitive market.
As the product matures and the firm reduces the prices, higher demand allows for economies of scale, thus reducing the product's manufacturing costs.
High-profit margins attract competition. By reducing the product's price, the launching company makes it more difficult for competitors to enter the market.
Price skimming is a short-term strategy, and it is all about timing. The business must make timely adjustments to the price as competitors enter the arena. So, the strategy can only work if the business can afford lower prices.
Can Your Online Business Use a Price Skimming Model?
The opportunity to charge high prices when launching a new product may be tempting, but it is risky. It is only possible under the following circumstances.
- You’re introducing new and exciting technology onto the market
- You sell a luxury product
- You have little or no competition
- Your brand is a market leader with many potential customers willing to buy the product.
Price skimming is an appropriate strategy when the product has an inelastic demand curve. This means the demand doesn’t change drastically in line with increases or reductions in the product's price.
When Price Skimming is Unlikely to Work
There are circumstances under which a price skimming model won’t work.
- The competition is high, resulting in customer price sensitivity
- Your product has no appeal for high-end customers
- Your brand hasn’t quite made it.
Price skimming is most commonly used in the following industries
- Technology companies – Apple and Samsung are examples of companies that use this pricing strategy for the launch of new product
- Software as a service (SaaS) – depending on the market entry strategy. Some SaaS companies prefer to enter using penetration pricing, the polar opposite of price skimming
- Retail and e-commerce – high fashion is an obvious example. At the beginning of each new season, clothing lines sell at a high price. As the year progresses, the fashion moves onto the sales racks, often with incremental price decreases.
The Advantages of Price Skimming
- Your online business can quickly recover some of the costs incurred in developing and promoting the product
- For a while, your business can make above-average profit margins. By understanding how price sensitive your customers are, you can sell your product at the highest profit margins. As sales drop off, you decide when to drop the price and by how much. Because you control the price, you can react to customer behavior and market conditions
- In the minds of the consumer, a higher price is often associated with a better-quality prestige product. This, in turn, helps to promote the brand image.
The Disadvantages of Price Skimming
- A price skimming strategy will only work when the demand curve is inelastic. In other words, the price sensitivity of buyers is such that they do not respond easily to price changes
- Initial sales may be lower than anticipated, particularly if the public suspect that a price skimming strategy is in place and that prices will drop
- It is not a viable strategy where are many competitors
- Price skimming will attract competition and force prices down
- If the price drops rapidly, early adopters may see this as a form of price discrimination and lose trust in the brand.
What is the Main Benefit of Price Skimming?
The most significant benefit of a price skimming strategy is the opportunity to make above-average profit margins on the product sold. Price skimming is all about timing. You must reduce the price of the product at the right time. Drop it too soon, and you lose margin unnecessarily; too late, and you’ll lose sales.
What are the Downsides to a Price Skimming Strategy?
Price skimming is not without downside risks. It is not a viable pricing strategy in highly competitive markets where buyers are price sensitive. You may annoy your loyal customers who paid more for your product when it was first launched.
Though many first adopters expect to pay a bit more, they may consider the subsequent reduction in prices a form of price discrimination. If buyers expect the prices to drop, market demand may not meet your expectations, and the initial sales may disappoint.
What Are Some Examples of Skimming Pricing?
Price skimming strategies are most often seen in high-tech environments like electronics. Very often, new top-of-the-range cell phones will cost more when they are launched. This is also true for gaming consoles.
Any new and sought-after product with no competition and backed by a trusted brand can pull off a price skimming strategy. This is because the buyers of these products are not price-sensitive and will buy the product at inflated prices.
Can You Adopt a Price Skimming Strategy for Your Online Business?
If you’re about to launch an innovative product and customers are prepared to pay a premium, a price skimming model may work for you. Price skimming is, however, all about timing. You must know when to reduce the price and by how much. You must include your price reduction plans in your business strategy because the high prices are not sustainable.
As long as there is little competition in the market, you could use price skimming to make a quick return on investment.