Pricing may seem like the least complex element of launching a new product, but the truth is that the pricing strategy you employ has a profound impact on both the perception of an item’s quality and the profit potential your business enjoys. Price skimming is a strategy designed to maximize profits by adjusting the fee for a product or service over time.
After setting the initial price high for early adopters and less price-conscious consumers, the firm gradually lowers rates until even the most frugal of buyers will partake. In this way, the company is skimming customer segments like layers of cream.
Pros of Price Skimming
While price skimming can be an effective way to maximize profits on new products and offerings, businesses need to understand all the potential benefits and drawbacks before employing this technique. Let’s start with the benefits first.
Increased Quality Perception
It’s no secret that quality is a key factor that customers consider when making buying decisions, but not all consumers measure quality in the same way. Understanding that price is a measure of quality for many buyers, companies often utilize price skimming to boost the market perception of their wares with higher initial pricing.
By pricing goods high when they’re first released, companies create an impression of quality and exclusivity that tends to attract early adopters.
Benefits from Early Adopters
While traditional pricing strategies appeal to all segments of the market, price skimming tends to aid a firm in capturing early adopters. These buyers are willing to pay a higher rate in exchange for being one of the first people to own a product.
Not only do early adopters contribute to your bottom line, but they also act as brand ambassadors, encouraging others to try out your goods and services. Once early adapters have spread the word about your products to other audiences, the firm can lower prices to capture these buyers. The goal is to drop your prices before a copycat company comes in and attempts to undersell you.
Development Cost Recovery
If your company spends a significant amount of money on product development, employing a price skimming strategy can be a good way to recoup those costs. Development costs for new innovations can be expensive. With price skimming, you have the chance to gain back this spend in your first few sales.
If your company tends to produce a steady stream of new wares, price skimming may still be an effective strategy, since it doesn’t necessitate the lowering of costs by increasing unit volume.
Cons of Price Skimming
Of course, price skimming is not without its drawbacks. Here are some notable ones to carefully consider before taking the price skimming plunge.
Eventual Sales Drop
While price skimming can be effective in the early stages, companies considering this technique should realize that it’s at best a temporary solution. Once the early adopter market is saturated, your firm will need to compensate by increasing sales to more price-conscious buyers. As a result, you will likely have to drop prices, or risk losing sales to your competitors.
In rare instances, a company with a strong brand image may be able to maintain its high prices. This is true of certain designer fashion firms as well as innovative technology giants like Apple.
Competition from Sub-Premium Dealers
Firms considering price skimming need to be aware of threats from competitor businesses. As a business raises its prices, sub-prime competitors may swoop in and undercut sales. In the long run, competitors can reduce sales volume and force businesses to abandon price skimming in favor of providing goods at lower, less profitable margins.
The nature of price skimming is that some customers are paying far more for goods and services than others. As a result, businesses can expect to incur some negative feedback as they lower their prices, especially from consumers that just purchased your goods at a previously higher price.
If a company engages in price skimming regularly, it may eventually affect customer loyalty, which can give competitor businesses the opening they need. Additionally, companies that maintain high prices for too long may wind up losing the interest of their prospective marketplace.
Businesses Best Suited for Price Skimming
Certain businesses and industries are better suited for price skimming than others. Because price skimming is only effective if certain customers are willing to pay top value for products, a business needs to ensure that its target audience has enough disposable income to pay its desired price. Additionally, the strategy is better suited for luxury items like high-end cars, electronics and new technologies that usually stir up great interest in early adopters.
Along with evaluating customer interest, companies considering price skimming should evaluate the roles their competitors play. If your business has a large number of competitors, they can easily step in and undersell you when your own rates rise. For this reason, price skimming is most effective if your company has few competitors or your product has a great deal of name recognition.
If you’re planning to launch a new, high-value product in the coming months, price skimming may be an ideal strategy. It’s crucial, however, that you keep tabs on interest levels and gradually lower your rates as sales drop off. The goal is to skim each layer of the market until even the most penny-pinching buyers decide to give your item a chance.
Price skimming is just one approach to a sound pricing strategy. If you’re wondering how to price your goods or services, start with this 10-step list for guidance.