It goes without saying – choosing a pricing strategy is a huge decision for every business.
Not only does it decide how much profit your business will make, but it also has a huge influence on what market segments you will appeal to and what your brand image is going to be.
The general perception, however, is that a lower price automatically leads to more sales and more market share. Sorry to break your bubble, but this isn’t always the case.
No, we’re not just blurting out random things! There is actually a pricing strategy used by many companies (including Apple), and it’s known as ‘price skimming’.
Basically, companies that create innovative products, usually set their prices HIGH when they first introduce the products to the market. Then, as their products get replaced/outdated, they gradually lower the prices.
Apart from breakthrough innovation, price skimming also works well when a company has a cult-like fan base that does not really care about other competitive products.
Honestly, price skimming is quite the perfect way to win those affluent, upper-market segments, without making yourself inaccessible or off-limits to the more price-sensitive consumers.
But, even though price skimming can be a good driver of high profits and can help you recover your fixed costs quickly, it can also harm your relationship with your loyal customers.
It all comes down to using the tactic carefully and finding the right balance. That’s why, in this blog post, we will explore what price skimming exactly is, the pros and cons of this tactic, and much more. Let’s roll!
What Exactly is Price Skimming? (Definition)
Price skimming is a business strategy in which a new product/service is introduced at a higher-than-usual price, and then, the price is lowered incrementally over time.
‘Skimming’ refers to skimming off of customers who are willing to pay the high price and want to acquire a new product as soon as possible. These customers are often known as ‘early adopters.
Once this customer segment is satisfied or saturated, they are ‘skimmed’ off’. Then, the product price is gradually reduced for the next segment of buyers, i.e, more price-sensitive customers.
There are three phases of price skimming, and if you work on them properly, you will be able to reach most of your target market. Let’s dig a little deeper into these phases.
The Three Phases of Price Skimming
The First Phase
First off, a product is introduced to the market at its highest price. During this phase, the company’s market share is relatively low, but the profit margins are super high.
In this phase, the company is targeting early adopters, i.e, those people that just want the latest and greatest thing, and price does not really matter to them.
The Second Phase
When the early adopters have purchased the product and the product loses its cutting-edge status, its pricing is decreased. This reduces the profit margin but increases the sales volume and market share.
How? Well, lower prices let the brand reach new market segments, especially those price-sensitive customers who couldn’t purchase the product at the initial launch price.
The Third Phase
When the sales start to decline, the third phase begins. In this phase, the price is reduced even more in order to attract the most cost-conscious consumers.
The profit margin decreases further, and the product reaches the end of its life cycle, replaced by new technologies and innovative products.
Many well-known brands have mastered the price skimming strategy to perfection. Looking for some inspiration? All you need to do is keep reading!
Read more: Go-To-Market Strategy Guide for Businesses
A Real-World Example of Price Skimming – Apple
Apple has been using the price skimming strategy on their iPhones for a long time, and the way they use it is pure genius. This is why it’s one of the best examples of price skimming.
Every time a new iPhone is is launched, it’s so exorbitantly priced and the price is much higher than that of the competitors. Yet, Apple fans queue up outside stores to get the latest iPhone.
Then, when a new iPhone model is launched, it slashes the prices of older models, as it’s no longer a ‘novelty’. This way, Apple is able to reap the maximum benefits from its customer base.
Now that you know the nitty-gritty of price skimming and how it works, let’s head over to the next section – the advantages and disadvantages of price skimming.
The Pros of Price Skimming
1. Quickly Pay Off High R&D Expenses: Developing new products, marketing thems, and getting customers on board can be expensive. This can result in extremely long pay-back periods. However, by getting a few people to purchase your product at a high price, you can more quickly pay off your fixed costs.
2. Builds Your Brand Image: Price skimming can actually be a solid marketing strategy. Yes, you read that right. By offering your product/service at a high price initially, you can build a perception among the target audience that your product is of superior quality.
3. Segments The Market: Once you find the customers who are okay with paying more just to be among the first ones to get your product, you can segment your different customer groups. This will certainly help you with your future marketing tactics and sales pushes.
The Cons of Price Skimming
1. Doesn’t Really Work in a Crowded Market: Price skimming strategy mostly leverages the scarcity of supply and high demand. In markets where competition is high and consumers are less sensitive to brands (telecom, etc), price skimming can do more harm than good.
2. Lures Competition: When your competitors realize how much money they can earn by selling the product, they might enter the market with a similar product at a lower price. This might force you to reduce the price of your product even earlier than you planned!
3. Damages Customer Loyalty: Early buyers who bought the product at a high price might feel that they’ve been ripped off if you decrease the price soon after. Moreover, once the consumers realize that your brand uses the ‘price skimming’ tactic, they might hold off on buying the product until the prices are reduced.
Charging a high price for your product sounds great, but the risks associated with it are intimidating. So, is price skimming actually the right strategy for your business? Let’s find out.
When You Should & Should Not Use Price Skimming?
Price Skimming is Definitely Worth Considering IF:
- You have an innovative product, and you don’t really have much competition: This means that your customers will be willing to pay a high price if they can’t find a similar product elsewhere.
- Your brand or company already has a significant market share: This way, you’ll have an easier time gaining traction and making sales – despite your high prices.
- Your product is regarded as a luxury: This strategy works the best for high-price products with high-profit margins. Avoid using it on low-price products.
Don’t Try Price Skimming IF:
- You offer personal or professional services, such as resume writer, plumber, architect: You should base your prices on the level of expertise you’ve and the level required for the job at hand.
- You offer subscription-based or tiered products: If you reduce your subscription price over time, the customers might feel that the value and quality of your product are decreasing.
- You’ve loyal, but entitled customers: Once you decrease the prices of your product, consumers who have already bought it might feel cheated. This leads to customer dissatisfaction.
We think it is safe to say that price skimming is a wonderful method for pricing an innovative product. It can bring in the revenue you require to recover the R&D costs, upgrade the product, and grow your business – as long as there aren’t many competitors in the market and you convey the price drops well enough.
Nevertheless, you need to be wary of everything that comes with price skimming, including all the pitfalls. Be careful when you’re setting high prices initially and then reducing them over time. The wrong move or a quick price drop can elicit a backlash from the market and your consumers. You certainly don’t want that, right?
So, before blindly diving into this strategy, first, learn how to price skimming works and how to execute it the right way. Then, uncover the demand curve and the viability of price skimming for your product or service! This will give you an unparalleled competitive advantage, an increase in revenue, and a larger customer base.
Hey! We know that there’s a lot of new information to digest here. If you’ve got any questions, we’re here for you. Let us know by tweeting us at @bit_docs. Cheers!