Posted on 8 December 2019 Conjoint.ly
We explore how pricing skimming works, when to use it, and how to ensure it benefits your brand/business.
Price skimming is a pricing strategy which involves setting a product/service at a high price when it first enters the market to ‘skim’ segments of the market who are willing to pay the higher price. A business will then gradually lower its pricing to reach the more price-sensitive markets and to align with competitors who have entered the market during this time.
Brands who are looking to differentiate from competitors by positioning their offering as the ‘leader’ in terms of quality, customer satisfaction, popularity, etc. are most likely to use price skimming for their new products.
Like any other pricing strategy, price skimming is not without its risks, and businesses must conduct thorough pricing research before deciding to implement it. This is because timing is of the essence for price skimming so effective planning is paramount to its success.
How It Works
Given its heavy reliance on timing, price skimming is one of the more demanding pricing strategies that a business can implement. Businesses must have a firm grasp on each stage of the price skimming cycle to strengthen their product’s chances of maximising profit and to remain competitive in the market once other products emerge.
Price skimming works best for new products as its main goal is to capture as much profit as possible when the pricing is at its highest. Considering that demand has a significant impact on price, businesses should ensure the product is of high demand, with a considerable portion of the market who are willing to pay the initial price. The presence or absence of alternatives often influences demand, i.e. the fewer competitors a new product has, the higher the change it will work successfully with a price skimming strategy.
For this reason, price skimming is highly prevalent across the electronics industry; new technologies emerge regularly, leaving space for unique products. Leading businesses build hype surrounding these innovations, releasing the latest products at high prices which tech-savvy consumers are willing to pay. These businesses then lower their prices in time for competitors’ cheaper ‘copy-cat’ products penetrating the market. It’s important to recognise that such pricing decisions are neither reactionary nor coincidental ones, but rather, part of a well-executed price skimming strategy that accurately aligns its pricing changes with the market.
As it’s inevitable that consumer demand and willingness to pay will lower over time, it’s crucial that businesses effectively and efficiently map out their price skimming strategies to ensure they can receive maximum profit for the longest possible time. Choosing the optimal time is the key to getting this strategy right – too soon and a business will miss out on profit from those still willing to pay a higher price, too late and the price-sensitive will turn to cheaper alternatives that have become available, and others will have simply lost interest at this stage.
Remember: Price skimming works off timing, exclusivity, and demand. Businesses must tailor their strategies to align with these factors or miss the mark and lose out to competition.
When to Use It
Businesses create their pricing strategies to also satisfy a certain set of broader organisational goals and needs. It’s important to acknowledge that whilst price skimming is directly attributable to the success of many businesses/brands’ new products, this does not make it a viable strategy for all. Most importantly, businesses must recognise that this is a short-term strategy and should not use it for long-term profit/revenue maximisation or sustainability measures.
A business should only consider price skimming if:
- It can rapidly adapt to the market: Price skimming requires timely pricing adjustments to stay afloat as competitors arise within the market – if a business cannot afford to lower its product pricing as required, the strategy cannot work.
- It can justify the higher product pricing: The product must have something to offer, e.g. high quality, exclusivity, or individuality to justify its high price point or customers may be left unwilling to purchase it.
- Its brand is already relatively reputable: As customers are becoming increasingly aware of this strategy, brands who use it should have an established image within the market to ensure there is a trusted and loyal customer base who are willing to pay the higher price.
Alongside these elements, businesses should also be mindful of the potential downsides of price skimming which can ultimately hinder its purpose and desired outcomes;
- Customer awareness: Although some customers (early adopters) will still be happy to pay the higher price for a product despite knowing they can pay less if they wait, many will still wait for the price drop instead. This can cause a significant dent to profit margins if too many customers take the latter route.
- Unsuitable market: A price skimming strategy cannot work if the product being sold has a highly price-sensitive market, is over-saturated, or simply does not create the high demand it requires to garner customers willing to pay higher prices.
- Proactive competition: As businesses become more in-tune with their competitors’ pricing tactics, they now have the means to produce copy-cat products relatively soon after the the ‘leading’ business introduces it to the market. This shortens the amount of time that a business can sell its product at the initial price.
Remember: This is a short-term strategy designed to increase profit margins over a limited time; businesses still need other pricing strategies in place for long-term sustainability.
- Price skimming involves setting a product at a high price to welcome ‘early adopters’’ profits, before lowering it to accommodate for price-sensitive markets/competitors.
- It predominately works off demand and the product must offer something that makes customers willing to pay extra for it.
- It works well for the electronics industry as new, innovative products are released constantly, prompting consumer demand.
- Timing is essential. Businesses must conduct adequate research to ensure they lower prices at the right time, or risk losing out to competition.
- This strategy isn’t suitable for every business/brand – the product must remain steady at varying price points.