What Is Price Skimming? A Definitive Guide With Examples

When a business launches a new product or service that has minimal competition in the industry, they might adopt certain pricing and marketing practices, like price skimming, to maximise profits in the short-term. Price skimming can help a company recover some of its initial production costs and improve the overall return of its investment. Understanding what price skimming is, how it works and what its advantages are can help business operators choose whether to use this method for their own product launches.

In this article, we answer the question, "What is price skimming?" by exploring the definition of the term, showing some of the pros and cons of this method and providing various examples of the method in practice.

What Is Price Skimming?

Consider the following information to answer "What is price skimming?":

Price skimming is a pricing method some businesses use to maximise initial profits following a product or service launch. Initially, the business offers the product or service at a higher price to make as much on the product launch as possible, before gradually reducing the cost over time to make it a more attractive and affordable option for customers. For example, an electronics company might offer its latest gaming console for ₹500 at launch, reducing the price over the next year to ₹399. Since customers anticipated the launch, they can be more willing to pay the higher price.

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Pros And Cons Of Price Skimming

While price skimming is a viable option for many businesses, it does have both pros and cons. Here are some examples of each:

Pros

Price skimming offers many pros for both small and large businesses. For example, a business might create anticipation for a new product launch, which can help attract new customers and maximise profits. Explore more pros of price skimming below:

Maximising initial sales

One of the main benefits of using the price skimming method is that businesses can maximise the initial sales, and therefore profits, of their products or services. When the company launches a new product, they can charge an initial price that reflects the value of the product for the customer and generates more revenue. For example, a clothing company might offer their latest clothing line for a premium, allowing the first 500 customers to also get extras like a premium membership to the store. These extras help customers justify the cost and generate excitement about the product launch.

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Generating interest in the product and business

With an initial product launch, the business has a unique opportunity to create interest and excitement about its products. This can help attract both new customers and existing customers. New customers might want to explore the business for the first time following a recommendation from a friend or simple curiosity, and existing customers may already know the company offers quality in its products and services. The initial price skimming can help create a sense of prestige among customers that purchase those products, increasing the appeal and potentially the company's revenue.

Creating a FOMO situation for customers

Price skimming can also generate something called FOMO, or fear of missing out among customers. This may encourage customers to make a purchase so they can be part of the product's prestige and share their status with friends and family. For example, if an electronics company offers a limited edition cell phone, customers might be more willing to pay the higher initial price to be one of only 1,000 customers to own that particular model. This may also increase the long-term value of the item or service the company is selling.

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Building a stronger brand image

Price skimming can help generate FOMO, attract customers, create a sense of prestige and allow a company to maximise its initial profits, all of which contribute to the brand's image. When customers know a brand offers premium products and a sense of status, they might be more willing to both buy from that brand and suggest its products and services to others. This can help improve long-term sales because how a current or prospective customer sees a brand's image can largely influence their decision to make a purchase.

Cons

While price skimming can offer many benefits to companies that use it, it also comes with some drawbacks. Offering an initially higher price for an item may cause customers to feel cheated when the company reduces the price later. Here are some cons of price skimming to explore:

Short-term benefits

Overall, price skimming offers only a small list of solely short-term benefits. Over time, the efficacy of price skimming can decline, as customers start to feel like a company is charging them too much for a product. Initially, price skimming can create excitement, but it may be a good idea to adopt different pricing strategies for the long-term. Many companies adopt price skimming only for the first few weeks or months of a product launch, then drop the price to keep customers' attention.

Potential for customer mistrust

Price skimming has the potential to create mistrust on behalf of the customer, as customers may feel cheated or misled when prices change later. For example, if a company offers an attractive product and the price drops 25% in six weeks, the initial buyers might feel they overpaid for something that other people can now buy for a quarter less than the original price. This might tarnish a company's reputation, especially if the company adopts the practice for the long-term or uses it frequently.

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Competitor advantages

Price skimming may also give a company's competitors something of an advantage, especially if they offer a similar product or service. If a customer can purchase something similar, with similar features, benefits and the trust of a familiar brand, it is likely they want to do so. If the competitor's product is significantly less than the company's initial price, the customers might completely avoid the new product in favour of a more reasonable pricing structure. Customers typically want to save money while maximising the value of what they buy.

Ineffectiveness for follow-up products

Some companies use price skimming for follow-up products in a product line, which can ultimately be ineffective, especially if the newer model offers minimal improvements over the old version. Customers might feel the new model is too close in style, functionality or perceived value to justify the cost of the newer model, and thus avoid the product or service. This can give competitors an opportunity to take advantage of that ineffectiveness, undermining the company's efforts and potentially their revenue and profits.

Examples Of Price Skimming

To better understand price skimming, here are two examples you can explore, each showing a different side of price skimming:

Positive price skimming

This example shows how a company might use price skimming for an initial product launch with positive results:

Mountain Man Clothing Co. launches its new line of hiking boots with Rubber Ace soles, a patented technology unique to the company. Upon launch, they offer each pair for ₹150, including several benefits for the first 1,000 customers that purchase a pair of these limited edition hiking boots. The company created multiple marketing campaigns prior to launch, and analytics data indicated that there was significant anticipation for the new technology. After six weeks of consistent sales, the company reduces the price by ₹50, encouraging the next wave of customers to purchase a pair.

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Negative price skimming

This example shows how price skimming might negatively affect a product's performance on launch:

Duraj Cosmetics launched 15 different makeup palettes in the previous year, each using the price skimming method to maximise initial sales. The first three palettes generated significant sales, but the company received many complaints about how each palette seemed too similar to the previous launch. In November, the company launches its 16th palette at a significantly higher price than the previous renditions, resulting in minimal sales because of price saturation and no improvements to justify the cost.

Please note that none of the companies, institutions or organisations mentioned in this article are associated with Indeed.