Definition:
Price skimming is when the business launches a new product and charges a higher price from the customers. This strategy of pricing sets the highest initial price and lowers the price with the passage of time.
At the initial time of the launch, the target customers are the rich people of the society with higher income and purchasing power. With the passage of time, the prices are reduced to increase the number of customers and quantity of the sales.
Usually, the reason for the decrease of the price is the satisfaction of the market and entry of the competitors that may put the business in trouble if the price is not lowered on a timely basis.
For instance, the business may lose the customer if the competitor is supplying the same goods at a lower rate than the business, which is still charging higher prices. Price skimming is so-called because it takes skims the successive layers of the customers as prices are lowered with the passage of time.
The price skimming ensures that the price is reduced from time to time to increase the portfolio of the customers. Although the profitability of the products keeps decreasing, the quantity of the sales increases from time to time.
An important point to note is that the business needs to understand profitability in terms of price and demand. For instance, the business may be able to sell more quantities of the goods and generate more profit due to higher quantity sales. So, the decision needs to be made based on the probability analysis and expected profits with different levels of the prices.
Examples
Most companies in manufacturing innovative products exercise price skimming—for instance, the Sony play station, the Tesla model and, the iPhone of Apple.
These companies develop and launch the products at a skimming price like Play station of Sony was launched in the United States for the USD 599 and the price was gradually reduced to USD 200. This is the perfect example of price skimming as USD 200 can be afforded by more people than USD 500.
Advantages
The price skimming helps to reduce the payback period of the development cost. It helps to improve the attraction for the investment as more cash inflow is expected to arrive in the initial years of the product launch.
Further, It helps the business to enjoy the first-mover advantage by charging higher prices from the customers and gives the perception to buyers as a reputable business. However, the business needs to continuously monitor the market conditions to assess the progress of the competitor regard to development and launch of the product.
In addition to this, skimming prices are the only option when the style of a product gets outdated instantly. For instance, the design collection of the clothes is frequently outdated, and the price is reduced after a shorter period.
Disadvantages
The price skimming believes in charging higher prices on the initial launch of the product which may be actually the reason for the failure of the product. Further, charging higher prices may impair the loyalty of the customers with the business and they may find a substitute in a low price of the goods.
In addition to this, the higher profit margin of the company may be actually signal for the competitor to develop a similar product and the business may not have higher purchasing power leading to loss of economies of scale and other purchasing benefits.
When price skimming is suitable?
Price skimming is suitable when the business has a strong customer portfolio ready to buy the product, charging artificially higher prices does not seem to attract the competitor as they may not have a patent to develop the product.
The business does not expect to earn more by decreasing the prices as decreasing prices does not increase the demand. Or the business does not have a strong production facility to meet excessive demand by lowering the prices, and operates in an industry where a higher price is considered to be a symbol of quality.
Does Apple believe in price skimming?
Yes, Apple believes in the price skimming of products. They charge higher prices on the launch of the new model for the iPhone. They charge skimming prices on the launch and subsequently reduce the prices to target price-sensitive segments of the customers.
Skimming prices seems to be an exceptional strategy for Apple as they are a strong brand and people perceive superior by getting the latest i-phone.
Price skimming and penetration pricing
Price skimming and price penetration are opposite concepts. Both strategies are useful for the business depending on the market situation. In the price skinning strategy, the prices of the product are higher on the launch and in price penetration, the prices are lower.
Price penetration is a suitable strategy when there is intense competition in the existing players of a market and the product cannot be differentiated based on the quality.
The greater advantage of the price penetration is immediate access to the greater customer base and the business intends to sell more quantity of the products to be more profitable.
On the other hand, price skimming is suitable if the company has developed some exceptional products and wants to enjoy a first-mover advantage.
Although the price is decreased in the skimming method the recovery of the investment is expected to be at a higher proportion as the profit margin is higher.
In the world, there is no best pricing strategy. These are the circumstances that should be considered in making a decision about the suitability of the pricing strategy.
Why pricing strategy is important?
The pricing strategy plays an important role in the success and failure of the project launch. The price is a key factor considered by the customer in making the final purchase decision. Other psychological factors like quality perception need to be considered in setting an optimum price for the product.
If prices are unreasonably higher, the customer may not purchase the product. Similarly, if the price is very much lower it might signal inferior quality. Hence, the pricing decision needs to be made appropriately.
