What Is Price Skimming? (With Advantages and Disadvantages)

By Indeed Editorial Team

Published August 3, 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Knowing the answer to "What is price skimming?" can provide a beneficial strategy to give a company a competitive advantage in the market. Price skimming can maximize profits in various sectors of the market, diversify a company's offerings to attract different customers, and improve a brand's image. In this article, we explain what price skimming is, discuss how companies use price skimming competitively, and share the advantages and disadvantages of this strategy.

What is price skimming?

If you work in sales or marketing, you may wonder, "What is price skimming?". Price skimming is a product pricing strategy, where a company charges the highest initial market value of the product, and then lowers it over time to attract more customers. The main purpose is to appeal to the top market segment when a product is brand new. This strategy is called "skimming" because once the product has traction in the market, and you've maximized all profits in the top market segment, you can move on to the next one, by taking a little bit off the price.

How do companies use price skimming?

Companies often use price skimming when they introduce a new product into the market. The goal of price skimming is to gather as much revenue as possible, while the demand is high, and while there are very few competitors. The initial price of a new product can affect the perception of it. Items priced towards a higher range can suggest high quality and exclusivity.

The best time to use price skimming is when there are a lot of prospective buyers who value the product at the highest price and are willing to buy the product at the initial price. An initial high price may also prevent competitors from entering the market at a competing price. When a company has gained a reputation by having an initial high price, they may also have the advantage of having the freedom to lower their price, while staying competitive.

Read more: Target Market Examples (With Considerations for Your Own)

What are the advantages of price skimming?

There are many advantages to price skimming. The revenue earned from the early buyer segment can provide an immediate return on the initial investment of manufacturing and promoting the product. It can also help market brands and products, as early buyers can be good promoters. Other advantages of price skimming include:

Higher return on investment

An advantage of price skimming is gaining a higher return on the initial investment of the product. When you invest resources into a unique product that may be unmatchable, it can create a competitive advantage for the company, as other competitors may not be able to match or upstage it. This can allow you to set a high initial price. If demand for the product is high, and if customers are willing to pay the value, you may be able to gain an initial high profit quickly, large enough to create a high return on investment.

Being able to quickly create a high return on investment from generated profits in the first market segment demonstrates the success of a new product. After eliminating the concerns of initial investment costs, any future sales can be attributed to the company's profits. This also means that if the company needs to lower their prices to enter other market segments, its profit margins may not be affected, as it can still be considered a profit.

Read more: What is ROI? Understanding the Meaning and Calculation

Maintaining a brand image

Another advantage of price skimming is being able to create and maintain a brand's image. If a company has products that are unmatchable, it can be easy to establish the products as high-quality goods, and encourage customers to purchase them. Pricing products at a higher range can create a prestigious brand image, as those who can afford expensive products are a very niche group of consumers, who are brand conscious, which can create a very exclusive market. Enthusiasm for a product may be highest when it's brand new, and if it's an exclusive item.

Having a reputable brand image may also be beneficial for retaining customers. If a company is known for having valuable products, there may be a high chance they can have repeat customers who are willing to purchase more products from them. These same loyal customers may also be willing to pay top value for these products.

Read more: What Are Branding Strategies? (With Definition and Benefits)

Segmenting the market

Price skimming can also segment the market. Segmenting the market means to group people who have similar attributes. The first market segment companies appeal to is called the "early buyers" or "early adopters" segment. This segment comprises of a group of people who are either loyal supporters of a particular brand, or who are brand conscious. They're both willing to pay the highest price for these products. The rest of the market segments are buyers who aren't as willing to pay the top price for these products, but are still interested.

Segmenting the market can allow you to maximize profits in all categories of the market. Knowing that there are loyal "early adopters" who are willing to pay, you can initially price a product in the higher range. As you maximize profits in this segment, you can start to lower the price, to attract other customers in the next market segment. This allows you to generate more revenue in other market segments.

Read more: What Is a Market Segment? Definition, Benefits, and Steps

Testing new products with early buyers

Price skimming can also create an exclusive market where early buyers can test the new products and provide valuable feedback and reviews for companies. This can be beneficial for troubleshooting issues with the product before expanding it to a wider market. New buyers can also help with promoting products to customers waiting to buy the product, as they may have first-hand experience with it.

What are the disadvantages of price skimming?

There are limits to using price skimming. Price skimming saturates an early buyer market, but if you use it for too long, it can alienate other buyers. Other buyers may turn to other competitors for a better price if you take too long to reduce prices. This may create a loss in sales and revenue. Price skimming may be more effective for original products, as consumers are more likely to purchase follow-up products from the original company. Other disadvantages may include:

Demand curve must be inelastic

It's important for the demand curve for a product to be inelastic. When the demand curve for a product is inelastic, this means there's not a lot of change for demand when the price changes. If the demand for the product rises and falls dramatically when the price changes, customers may take notice of this trend, and may want to wait until the price decreases. This means it's important to have an inelastic demand curve to maximize profits in each market segment, allowing you to regain what you invested initially.

Crowded markets

A crowded market may affect the ability to price skim. It's crucial to assess the competition and to analyze if the consumer finds the product valuable, before using a price skimming strategy. Price skimming can be a great strategy to maintain competitiveness, unless there are other competitors in the market, or if there's little demand for a certain product. It's important to be able to justify a high price for a product, for consumers to be motivated to purchase it.

Skimming attracts competitors

Price skimming can also attract competitors. If a new product has success with a high price at the beginning of its cycle, this may intrigue other competitors to enter the market. If consumers are slow to buy into the product, other competitors can use this to their advantage to imitate and make improvements before you've capitalized on the demand for the product. They may enter the market with rival products at cheaper prices, which may attract other consumers, which can affect revenue.

Consistency

Price skimming also requires a delicate balance of the amount reduced and the timeframe of when to reduce. If the price of a product drops too much, or too soon after the initial launch, customers may feel dissatisfied if they knew that they could have waited a few weeks for a cheaper price. In this case, it's important to be consistent when price skimming, and to avoid obvious price reductions.

It's also essential to be careful when using the price skimming strategy, to avoid price discrimination. This is when you sell the same product at different prices to different groups of consumers.

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