The practice of ‘price skimming’ involves charging a relatively high price for a short time where a new, innovative, or much-improved product is launched onto a market.
The objective with skimming is to “skim” off customers who are willing to pay more to have the product sooner; prices are lowered later when demand from the “early adopters” falls.
The success of a price-skimming strategy is largely dependent on the inelasticity of demand for the product either by the market as a whole, or by certain market segments.
High prices can be enjoyed in the short term where demand is relatively inelastic. In the short term the supplier benefits from ‘monopoly profits’, but as profitability increases, competing suppliers are likely to be attracted to the market (depending on the barriers to entry in the market) and the price will fall as competition increases.
The main objective of employing a price-skimming strategy is, therefore, to benefit from high short-term profits (due to the newness of the product) and from effective market segmentation.
There are several advantages of price skimming
• Where a highly innovative product is launched, research and development costs are likely to be high, as are the costs of introducing the product to the market via promotion, advertising etc. In such cases, the practice of price-skimming allows for some return on the set-up costs
• By charging high prices initially, a company can build a high-quality image for its product. Charging initial high prices allows the firm the luxury of reducing them when the threat of competition arrives. By contrast, a lower initial price would be difficult to increase without risking the loss of sales volume
• Skimming can be an effective strategy in segmenting the market. A firm can divide the market into a number of segments and reduce the price at different stages in each, thus acquiring maximum profit from each segment
• Where a product is distributed via dealers, the practice of price-skimming is very popular, since high prices for the supplier are translated into high mark-ups for the dealer
• For ‘conspicuous’ or ‘prestige goods’, the practice of price skimming can be particularly successful, since the buyer tends to be more ‘prestige’ conscious than price conscious. Similarly, where the quality differences between competing brands is perceived to be large, or for offerings where such differences are not easily judged, the skimming strategy can work well. An example of the latter would be for the manufacturers of ‘designer-label’ clothing. Source
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