Price skimming is a type of pricing strategy aimed at setting a high price to maximize profit when a new, much improved, or innovative product is launched onto a market.
The objective of price skimming is to skim off the first waves of revenue from those prepared to pay the price for it. Producers initially charge a high price when they release a product or a service, and, after time, they reduce the cost.
There are both advantages and disadvantages of price skimming. The main positive effect is an increase in revenue through segmentation. Moreover, the method makes it possible to enhance the brand’s status and helps a company make a profit from it. The disadvantage of the strategy is that it brings positive results only when there are no rivals, or they are not going undercut the producer.
There are some market conditions required for price skimming to work. First of all, the product needs to have a high quality and brand image to support a high price. Secondly, there is a need to make the product unique in order to encourage enough consumers to pay a high cost. Thirdly, competitors must be deterred from being able to enter the market with a similar product and under-cutting the price-skimmer.
Price skimming usually works most effectively when it is a brand-new product in a market, and there is limited competition. Due to it, the company is given more leeway in terms of its pricing strategy and can justify a higher price. Moreover, the instrument often occurs in technological and famous brand’s markets. Consumers are usually prepared to pay significantly higher cost to be the first ones to buy the product that may improve their social status.