Author: Jim Riley Last updated: Sunday 23 September, 2012
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
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.