What is Price Skimming? (Pricing Strategy, Definition, Examples)
Price skimming is the pricing strategy in which a business sets a high initial price for a new product and then gradually lowering it over time. Apple's iPhone pricing strategy, for instance, demonstrates classic price skimming, starting high with each new release, and lowering prices as newer models emerge.
Setting a High Initial Price
Why would a company opt for a high initial price? A prime example is the pharmaceutical industry. When a new drug hits the market, years of R&D investments need recouping. By targeting consumers with a high willingness to pay, these companies can recover costs rapidly.
Decreasing Price over Time
Sony's PlayStation consoles demonstrate this aspect brilliantly. A new PlayStation release is initially high-priced. As production costs decrease and market saturation increases, the price drops, attracting a new segment of buyers.
Advantages of Price Skimming
Price skimming is not merely a strategy of setting high prices and then slowly reducing them. When applied aptly, it serves as a multidimensional tool offering multiple advantages that go beyond mere revenue accumulation.
Maximizing Profits Early On
Early adopters, often driven by enthusiasm for innovation or the status associated with possessing the latest products, are less sensitive to high prices. They are more inclined to invest in cutting-edge products or services, viewing them as a way to differentiate themselves.
For instance, when the first OLED TVs came on the market, they were incredibly pricey. Yet, early adopters who desired an unparalleled viewing experience were ready to pay the premium.
Covering High Initial Costs or R&D Investments
The initial stages of product development often involve high costs, especially in sectors like biotechnology, pharmaceuticals, and technology. Take the example of Gilead Sciences' Hepatitis C drug, Sovaldi. The drug came with a whopping price tag of $84,000 for a 12-week treatment.
This pricing was, in part, to recoup the billions invested in research and development and to fund future innovations. Price skimming allows such companies to recover these expenditures quickly.
Segmenting the Market
The beauty of price skimming is its ability to cater to different market segments sequentially. Initially, it targets premium customers, and as the price reduces, it captures the middle and lower segments of the market. This strategy was evident when Apple launched its iPhone SE models. After catering to the high-end market with its pricier models, Apple sought to attract a broader audience with a more affordable yet powerful device.
Tailoring Marketing and Sales Strategies Accordingly
With changing price points, companies can adapt their marketing strategies. In the early stages, they might emphasize exclusivity, innovation, and premium quality. As prices drop, the narrative can shift to accessibility, widespread availability, and value for money.
Samsung often employs this tactic, launching its Galaxy phones with high-end campaigns, and then, as prices reduce, marketing them as the ideal choice for every individual.
Creating a Perception of Quality and Exclusivity
High prices often act as a psychological indicator of quality. When consumers see a product priced significantly higher than its counterparts, the immediate assumption is that it offers superior quality or features. Luxury brands, such as Rolex or Hermès, thrive on this perception.
Their products are not just timepieces or bags; they are symbols of prestige, craftsmanship, and class.
The Psychological Aspects of Pricing and Perceived Value
Price has always had a profound psychological impact on consumers. It can influence how they perceive a product and its value. An interesting experiment in the wine industry revealed that individuals believed they enjoyed wine more when told it was pricier, even if the wines were identical.
This study underscores how price skimming can capitalize on the psychological association of price with quality and enjoyment.
Challenges and Pitfalls of Price Skimming
Market Entry of Competitors
High initial prices might invite competitors. As seen in the streaming wars, the entry of Disney+ and Apple TV forced other platforms to reconsider pricing.
Potential Backlash from Late Adopters
Companies run the risk of alienating future customers who might feel cheated. Samsung faced backlash after reducing the Galaxy S10 prices soon after launch, which upset early buyers.
Requires Continuous Monitoring and Adjustments
Market reactions are unpredictable. The airline industry, with its dynamic pricing based on demand, seat availability, and other factors, highlights the complexity of constant price adjustments.
Alternatives to Price Skimming
Companies like Xiaomi adopt a low initial price strategy to quickly gain significant market share, contrasting with the skimming approach.
Many traditional industries, like the restaurant business, adopt this straightforward pricing method, focusing on production costs and desired margins.
Price skimming is a complex yet rewarding strategy when applied effectively. By understanding its nuances, finance professionals can make informed decisions, whether it's investing, banking, or steering a corporation's financial course.