Price Skimming Strategy: Advantages and Disadvantages

While launching a new product, your business has the option to choose from many pricing strategies. Unlike other product pricing strategies, the price skimming strategy emphasizes maximizing revenue and profits in the short run by setting the initial price of the new product high. You have to lower prices gradually as the demand for the product declines.

According to Investopedia,

“Price skimming is a product pricing strategy by which a firm charges the highest initial price that customers will pay and then lowers it over time. As the demand of the first customers is satisfied and competition enters the market, the firm lowers the price to attract another, a more price-sensitive segment of the population.”

Multinational tech companies like Apple implement price skimming strategy successfully to generate more revenue when the demand for the tech product is extremely high. But your business should consider price skimming only when your brand is well-established, the product is unique, and the competition is limited. You must keep in mind the major advantages and disadvantages of the price skimming strategy to capture the high demand for the product.

Major Advantages of Price Skimming Strategy

Earn Profits Consistently

Many tech companies leverage price skimming to maximize profits in the short run by setting high prices. Also, the strategy helps them to earn recurring revenue and profit in the long run by selling the product to more customers at lower prices over a period of time. Hence, your business can consider price skimming to keep up profits in the long run.

Quick Return on Investment (ROI)

Tech companies incur research and development (R&D) expenditure to develop and launch unique products. Also, they promote the newly launched product aggressively to boost demand. Price skimming strategies help businesses recover the investment in R&D and promotion costs by generating higher profits in the short run. Also, the product pricing strategy helps enterprises to make R&D an ongoing process.

Target Different Customer Segments

The price skimming strategy divides your customers into two broad segments – early adopters and price sensitive. While launching the new product, your promotional and marketing campaigns can target early adopters who are willing to pay higher prices. But the price-sensitive customers can buy the same product subsequently as its price drops. Your business can adopt this product pricing strategy to target different segments of customers.

Make Early Adopters Promote the Product

The early adopters help your business to improve both quality and experience by acting as testers. Their feedback and suggestions will help you to improve and update the product consistently. At the same time, early adopters help tech companies to increase the demand for the product in the long run through word-of-mouth promotion. Your company can further use customer reviews and testimonials as a powerful marketing tool while offering the product to price-sensitive customers.

Position the Product as a Premium Brand

According to Entrepreneur.com,

“Price sends a psychological message related to value: things that cost more are assumed to be of higher value. Things that cost less are assumed to be of lower value.”

Your business can position and promote the newly-launched product as a premium brand simply by increasing the initial price. Unlike other product pricing strategies, price skimming emphasizes setting the initial product price high. Hence, you can create a higher-end brand image without running expensive marketing campaigns.

Analyze Market Behaviour

After implementing the price skimming strategy, you can monitor and compare the changes in the demand of the product as the follow-up prices drop. You can further analyze the market behavior elaborately by dividing the customer base into multiple segments and timing price reduction. Hence, you can easily identify the price that maximizes the demand for the product. The demand analysis will be of great help to your business while determining the prices of other products in the future.

Manage and Control Inventory Efficiently

Often businesses have to produce a certain number of units to recover production costs. But demand for and popularity of the new product may not remain intact due to a variety of reasons. Price skimming strategy helps your business to manage and control inventory efficiently by driving sales by reducing product prices. You can reduce the warehouse inventory levels simply by reducing the product price.

Important Disadvantages of Price Skimming Strategy

Not Suitable for Crowded Markets

Tech companies leverage price skimming strategy successfully by making product innovation an ongoing process. They invest in R&D to develop unique products that can be sold at higher prices. But you cannot leverage price skimming if customers have the option to choose from similar products offered by many companies. Your business should consider a price skimming strategy when the competition is limited and demand for the product is inelastic.

Higher Profit Only in the Short Run

As mentioned earlier, the price skimming strategy increases profits by leveraging product innovation and limited competition. The demand for your product will decrease gradually as competitors offer similar products at lower prices. Hence, you cannot increase revenue and profits in long run among heavy competition.

Must Meet High Customer Expectations

The customers always expect flawless quality and an excellent experience when they pay a higher price for a new product. Many customers will start posting negative reviews and comments when your product does not meet their high expectations. Hence, the price skimming strategy will impact both your brand and product adversely in case the customer expectations are not met.

Can’t Reduce Price Significantly

The effectiveness of a price skimming strategy directly depends on your follow-up pricing strategy. You cannot beat the competition by decreasing the price of the product drastically. A huge drop in the product price will make early buyers feel like being cheated and deceived by your company. Hence, you have to decrease the follow-up prices gradually to sustain customer loyalty despite an increase in competition. 

Your business can increase both revenue and profit in the short run by implementing a price skimming strategy. But you must remember that price skimming, like other product pricing strategies, has its pros and cons. Hence, you must understand the advantages and disadvantages of the price skimming strategy to boosts the initial demand for your product.