Price skimming is a pricing strategy

Pricing

Pricing is the process of determining what a company will receive in exchange for its products. Pricing factors are manufacturing cost, market place, competition, market condition, and quality of product. Pricing is also a key variable in microeconomic price allocation theory. Pricing is a...

 in which a marketer

Marketing

Marketing is the process used to determine what products or services may be of interest to customers, and the strategy to use in sales, communications and business development. It generates the strategy that underlies sales techniques, business communication, and business developments...

 sets a relatively high price

Price

-Definition:In ordinary usage, price is the quantity of payment or compensation given by one party to another in return for goods or services.In modern economies, prices are generally expressed in units of some form of currency...

 for a product

Product (business)

In general, the product is defined as a "thing produced by labor or effort" or the "result of an act or a process", and stems from the verb produce, from the Latin prōdūce ' lead or bring forth'. Since 1575, the word "product" has referred to anything produced...

 or service at first, then lowers the price over time. It is a temporal version of price discrimination/yield management

Price discrimination

Price discrimination or price differentiation exists when sales of identical goods or services are transacted at different prices from the same provider...

. It allows the firm to recover its sunk cost

Sunk cost

In economics and business decision-making, sunk costs are retrospective costs that have already been incurred and cannot be recovered. Sunk costs are sometimes contrasted with prospective costs, which are future costs that may be incurred or changed if an action is taken...

s quickly before competition steps in and lowers the market

Market

A market is one of many varieties of systems, institutions, procedures, social relations and infrastructures whereby parties engage in exchange. While parties may exchange goods and services by barter, most markets rely on sellers offering their goods or services in exchange for money from buyers...

 price.

Price skimming is sometimes referred to as riding down the demand curve. The objective of a price skimming strategy is to capture the consumer surplus. If this is done successfully, then theoretically no customer will pay less for the product than the maximum they are willing to pay. In practice, it is almost impossible for a firm to capture all of this surplus.

Limitations of price skimming

There are several potential problems with this strategy.

• It is effective only when the firm is facing an inelastic
  Price elasticity of demand
  Price elasticity of demand is a measure used in economics to show the responsiveness, or elasticity, of the quantity demanded of a good or service to a change in its price. More precisely, it gives the percentage change in quantity demanded in response to a one percent change in price...
  
   demand curve
  Demand curve
  In economics, the demand curve is the graph depicting the relationship between the price of a certain commodity, and the amount of it that consumers are willing and able to purchase at that given price. It is a graphic representation of a demand schedule...
  
  . If the long run demand schedule is elastic (as in the diagram to the right), market equilibrium will be achieved by quantity changes rather than price changes. Penetration pricing
  Penetration pricing
  Penetration pricing is the pricing technique of setting a relatively low initial entry price, often lower than the eventual market price, to attract new customers. The strategy works on the expectation that customers will switch to the new brand because of the lower price...
  
   is a more suitable strategy in this case. Price changes by any one firm will be matched by other firms resulting in a rapid growth in industry volume. Dominant market share
  Market share
  Market share is the percentage of a market accounted for by a specific entity. In a survey of nearly 200 senior marketing managers, 67 percent responded that they found the "dollar market share" metric very useful, while 61% found "unit market share" very useful.Marketers need to be able to...
  
   will typically be obtained by a low cost producer that pursues a penetration strategy.
• A price skimmer must be careful with the law
  Law
  Law is a system of rules and guidelines which are enforced through social institutions to govern behavior, wherever possible. It shapes politics, economics and society in numerous ways and serves as a social mediator of relations between people. Contract law regulates everything from buying a bus...
  
  . Price discrimination is illegal in many jurisdictions, but yield management is not. Price skimming can be considered either a form of price discrimination or a form of yield management. Price discrimination uses market characteristics (such as price elasticity) to adjust prices, whereas yield management uses product characteristics. Marketers see this legal distinction as quaint since in almost all cases market characteristics correlate highly with product characteristics. If using a skimming strategy, a marketer must speak and think in terms of product characteristics in order to stay on the right side of the law.
• The inventory
  Inventory
  Inventory means a list compiled for some formal purpose, such as the details of an estate going to probate, or the contents of a house let furnished. This remains the prime meaning in British English...
  
   turn rate can be very low for skimmed products. This could cause problems for the manufacturer's distribution chain. It may be necessary to give retailers higher margins to convince them to handle the product enthusiastically.
• Skimming encourages the entry of competitors
  Competition (economics)
  Competition in economics is a term that encompasses the notion of individuals and firms striving for a greater share of a market to sell or buy goods and services...
  
  . When other firms see the high margins
  Margin (economics)
  In economics, a margin is a set of constraints conceptualised as a border. A marginal change is the change associated with a relaxation or tightening of constraints — either change of the constraints, or a change in response to this change of the constraints.- Extensive and intensive margins...
  
   available in the industry, they will quickly enter.
• Skimming results in a slow rate of stuff diffusion
  Diffusion (business)
  Diffusion is the process by which a new idea or new product is accepted by the market. The rate of diffusion is the speed that the new idea spreads from one consumer to the next. Adoption is similar to diffusion except that it deals with the psychological processes an individual goes through,...
  
   and adaptation. This results in a high level of untapped demand. This gives competitors time to either imitate the product or leap frog it with a new innovation. If competitors do this, the window of opportunity will have been lost.
• The manufacturer could develop negative publicity if they lower the price too fast and without significant product changes. Some early purchasers will feel they have been ripped off. They will feel it would have been better to wait and purchase the product at a much lower price. This negative sentiment will be transferred to the brand and the company as a whole.
• High margins may make the firm inefficient. There will be less incentive to keep costs under control. Inefficient practices will become established making it difficult to compete on value or price.

Examples of price skimming

• Price skimming has been used for certain high-end electronics. For instance, the Sony PlayStation 3 was initially sold at $599, but the price has gradually reduced to $299.

Reasons for price skimming

Price skimming occurs in mostly technological markets as firms set a high price during the first stage of the product life cycle. The top segment of the market which are willing to pay the highest price are skimmed of first. When the product enters maturity the price is lowered.

See also

• Pricing
  Pricing
  Pricing is the process of determining what a company will receive in exchange for its products. Pricing factors are manufacturing cost, market place, competition, market condition, and quality of product. Pricing is also a key variable in microeconomic price allocation theory. Pricing is a...
  
  
• Marketing
  Marketing
  Marketing is the process used to determine what products or services may be of interest to customers, and the strategy to use in sales, communications and business development. It generates the strategy that underlies sales techniques, business communication, and business developments...
  
  
• Microeconomics
  Microeconomics
  Microeconomics is a branch of economics that studies the behavior of how the individual modern household and firms make decisions to allocate limited resources. Typically, it applies to markets where goods or services are being bought and sold...
  
  
• Production, costs, and pricing
  Production, costs, and pricing
  The following outline is provided as an overview of and topical guide to industrial organization:Industrial organization – describes the behavior of firms in the marketplace with regard to production, pricing, employment and other decisions...
  
  
• Business model
  Business model
  A business model describes the rationale of how an organization creates, delivers, and captures value...