What is price skimming and how can you use it?

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 product's price. You’ll also hear this referred to as price discrimination.

How price skimming works

Price skimming works by taking advantage of the initial high consumer interest when a product has just launched. Immediately after a new release, products are usually at the peak of the market’s attention. Consumers may be willing to purchase solely out of curiosity or to be ahead of the curve.

In many cases, especially in fast-moving industries, there may also not be much competition at the time of launch.

Price skimming takes advantage of this period, essentially “skimming” off the top, and setting the highest price possible without completely alienating their target market.

When a company has attracted as many sales as possible and starts seeing its numbers decrease, it progressively lowers the product price to capture the rest of the market. 

As a result, price skimming effectively works around all phases of a product’s life cycle to maximize profitability.

Which industries use price skimming most?

Price skimming is most commonly used in these industries:

Technology

Tech companies often employ price skimming for new gadgets or software. Early adopters are willing to pay a premium for the latest innovations, allowing companies to reap maximum profits before market competition intensifies and prices naturally drop.

Fashion

People are willing to pay for exclusivity and luxury. That’s why high-end fashion brands frequently use price skimming. They will set initial prices high to appeal to affluent consumers seeking status symbols. Prices are later lowered to attract a wider audience.

Pharmaceuticals

Price skimming is often used by pharmaceutical companies when introducing drugs or treatments that have minimal competition or that offer a new solution. High initial prices help recoup research and development costs prior to lower cost generic alternatives entering the market.

Consumer electronics 

Like tech companies, consumer electronics manufacturers may use price skimming for new products like smartphones, smart home devices. audio and video systems, gaming consoles, or televisions. Again, those early adopters and tech enthusiasts may be willing to pay more to be among the first purchasers of the latest and most innovative models.

Price skimming is not limited to these industries and can be effective in other markets if certain conditions exist, such as:

• High product demand: There must be strong initial demand to justify the high price.
• Unique or innovative product: The product should offer unique features or benefits that differentiate it from existing alternatives.
• Limited competition: Ideally, there should be few or no direct competitors offering similar products at the time of launch.

Here are some real-life examples of where this pricing strategy:

• 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 ecommerce: Retailers or ecommerce 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.

Legality of price skimming

Price skimming, in and of itself, is not considered inherently illegal or anti-competitive. However, there are some situations where price skimming could raise legal concerns:

Price gouging

In times of crisis or emergency, excessively high prices could be considered price gouging, which is illegal in many jurisdictions. For example, during a hurricane, a local store selling bottled water for $1 suddenly increases the price to $10 per bottle due to high demand and limited supply.

Predatory pricing

Utilizing price skimming to intentionally drive out smaller competitors can be interpreted as illegal predatory pricing under antitrust laws.

Price discrimination

While price skimming involves charging different prices at different times, it's generally considered legal as long as the price differences are not based on discriminatory factors like race, gender, or age. However, there are specific regulations regarding price discrimination in certain industries, such as pharmaceuticals.

Deceptive practices

Misleading consumers about the reasons for price changes or the actual value of the product can lead to legal action for deceptive practices. For instance, falsely advertising a "limited-time offer" to pressure consumers into buying a product at a higher price is a deceptive practice if it creates a false sense of urgency.

Price skimming vs. penetration pricing

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. 

The reason for choosing either pricing strategy largely depends on the company’s industry and target market. 

Penetration pricing is more frequent among small or starting companies in a competitive market. Low initial pricing can help gain a footing against incumbents and quickly attract as many customers as possible. 

Penetration pricing is also preferred by companies with low profit margins that need a larger market share to meet their bottom line.

On the other hand, price skimming is more common within technology hardware industries where there’s high consumer demand, perceived product value, and little direct competition. Thanks to the company’s investment in new developments, they create a significant barrier to entry and can confidently set high prices for their new products.

Aside from increased profit, price skimming can benefit companies in many other ways. The following section goes over some of the main benefits of this pricing strategy.

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. Then they can reinvest that money into developing future products that can increase their market share. 

Additionally, price skimming is beneficial when there’s a lack of competition at product launch. Customers can’t get less-expensive 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 high 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 up the brand image, and instill a sense of urgency in other customers.

The market for premium price goods, for example, makes these products less resistant to any economic shifts. Customers of premium brands have less price sensitivity and 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 make short-term price changes 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. 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, 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 check 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 without 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.

Alternatives to price skimming

Price skimming is a legitimate pricing approach used to maximize profits and reach different consumer segments. However, it's not the only option, and businesses should be aware of potential legal pitfalls, such as price gouging and predatory pricing, as well as the importance of distinguishing it from price discrimination.

If price skimming doesn't align with your business goals or market conditions, consider these alternative pricing strategies:

Penetration pricing

Set a low initial price to gain market share and attract a large customer base quickly. Penetration pricing can be effective for those products with high price elasticity, meaning demand is sensitive to price fluctuations.

Value-based pricing

Price your product based on its perceived value. In order for this strategy to be successful you’ll need to do market research and be sure you understand your target audience's level of price acceptance.

Competitive pricing

Competitive pricing is a popular pricing strategy involving setting your prices in line with or slightly lower than your competitors. This approach can be effective in attracting price-conscious customers.

Cost-plus pricing

The cost-plus pricing strategy entails calculating your costs and adding a markup. While this approach ensures you are covering your expenses, it may not be the most effective way to maximize profitability.

Dynamic pricing

Assess factors like demand, inventory levels, competitor prices, or customer behavior and adjust your prices accordingly. This approach allows you to optimize pricing for maximum profitability.

Freemium pricing

Offer a basic version of your product or service for free, while charging for premium features or additional functionality. This can entice new customers to try your product or encourage existing customers to upgrade.

Subscription pricing

Subscription pricing, which involves charging customers a recurring fee for access to your product or service, is another alternative to price skimming. This model can generate a predictable revenue stream and cultivate customer loyalty.

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, there are many factors to consider when determining the best pricing strategy for your brand. QuickBooks Enterprise includes robust pricing functionality to simplify your pricing process, automate custom price rules, and maintain optimal profit margins