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2021-01-07 20:48:53How To Run Your BusinessEnglishLearn how businesses use price skimming to introduce products to the market and capture value. Read the complete guide from QuickBooks.https://quickbooks.intuit.com/au/resources/au_qrc/uploads/2021/01/small-business-owner-price-skimming-feature-qrc-au.jpghttps://quickbooks.intuit.com/au/resources/how-to-run-your-business/price-skimming/What is price skimming and how can you use it? | QuickBooks Australia

What is price skimming and how can you use it?

7 min read

Think that a lower price automatically equates to more sales? Not always.

Price skimming is a pricing strategy that involves launching at a high price and reducing the price over time. This high initial price allows businesses to maximize profit upfront and then continue to capture sales as pricing decreases.

Wondering if a price skimming strategy is the right choice for your business? We’re answering all of your questions about price skimming here, including its advantages, pitfalls and use cases.

What is price skimming?

When you use price skimming, you start with a high initial price for a new product and then decrease its price over time.

It’s effective at capturing numerous different customer segments. Your highest initial price will attract early adopters and brand loyalists who are eager to get their hands on something when it launches.

As the price drops, you’ll continue to appeal to more and more price-sensitive customers. That’s where the term “price skimming” comes from: you’re continuing to skim different market segments off the top as you keep reducing the price of the product. You’ll also hear this referred to as price discrimination.

A variety of different businesses and industries use this pricing strategy, but it’s especially common in:

  • Technology: Apple is perhaps one of the notorious examples of price skimming. It’s a strategy they’ve used with everything from iPhones to iPods. The iPod classic was priced at $399 in 2002 and was decreased to $299 about one year later. Other technology companies like Samsung and Google have also used this strategy. They capture a small number of innovators and early adopters upfront, hit their sales peak at mid-market and then drop off again when the price is lowered further.
  • Retail and e-commerce: Retailers or e-commerce companies often start with a high initial price but then roll out sales and other steep discounts to appeal to their price-sensitive segment of customers. Handbag retailer Kate Spade has an entire sale section on their website where they display the original price of the product and its new lower price.
  • Software as a service (SaaS): Software companies have been known to use price skimming as well. Salesforce is a customer relationship management (CRM) platform that started with a high price point for enterprise-level customers. They later rolled out more affordable options for smaller businesses.

Note that price skimming is the opposite of penetration pricing, where you start with a low price to penetrate the market and pull customers away from the competition. Penetration pricing is used frequently by service providers and some product-based businesses as well.

What are the benefits of price skimming?

If you’re going to eventually reduce the price anyway, why not launch at that lower price tag? Well, because price skimming offers several different advantages.

1. Quick return on investment

Particularly in industries with high product development or research and development costs, companies often need to recover that investment quickly.

Starting with a higher price point allows them to recoup those costs from an eager customer base before the market becomes saturated. They can then reinvest that money into developing future products that can increase their market share. Google Home launched at a price point of $129 in 2016. Now, it’s available for $99—with even cheaper alternatives available.

Additionally, price skimming is beneficial when there’s a lack of competition at product launch. Customers can’t get cheaper alternatives, and those who are particularly interested in your product will pay a higher price.

This is where companies reap the benefits of price skimming. They get higher profit margins from their highest-paying customers because their competitors haven’t caught up yet.

2. Perception of quality and exclusivity

While it happens subconsciously, many of us operate with the assumption that a product or service is better because it’s more expensive.

That perception may or may not be accurate, but it’s a massive piece of the price skimming puzzle—especially when it comes to early adopters. They generate natural interest in products, build hype and instil a sense of urgency in other customers.

There are plenty of examples of how this has played out with real products. Samsung’s pre-sale of the Note 8 saw 650,000 orders in 40 countries. Customers lined up around Tesla showrooms to purchase the Model 3, despite the fact they didn’t even know what the car looked like.

These customers have less price sensitivity but want to be among the first to get their hands on a new, innovative product. They generate enthusiasm and become a source of recurring revenue as they spread the word about the product.

3. Flexible product pricing

Finally, price skimming also provides room to change pricing as the market shifts. Businesses often need to tweak their prices depending on market conditions, competition, customer feedback and more.

With price skimming, companies start at a higher price point to capture as much revenue as possible before tailoring prices to fit the current circumstances.

This strategy gives companies a chance to determine how price sensitive their customers are and adjust their product pricing accordingly. They test the market without leaving money on the table.

What are the potential drawbacks of price skimming?

Like any other pricing strategy, price skimming isn’t without its pitfalls. Here are a few disadvantages to be aware of.

1. Low initial sales

Brand loyalists often know and accept that price skimming happens and are willing to overlook it to be first in line to get a product.

However, non-loyalists don’t experience that same push to purchase immediately and will wait to see if the price goes down.

If a business doesn’t have an existing strong brand with high customer engagement, price skimming can lead to low initial sales because there aren’t enough people willing to stomach the high initial price.

2. Customer mistrust and frustration

Price skimming can also feel manipulative and dishonest to customers, as they can become angry if the price they paid for a product at launch continues to drop.

Is the product worth as much as a company is asking if they’re willing to reduce the price shortly after? Are they just trying to charge a huge markup to their most loyal customers?

When price skimming is applied, businesses risk losing trust and increasing customer churn. They can lose their brand loyalists and struggle to launch future products successfully as a result.

When should you use price skimming?

The opportunity to charge a high price at first is appealing, but at the same time, the risks are intimidating. How can you know if price skimming is the right pricing strategy for your business?

There isn’t a tried and true formula. However, price skimming is generally most effective if you meet the following criteria:

  • Your brand or company already holds a significant portion of the market share. You’ll have an easier time making sales and gaining traction, despite the big-ticket price.
  • You have an innovative new product with very little competition. You might have industry competition, but not necessarily competition for your specific product. This means customers are willing to pay a higher price for a product they can’t get elsewhere.
  • Your product is considered to be a luxury. This pricing strategy isn’t nearly as effective on low-price products. Price skimming works best for high-price products with high profit margins.

If you tick at least one of those boxes, then a price skimming strategy is worth considering.

When using price skimming doesn’t make sense

Again, figuring out your pricing isn’t black and white, but there are a few circumstances when price skimming isn’t best for your company or product, including:

  • You have many competitors at similar price points. Your competitors are ready and waiting to undercut your high price with a penetration pricing strategy of their own.
  • Your brand has little buzz. As many of the examples demonstrated, word-of-mouth marketing is critical for generating enthusiasm and building brand loyalists. If you’re new in your industry and don’t have an established customer base, it’s going to be tough to gain enough traction to warrant the high initial price point.
  • Your product isn’t appealing to the high end of the market. For price skimming to be effective, you need a user base or customer segment that’s excited about your product—despite the price. Google Glass is a classic example of failure in this area. Even early adopters weren’t intrigued, and the product flopped at a $1,500 price point.

Is price skimming right for your business?

Price skimming works in many different industries, but that doesn’t make it the right default pricing strategy for every company.

Ultimately, you need to carefully consider your brand, customers and competitors to see if launching at a high initial price would benefit your business.

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Information may be abridged and therefore incomplete. This document/information does not constitute, and should not be considered a substitute for, legal or financial advice. Each financial situation is different, the advice provided is intended to be general. Please contact your financial or legal advisors for information specific to your situation.

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