From an economic perspective, price is determined by demand and supply. However, how such forces play out with new products untested in the market can be unpredictable. Therefore, business owners and innovators are left with the vital task of deciding the appropriate prices for their new or innovative products during their marketing planning.
Your first step toward getting your pricing right is adopting the right pricing strategy. This will help guarantee the profitability, success, and sustainability of your business.
A high price may cause a loss in sales opportunities since it'll be unaffordable for most target customers. Loss in sales translates to a loss in revenue. A low price may lead to the business not meeting its profit objectives even though many customers may consider the product to be of great value at such a price. In some cases, customers may consider low price products inferior.
For most new products, the choice boils down to a price skimming strategy or penetration pricing strategy. Whichever approach you go with, understand that their relevance or effectiveness is influenced by external factors like economic conditions, market competitors, and more.
This article will focus on skimming pricing strategy, its pros and cons, and how you can implement it in your own business.
What Is a Skimming Pricing Strategy?
With a price skimming strategy, a business owner or innovator places a high initial price on a new product and subsequently lowers the cost over time once competitors enter the market. The idea is to target the first set of customers or early adopters keen to buy your innovative product at a high price.
Subsequently, you sell at a lower price when competitors with similar product offerings start entering the market. By selling at a lower price or market price, you target customer segments that are more price-sensitive. Such customers are happy to buy your unique product at a bargain. You can continue lowering the price during the product life cycle until you can capture the various customer segments on the market.
Price skimming is ideal for high-quality, unique, and highly innovative products, especially technology. A higher price creates a sense of exclusivity and originality around a product, giving it a competitive advantage.
Pros and Cons of Skimming Pricing Strategies
Some pros and cons of price skimming strategies include:
Pros
- High profits: When a new product sells at a high price, it helps the company generate higher profits. With price skimming, you can target different market segments. You also profit when there's an increase in demand among price-sensitive customers during a low price regime.
- Quick returns: The expenses made during production quickly get recovered. This is due to quick returns from selling at an initial high price to early adopters.
- Proper segmentation: When you set a high initial price, you can segment the market into different categories with early adopters, brand loyalists, and everyday customers. This will help when testing how acceptable your new product will be.
- Saves cost: Early adopters can help test new products and provide feedback on how they feel about them. This saves businesses money they would have spent on testing and marketing the product.
- Flexible product pricing: As the market changes or shifts, you must affect price changes to suit the market. With price skimming, you can tailor your price based on the market condition, customer feedback, competition, etc. You can also set high prices at the beginning to maximize profit before reducing the cost to suit the prevailing market condition.
- Helps create buzz: A lot of attention is drawn to a product when it provides unique features with a high price set. Many buyers assume a product has excellent quality when the price is high. As such, early adopters tend to create a buzz around the product, drawing the attention of others. This awareness is also good for brand image.
Cons
- Short-term advantages: While a skimming pricing strategy can help increase the profit margins of your business, it usually lasts for a short time. It's harder to hold on to the high price tag on your product for long, especially when the market starts to gain a few competitors. This may lead to a loss of customers in the long run if your product's high price isn't justifiable or you can't lower your price on time.
- Dissatisfied customers: Price skimming can seem manipulative. Customers may feel cheated or ripped off, witnessing a price drop after buying at a high price. This often leaves loyal customers dissatisfied. In the future, they may not want to buy your new products early to enjoy a low price.
- Competitors may take advantage: Competitors are happy when there's a new product with a high price. They only need to find a way to replicate the product but at a lower price. They can, therefore, penetrate the market and attract a lot of buyers, especially price-sensitive ones.
- Limited sales volume: Price skimming is ideal for brands with an established reputation. Businesses without loyal customers may not get buyers to purchase a new product at a higher price. Some customers may even have to wait until the product's price reduces before making a purchase.
How to Apply a Skimming Pricing Strategy
Price skimming is an effective way to cut across the different market segments and also create new markets. However, for it to be successful, you need to consider the following:
- Type of product or innovation: Is it unique and innovative enough to sell at the highest price possible? Skimming can never work for an undifferentiated product. It necessitates that the product is of superior value and unique quality.
- Goal: Is your short-term goal market shares, maximum revenue per unit, total profit, or profit margins? You must be able to trade off some goals in place of others. If you're looking for short-term profit maximization, go for skimming. Also, suppose the innovation is poised to witness production constraints during a product launch. In that case, a skimming strategy is the best way to deliver short-term profit.
- Price-sensitivity: Is it very high or very low? A skimming pricing strategy works well for low price elasticity of demand. In such instances, profit can only be guaranteed through high prices since a small number of customers are buying.
- Customer segmentation: Are there many segments or just one? Some customers don't want to wait for new products to hit the mainstream before buying. For such customers, it feels good showing their latest tech gadgets to their peers. The same is true for business-to-business (B2B) companies that can acquire state-of-the-art technology to gain a competitive advantage.
In either case, early adopters are willing to pay more than late consumers. The more willingness to pay differs among customers, the more it favors skimming. Skimming is also favored when there's a chance that your new products trigger a price war with deeply entrenched competitors.
Consider a hypothetical company that manufactures single-use plastic straws, shopping bags, water bottles, and coffee cups with a plastic lid. Let's call this company Continental Plastic. Due to the environmental impact of plastics and an increased emphasis on green products, Continental Plastic can add various environmentally friendly alternatives to its product line and charge premium prices.
For instance, they can make high-quality paper straws in addition to regular plastic straws. They can also make collapsible water bottles and coffee cups that occupy smaller spaces and are reusable. The idea is to skim profit from core consumers while leaving everyday products for price-sensitive customers. This way, the company creates valuable and unique products that can sell at a higher price. Before competitors arrive, Continental Plastic can make an appreciable profit.
Skimming Pricing Strategy Example
A famous and notable skimming pricing strategy example is Apple. When Apple first launched the iPod and the iPhone, the company made them expensive. With the high price, buyers assumed that the product was of greater value.
Early adopters purchased the product at a high price and then used word of mouth and other means to advertise the products. This made the demand increase.
Every year, Apple releases a new iPhone series at a very high price compared to other electronics brands. The company then sets another date for a new product to release. The price of the older version is then reduced. Apple effectively executes the skimming pricing strategy because:
- It always has a high demand from early adopters
- It has been able to set itself as a luxury brand
- Its brand reputation can't be affected
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Notice to the Reader
This article is about the price skimming strategy and shouldn't be considered expert advice. Although price skimming works, there's no guarantee it'll work in your specific situation or business. You should seek an expert opinion on the right strategy that'll work for you.