Price skimming the pricing strategy that the company set a very high price on new product during the initial release, and reduce it over time. This method help company to collect the profit as soon as possible while products are hot in the market and competitors’ product not yet enter. It is suitable for high-tech products such as phones and laptops.
This price strategy work well for an innovative company that has few competitors while launching products. It will help them to recover the research and development cost very fast. Moreover, it is also a tool to put pressure on competitors who are trying to copy the products.
Price Skimming Example
For example, ABC is a tech company that produce smartphone. Every year, they will release the new model. The company is using a price skimming model, they set a new smartphone at a high price during the first quarter. After that, they will drop the price to compete with competitors who are copying the phone features. In the end of product cycle, the next smartphone will release at a high price again.
On 01 Jan 202X, ABC launches a smartphone call X1 at $ 1,000 per unit with the new feature. The customers will purchase the phone to try new technology. As time went by, company drop the price to $ 800 on 01 June 202X while the other smartphone companies start to sell a similar phone for $800-$900. The price drops again in October as the company tries to clear stock for the new smartphone.
What are the advantages of Price Skimming?
|Advantages of Price Skimming|
|To boom the profit||The company will try to increase the profit as much as possible during the initial product release as they know that competitors will introduce new products with the same or better feature, and their sale quantity will decrease over time. Moreover, after some time the sales quantity will decrease, so the company must decrease some price to maintain the selling quantity. They will suffer from low margins, but it much better than allowing the customer to go and buy competitor products. The company may have heavily invested in the production equipment, so they have to take a lower profit rather than dealing with substantial fixed costs. They will keep doing this until the new product arrives.|
|To maximize profit from different market segment||Customers are willing to pay more to own the products while others may wait until price decrease and pay for the best value. By using price skimming, the company will be able to maximize profit from both customers. For example, PlayStation 3 was sold $ 599 and then decrease to $ 200. The loyal customers will be happy to pay premium during the initial release.|
|High Innovation product||The price of new technology product is highly likely to be increased more than market as it is new and innovative. Their products are not easy to copy by competitors or it is protect by copyright law. Its price does not limit by the production cost but the features which are not available elsewhere. It will take some time for the competitor to catch up with them. By the time they can produce a similar one, we will drop the price to compete with them too.|
|Massive demand in the market with low supplier||The company can take this opportunity to increase the price as they know their products will be the market leader as it is new and unique. It doesn’t matter if we charge a higher rate; customers are willing to pay for it.|
|Technology improvement||Some products will be costly to produce as the limitation of new technology. However, the production cost will decrease, so we will be able to charge lower prices.|
|Short life product||Some products life span is concise, and the demand will drop very quickly. So the company needs to act fast. For example, in the fashion industry, the price of new clothes are very high due to the original design and customers willing to pay for them. But after several months, the company needs to decrease price as the market moving forward to new trending.|
|To protect the brand value||High prices also differentiates ourselves from the other competitors. For example, Apple, Supreme, Lamborghini is the brand that considers as the luxury brand due to its high price.|
What are the Disadvantages of Price Skimming?
|Disadvantages of Price Skimming|
|Encourage the competitor to join the market||When we set a high price, it means there is a huge profit. The competitor sees the opportunity and will try their best to enter the market. For example, after Apple introduced the iPhone in 2007, the gross margin was around 50%-58% based on the experts. It such a high-profit business while another company charge below 40%. As a result, many companies join the race and push the market up to now. In the top 10 smartphone companies, more than half of them introduce their smartphones later than 2010.|
|Slow down the product growth||In each product life cycle, the initial release is the time that the company needs to boost sales by increasing marketing expenses. However, the high price seems a barrier for customers to purchase our product. It will limit the potential growth of the product.|
|Damage reputation||The way that the company keeps charging high prices will alert to customers sooner or later. Customers will start to compare the product from one company to another. If we can’t differentiate our features, it will ruin our reputation. For example, Apple is known as the company with a high price tag. Some people even use the word “ Apple Tax” to represent Apple margin due to its high price.|
|Not encourage cost-efficient due to high price||When a company charges a high price, the manager will not worry about reducing cost. Even the cost is unreasonably high, and it will not impact on profit. Some expenses do not add any value to the customers, but they are not eliminated from the production. As it is less incentive for management to deal with it. It will impact the long term growth of the company. One day, the competitor will be able to get our market share as they can produce similar product at a lower price.|
|It will not last for long||We may have a plan to reduce prices within a period of time. However, competitors may come up with their product earlier than our expectations, and it will put pressure on us to decrease the price sooner. It will ruin our business plan.|
|A huge problem if the demand is elastic||Different product in a different market at different times has different elastic level. If we are setting price skimming without critical market analyzes, we will face the issue as the demand is very elastic. Customers will be looking for a similar substitute product at a lower price. It is mostly happening in a market recession when people try to save money. It also occurs when there are too many products available in the market at different prices.|