Price SkimmingDefined with Examples & More

Written By:
Lisa Borga

Reviewed By:
FundsNet Staff

Price skimming also referred to as skim pricing, is a price setting strategy used when first setting a price for a good or service.

Using this strategy, a business will set the initial price to the highest point customers will pay and then lower the price over time, often as competitors enter the market.

This strategy allows a company to earn higher profits from early adopters and its monopolistic position before lowering prices in order to attract more price-sensitive customers and compete with other market participants.

The term price skimming comes from the act of “skimming” layers of cream, which in this case refers to skimming customer segments as a company lowers its prices.

Price Skimming Explained

Price skimming is a price-setting strategy that is generally used when a company brings a product to a new or expanding market.

In this strategy, the price of the product is set at the highest price point, which early adopters will accept in order to gain maximum revenue while demand is high and there are few or no competitors in the market.

Once the company has met its short-term revenue goals from the market segment of early adopters, it can lower its prices in order to sell to more price-sensitive consumers.

This will also enable the company to possess competitive pricing as competitors introduce their own products to the market.

Generally, a company will begin lowering its prices once demand at the high price point begins to dwindle, which may occur when competitors enter the market.

Price skimming will often incentivize competitors to enter as they become aware of the high sales prices and large profit margins.

Price skimming, which aims to gain maximum revenue with a high sales price, operates in contrast to a penetration pricing strategy.

In this latter strategy, a company will introduce products, most often low-cost goods, at a low price in order to capture the maximum market share.

When Is Price Skimming Used?

Businesses often use price skimming in order to recoup the costs of developing a product.

As a result, it is most often seen in industries such as the technology sector, where new and innovative products are brought to market regularly.

Some of the conditions which should be present in order for a price skimming strategy to be effective include:

• Enough customers are willing to purchase the good or service at the high sales price;
• Competitors will not enter quickly in response to the high prices;
• Reducing prices would not greatly increase demand and, in turn, reduce per unit costs;
• The high price does not damage the company’s reputation among customers.

Often a high price point attached to a new product is associated by consumers with exclusivity and a high degree of quality.

This can be beneficial for attracting early adopters.

However, if all of these factors are not present, price skimming can backfire and can result in a loss of market share to competitors, damage a company’s reputation, and potentially cause a product to fail.

Advantages & Disadvantages of Price Skimming

Advantages of Price Skimming

• Recoups Sunk Costs: In many cases, the costs of researching and developing a product may be high. By employing a price skimming strategy, a company can quickly recover its costs with the fewest sales before competitors enter and apply pricing pressure.
• Creates an Image of Quality: Consumers will often associate a high price point with an image of exclusivity and high quality. This can help to market the company through word of mouth.
• Maximizes Profits: Price skimming offers the opportunity to segment markets and gains the maximum possible profits. In cases where significant competitors will have to perform significant research and development in order to enter the market, a business has the opportunity to maximize its profits in a given market.
• Benefits Supply Chains: Retailers in a supply chain have a greater opportunity to mark up a higher-priced good, allowing them to earn a higher profit percentage.

Disadvantages of Price Skimming

• Deters Possible Customers: An artificially high price may deter some consumers who would otherwise purchase the product. This is a particularly high risk if consumers are not convinced that the product justifies such a price.
• Risk Competitors May Gain Market Share: If competitors are able to enter the market before the prices are lowered, they may be able to gain market share with a lower-priced product. Generally, price skimming should only be performed if competitors will have to undergo significant research and development in order to introduce their own products to the market.
• May Damage Customer Loyalty: Customers that paid a high price to purchase a product before a significant markdown may feel that they were ripped off. As a result, these customers may choose competitors in the future or wait for markdowns in the future.
• Not a Viable Long-Term Pricing Strategy: Price skimming is not a long-term strategy for product pricing. In time, competitors are likely to enter the market and offer lower-priced alternatives, which will apply pricing pressure.

Limitations of Price Skimming

Typically price skimming is best implemented for only a short amount of time in order to target early adopters.

It is important to reduce prices quickly in order to avoid alienating price-sensitive consumers as well as to avoid allowing competitors to capture market share by introducing a lower-priced product.

In general, price skimming is not an effective strategy in established markets, as attracting early adopters is not an option.

Buyers are unlikely to choose a higher-priced product unless it is highly differentiated from alternatives, such as through significant product improvements.

Example of Price Skimming

As an example of price skimming, consider a digital camera manufacturer that just introduced a new type of technology to enhance the definition of its images.

The company introduces this new product to the market using a price skimming strategy.

The company sets its prices high in order to quickly recoup its research and development costs and saturate the market of early adopters.

It then lowers its prices to reach the market of more price-sensitive consumers and remain competitive with competitors it expects to enter the market soon with similar products.

As a result of this strategy, the manufacturer has generated the highest possible revenue from both early adopters and price-sensitive consumers.

Key Takeaways

• Price skimming is a price-setting strategy in which the initial price of a good or service is set at the highest point that consumers will accept and is then lowered with time to attract new customers and compete.
• A price skimming strategy is often employed by first movers when introducing a new product with little or no competition. Once competitors enter a market, the initial company is likely to lower prices to compete.
• Price skimming can often help a company to recoup the costs of bringing a new product to market, but it is not a viable long-term pricing strategy.
• Price skimming acts in contrast to a penetration pricing strategy in which a company introduces a product at a low price in order to claim the largest amount of market share possible.